In a tax system, the tax rate is the ratio (usually expressed as a percentage) at which a business or person is taxed. The tax rate that is applied to an individual's or corporation's income is determined by tax laws of the country and can be influenced by many factors such as income level, type of income, and so on. There are several methods used to present a tax rate: statutory, average, marginal, flat, and effective. These rates can also be presented using different definitions applied to a tax base: inclusive and exclusive.
Statutory A statutory tax rate is the legally imposed rate. An income tax could have multiple statutory rates for different income levels, where a sales tax may have a flat statutory rate. The statutory tax rate is expressed as a percentage and will always be higher than the effective tax rate.
Average An average tax rate is the ratio of the total amount of taxes paid to the total tax base (taxable income or spending), expressed as a percentage. Average tax rates is used to measure tax burden of individuals and corporations and how taxes affect the individuals and corporations ability to consume.
Let t {\displaystyle t} be the total tax liability. Let i {\displaystyle i} be the total tax base.
= t i . {\displaystyle ={\frac {t}{i}}.}
In a proportional tax, the tax rate is fixed and the average tax rate equals this tax rate. In case of tax brackets, commonly used for progressive taxes, the average tax rate increases as taxable income increases through tax brackets, asymptoting to the top tax rate. For example, consider a system with three tax brackets, 10%, 20%, and 30%, where the 10% rate applies to income from $1 to $10,000, the 20% rate applies to income from $10,001 to $20,000, and the 30% rate applies to all income above $20,000. Under this system, someone earning $25,000 would pay $1,000 for the first $10,000 of income (10%); $2,000 for the second $10,000 of income (20%); and $1,500 for the last $5,000 of income (30%). In total, they would pay $4,500, or an 18% average tax rate.
Flat Flat tax rate, also known as single-rate, is one of the simplest taxations. Flat is a single tax rate (same percentage) on the whole taxable amount. A flat tax rate is used because of its simplicity, transparency, neutrality, and stability. Flat tax rates are quite transparent because it makes it easier for taxpayer to estimate their tax liability and for policymakers to estimate how changes would impact tax revenue. One simplified example is a flat tax rate in Colorado. There is a flat tax rate determined at 4.4%. Assuming that an annual taxable income is $100,000, then the income tax is equal to $4,400. A flat tax rate on income is used in many states of the USA, like Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah; or internationally, such as in many post-Soviet countries like Hungary, Serbia, Estonia or Ukraine; and in Iceland or Bolivia. In practice, no state has a perfectly flat income tax rate, and every state makes certain distinctions between types of income and has several discounts and reductions. A poll tax, also known as a head tax, is a flat tax of a set dollar amount per person. As an example, in the history of the USA, a poll tax was introduced in 1870, which was a fee paid for the right to vote. The marginal tax in these scenarios would be constant (in case of a poll tax—zero), but these are both forms of regressive taxation and place a higher tax burden on those who are least able to cope with it, often resulting in an underfunded government leading to increased deficits.
Marginal
A marginal tax rate is the marginal rate indicating what percentage of additional income at a certain income level would be paid in taxes. For example, if an individual earning $1,000,001 pays $0.37 more in taxes than the same individual would pay if they earned $1,000,000, then their marginal tax rate at $1,000,000 is 37% because they paid 37% of the additional $1 of earnings in taxes. The marginal tax rate on income can be expressed mathematically as Δ t Δ i {\displaystyle {\frac {\Delta t}{\Delta i}}} , where t is the total tax liability and i is total income, and ∆ refers to a numerical change. In accounting practice, the tax numerator in the above equation usually includes taxes at federal, state, provincial, and municipal levels. Many jurisdictions use tax brackets with progressive tax rates, meaning the marginal tax rate is designed to be higher for the last unit earned by a high-income taxpayer than the last unit earned by a low-income taxpayer. For example, in 2023, the United States used the following tax brackets:
For an income of $58,000 per year, the first $11,000 of it is taxed at 10%, the next $33,725 at 12%, and last $13,275 at 22%. The marginal tax rate of this individual is 22%, because if they earned an additional $1, it would fall within the 22% tax bracket.
Specific A specific tax rate, or per unit tax rate, is a fixed amount of tax on a specific good or service. It means that the tax rate is not in the form of percentages but in the form of single units, which does not depend on the price of goods but on the amount of units. Specific tax is used in tobacco taxation because it has been proven that a high specific tax significantly enlarges the price of cigarettes, making it an effective way to reduce the consumption of such goods. For example, the California tax rate on cigarettes is $0.1435 per cigarette stick and $2.87 per pack of 20 cigarettes. If a pack costs $10 or $12, the tax rate for both is $2.87.
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