What do "average tax rate" and "marginal tax rate" mean?
by: Better Tax
Your average tax rate is the percentage of your income that went to the government; it's the total tax you paid divided by your total income. As an example, if you made $10,000 and paid $1,000 in taxes, your average tax rate would be 10%.
This is what they mean if you hear the term "progressive taxation", you only pay a higher rate on your next dollar of income.
Example using a simple tax table
It's easiest to understand by looking at a slightly simplified tax table.
| If your income is… | $40,000 or less | Over $40,000 up to $80,000 | Over $80,000 up to $200,000 | Over $200,000 |
|---|---|---|---|---|
| Start with your income | ________ | ________ | ________ | ________ |
| Subtract the bottom of the bracket | − $0 | − $40,000 | − $80,000 | − $200,000 |
| Income in this bracket | = ________ | = ________ | = ________ | = ________ |
| Multiply by the tax rate | × 15% | × 30% | × 40% | × 50% |
| Tax on income in this bracket | = ________ | = ________ | = ________ | = ________ |
| Add tax on the lower brackets | + $0 | + $6,000 | + $18,000 | + $66,000 |
| Tax before credits | = ________ | = ________ | = ________ | = ________ |
In addition, we also have the concept of a "basic personal amount"—this is the amount of money you can earn on which you will pay no income tax at all.
| Basic personal amount | $15,000 |
|---|---|
| Multiply by the lowest tax rate | × 15% |
| Tax credit to subtract from tax before credits | = $2,250 |
Example — if you earned $50,000 income
In this example if you earn $50,000 you pay a total of $6,750:
| Portion of income | Amount | Rate after the basic personal credit | Tax |
|---|---|---|---|
| First $15,000 | $15,000 | 0% | $0 |
| $15,000 to $40,000 | $25,000 | 15% | $3,750 |
| $40,000 to $50,000 | $10,000 | 30% | $3,000 |
| Total tax | $6,750 | ||
While your marginal tax rate is 30%, your average tax rate is only 13.5% ($6,750 ÷ $50,000).
Example — if you earned $100,000 income
If your income increases, both your average and marginal rate will go up—and that's kind of the point. Let's say you now earn $100,000, you will pay $23,750.
| Portion of income | Amount | Rate after the basic personal credit | Tax |
|---|---|---|---|
| First $15,000 | $15,000 | 0% | $0 |
| $15,000 to $40,000 | $25,000 | 15% | $3,750 |
| $40,000 to $80,000 | $40,000 | 30% | $12,000 |
| $80,000 to $100,000 | $20,000 | 40% | $8,000 |
| Total tax | $23,750 | ||
Your marginal tax rate is now 40%, but your average tax rate is 23.75%. Notice, as well, that you still paid exactly the same amount of tax on the first $50,000.
While these examples are slightly oversimplified we hope it helps explain one of the most misunderstood tax concepts out there.
Last updated: