Q: What is the difference between effective tax rate and marginal tax rate?

A: People often confuse these two concepts. Effective tax rate compares the total tax you pay after considering deductions and credits and the tax tiers apply.  Marginal tax rate indicates what the next dollar you make would be taxed at.

Effective Tax Rate: The effective tax rate is the average rate at which your income is taxed. It’s calculated by dividing the total amount of tax you pay by your total income.  The formula is: Effective Tax Rate = total tax divided by total income​.  This rate gives you a broad view of your overall tax burden as a percentage of your income. For instance, if you earn $100,000 and pay $15,000 in taxes, your effective tax rate is 15% ($15,000 / $100,000).

Marginal Tax Rate: The marginal tax rate is the rate at which your last dollar of income is taxed. It reflects the tax rate applied to the next dollar of income you earn, given the progressive US tax systems. This rate is important for understanding how additional income will be taxed. For example, if your income falls into a tax bracket where the marginal rate is 24%, then any additional income you earn will be taxed at 24% (assuming the income is within that bracket).

Example to Illustrate the Difference:

Here are the 2024 US brackets for Single Filers:

• 10% on income up to $11,600

• 12% on income from $11,601 to $47,150

• 22% on income from $47,151 to $100,526

If you have taxable income of $60,000:

• You pay 10% on the first $11,160, which is $1,160.

• You pay 12% on the next $35,549 (from $11,161 to $47,150), which is $4,266.

• You pay 22% on the remaining $12,849 (from $47,151 to $60,000), which is $2,827.

• Total Tax Paid: $1,160 + $4,266 + $2,827 = $8,253.

Your effective tax rate would be: 13.75% ($8,253/$60,000) and your marginal tax rate is 22% because the last dollar you earn (and the next dollar) falls into the 22% tax bracket.