Question

What is the difference between a marginal tax rate and an average tax rate?

Short answer

The marginal tax rate is the rate an individual would pay on an additional dollar of income, and this rate applies to the highest tax bracket that the taxpayer's income falls into. In contrast, the average tax rate is calculated by dividing total tax paid by total income earned - it shows the overall proportion of income that is paid in taxes.

Step-by-step solution

Definition of Marginal Tax Rate

The marginal tax rate is the rate at which the next or last dollar of taxable income will be taxed. This means it is the tax rate that applies to the highest tax bracket that the taxpayer's income falls into.

Definition of Average Tax Rate

The average tax rate is calculated by dividing the total tax paid by an individual or business by the total income of that individual or business. It represents the overall percentage of income that has been paid in taxes.

Difference between the Marginal Tax Rate and Average Tax Rate

These two tax rates differ in their calculation and what they reflect about a taxpayer's financial situation. The average tax rate gives a good sense of the percentage of income going to the taxation in total, while the marginal tax rate provides information about the percentage of the additional income that will go to taxes.