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It is important to distinguish between the average and marginal rates of taxation. They can be very different, and both provide important information. The average tax rate is generally used to examine how different income groups are burdened by a tax, whereas the marginal tax rate is the key to understanding the negative economic effects created by a tax. Both can be computed with simple equations. The average tax rate (AT expressed as follows:
ATR = Tax liability / Taxable income
For example, if a person’s tax liability was $3,000 on an income of $20,000, her average tax rate would be 15percent ($3,000divided by $20,000).The average tax rate is simply the percentage of income that is paid in taxes.
In the United States, the personal income tax provides the largest single source of government revenue. This tax is particularly important at the federal level. You may have heard that the federal income tax is “progressive.” A progressive tax is defined as a tax in which the average tax rate rises with income. In other words, people with higher income pay a larger percentage of their income in taxes. Alternatively, taxes can be proportional or regressive. A roportionata – x is defined as a tax in which the average tax rate remains the same across income levels. Under a proportional tax, everyone pays the same percentage of their income in taxes. Finally, a regressive tax is defined as a tax in which the average tax rate falls with income. If someone making $100,000 per year paid $30,000in taxes (an ATR of 30 percent) while someone making $30,000 per year paid $15,000 in taxes (an ATR of 50 percent), the tax code would be regressive. Note that a regressive tax merely means that the percentage paid in taxes declines with income; the actual dollar amount of the tax bill might still be higher for those with larger incomes.