Effective tax rate
Also called average tax rate
The share of income actually paid in tax, found by dividing total tax by income; usually lower than the marginal rate.
What it means
The effective tax rate is an average: total tax divided by income. Because progressive brackets tax lower slices of income at lower rates, and deductions shield some income entirely, the effective rate is almost always below the marginal rate.
It can be measured against taxable income or total income, and the choice changes the result, so it helps to say which is meant. It is useful for comparing overall tax burden across years or households, while the marginal rate is better for judging the tax on extra income.
Formula
Effective tax rate = Total tax ÷ Income
- Total tax = tax owed after credits
- Income = taxable income or total income, stated clearly
Example
Suppose someone earns $60,000, takes a hypothetical $10,000 deduction, and has $50,000 of taxable income. With 10% on the first $10,000 and 20% above, tax is $9,000. Their effective rate is 18% of taxable income, or 15% of total income, while their marginal rate is 20%.
How it’s used
- Comparing tax burden across years
- Budgeting for annual taxes
- Understanding why the top bracket overstates total tax
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.