Policy Basics: Marginal and Average Tax Rates

PDF of this policy basics (2pp.)

Updated April 15, 2013

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Misunderstandings about two different types of tax rates often create confusion in discussions about taxes. A taxpayer’s average tax rate (or effective tax rate) is the share of income that he or she pays in taxes. By contrast, a taxpayer’s marginal tax rate is the tax rate imposed on his or her last dollar of income.

Taxpayers’ average tax rates are lower — usually much lower — than their marginal rates. People who confuse the two can end up thinking that taxes are much higher than they actually are.

Under Progressive Tax System, Marginal Rates Rise With Income

The federal income tax system is progressive, meaning that it imposes a higher average tax rate on higher-income people than on lower-income people. 

It achieves this by applying higher marginal tax rates to higher levels of income. For example, the first portion of any taxpayer’s taxable income is taxed at a 10 percent rate, the next portion is taxed at a 15 percent rate, and so on, up to a top marginal rate of 39.6 percent.

Average Tax Rate Generally Much Lower Than Marginal Rate

As an example, the graph on the next page shows a married couple with two children earning a combined salary of $110,000. They face a top marginal tax rate of 25 percent, so they would commonly be referred to as “being in the 25 percent bracket.” But their average tax rate — the share of their salary that they pay in taxes — is only 9.5 percent, as explained below.

There are three main reasons why an individual’s average tax rate tends to be much lower than his or her marginal tax rate.

1. Because of exemptions and deductions, not all income is subject to taxation.

In the example above, the couple can claim exemptions and deductions for tax year 2013 totaling $27,800 (a $3,900 personal exemption for each family member and a $12,200 standard deduction). Subtracting that $27,800 from the couple’s $110,000 salary leaves them with $82,200 in taxable income.

2. The top marginal tax rate applies only to a portion of taxable income.

As the graph shows, the first $17,850 of the couple’s taxable income is taxed at a 10 percent rate; the next $54,650 is taxed at 15 percent. Only the last $9,700 of their income faces their top marginal rate of 25 percent.

The couple’s resulting tax liability — before credits are taken into account — is $12,408.

3. Credits directly reduce the amount of taxes a filer owes.

Taxpayers subtract their credits from the tax they would otherwise owe to determine their final tax liability. In our example, the couple can claim the Child Tax Credit for both children, further reducing their tax by $2,000.

Our example couple is left with a final tax liability of $10,408. Dividing that amount by the couple’s total income ($110,000) results in an effective tax rate of 9.5 percent. For a more in-depth discussion of these issues, see “Policy Basics:  Tax Exemptions, Deductions, and Credits.”

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