Effective Tax Rate vs. Marginal Tax Rate

Effective tax rate vs Marginal tax rate

What is an Effective Tax Rate?

The effective tax rate represents the actual percentage of your annual income that you owe to the IRS. Also known as the average tax rate, effective tax rate measures how much federal income tax you pay on your earned income. The effective rate is usually lower than the marginal tax rate.

To calculate your effective tax rate, simply divide your total amount of federal income tax paid, by your taxable income. 

Effective Tax Rate Formula: Income Tax ÷ Income Earned Before Taxes = Effective Tax Rate

  • An effective tax rate represents the percentage of their taxable income that individuals have to pay in taxes.
  • For corporations, the effective corporate tax rate is the rate they pay on their pre-tax profits.
  • An effective tax rate typically refers only to federal income tax, but it can be computed to reflect an individual’s or a company’s total tax burden.

What is a Marginal Tax Rate?

The marginal tax rate measures the amount of tax applied on income that goes over the tax bracket limits. Tax brackets are progressive, so the IRS taxes income at different rates. This ensures that higher-income earners pay their fair share in taxes.

Marginal tax rates apply to each additional dollar of income that surpasses your tax bracket’s income limit. Due to the marginal tax rate, you might have to pay different tax rates on your income.

What is Difference Between Effective Tax Rate vs Marginal Tax Rate ?

The effective tax rate is a more accurate representation of a person’s or corporation’s overall tax liability than their marginal tax rate, and it is typically lower. When considering a marginal versus an effective tax rate, bear in mind that the marginal tax rate refers to the highest tax bracket into which their income falls.

Effective tax rates are lower than marginal rates because they measure the actual tax rate you pay on your entire taxable income. Conversely, your marginal tax rate is varies based on your tax bracket.


Misunderstandings about two different types of tax rates (Effective tax rate vs Marginal tax rate) 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.

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