Glossary
Effective tax rate
Definition
The effective tax rate is total tax divided by income, the average rate paid across all brackets. Because lower layers of income are taxed at lower rates, it is always below the marginal rate for a progressive tax.
How effective tax rate works
Effective rate is the right number for describing overall burden or comparing years. It can be computed against gross income or taxable income; calculators should say which.
It is the wrong number for decisions: deductions, bonuses and conversions are valued at the marginal rate.
Why it matters to a firm
The gap between effective and marginal rates is the clearest way to explain progressive taxation to clients.
Questions about effective tax rate
Which rate should I compare with friends?
Effective rate, on the same income basis.
Which rate do I use for planning?
Marginal rate.
Does it include payroll tax?
Only if the calculation includes it.
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Related terms: Marginal tax rate · Taxable income
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