Lesson 18: Marginal vs. Effective Tax Rate
Welcome to Lesson 18 of our series on Tax Brackets and Rates. In this lesson, we will explore the concepts of Marginal Tax Rate and Effective Tax Rate, two fundamental components for understanding your federal income tax obligations.
What Is Marginal Tax Rate?
The marginal tax rate is the rate at which your last dollar of income is taxed. This rate is determined by your income and the specific tax brackets established by the federal government. The marginal tax rate increases as income rises, placing higher earnings into higher tax brackets.
What Is Effective Tax Rate?
The effective tax rate is the average rate at which your total income is taxed. It is calculated by dividing the total tax paid by your total income and multiplying by 100 to get a percentage. The effective tax rate provides a better overall picture of your tax burden compared to the marginal tax rate.
An Example Calculation
Let's say your total income is $100,000, and you paid $15,000 in federal income tax. Your effective tax rate would be calculated as follows:
Comparing Marginal and Effective Tax Rates
It's important to understand the distinction between marginal and effective tax rates:
- Marginal Tax Rate: The rate applied to your highest dollar of income.
- Effective Tax Rate: The average rate of tax applied to your entire income.
For further reading, you can check out the Wikipedia article on Marginal Tax Rate. Additionally, consider reading Federal Income Taxation: Principles and Policies for a comprehensive understanding of tax laws.