Definition
In a tax system, the tax rate describes the ratio at which a business or person is taxed .
Tax Rate
The tax rate is a percentage of the taxable base.
Methods
There are several methods used to present a tax rate:
- statutory
- average
- marginal
- effective
Statutory
A statutory tax rate is the legally imposed rate. An income tax could have multiple statutory rates for different income levels, whereas a sales tax may have a flat statutory rate.
Average
An average tax rate is the ratio of the amount of taxes paid to the tax base (taxable income or spending). To calculate the average tax rate on an income tax, divide the total tax liability by the taxable income.
Marginal
A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending) and is often applied to the change in one's tax obligation as income rises.
For an individual, this rate can be determined by increasing or decreasing the income earned or spent and calculating the change in taxes payable. An individual's tax bracket is the range of income for which a given marginal tax rate applies.
The marginal tax rate may increase or decrease as income or consumption increases, although in most countries the tax rate is progressive in principle. In such cases, the average tax rate will be lower than the marginal tax rate. For instance, an individual may have a marginal tax rate of 45%, but pay an average tax of half this amount.
In a jurisdiction with a flat tax on earnings, every taxpayer pays the same percentage of income, regardless of income or consumption. Some proponents of this system propose to exempt a fixed amount of earnings (such as the first $10,000) from the flat tax.
Marginal tax rates may be published explicitly, together with the corresponding tax brackets, but they can also be derived from published tax tables showing the tax for each income. It may be calculated by noting how tax changes with changes in pre-tax income, rather than with taxable income.
Effective
The term effective tax rate has significantly different meanings when used in different contexts or by different sources. Generally it means that some amount of tax is divided by some amount of income or other tax base. In U.S. income tax law, the term is used in relation to determining whether a foreign income tax on specific types of income exceeds a certain percentage of U.S. tax that might apply on such income.
The popular press, Congressional Budget Office, and various think tanks have used the term to refer to varying measures of tax divided by varying measures of income, with little consistency in definition. An effective tax rate may incorporate econometric, estimated, or assumed adjustments to actual data, or may be based entirely on assumptions or simulations. It also incorporates tax breaks or exemptions.