Tax rate

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In a tax system, the tax rate is the ratio (usually expressed as a percentage) at which a business or person is taxed. There are several methods used to present a tax rate: statutory, average, marginal, and effective. These rates can also be presented using different definitions applied to a tax base: inclusive and exclusive.

A tax is a mandatory financial charge or some other type of levy imposed upon a taxpayer by a governmental organization in order to fund various public expenditures. A failure to pay, along with evasion of or resistance to taxation, is punishable by law. Taxes consist of direct or indirect taxes and may be paid in money or as its labour equivalent.

Ratio relationship between two numbers of the same kind

In mathematics, a ratio is a relationship between two numbers indicating how many times the first number contains the second. For example, if a bowl of fruit contains eight oranges and six lemons, then the ratio of oranges to lemons is eight to six. Similarly, the ratio of lemons to oranges is 6:8 and the ratio of oranges to the total amount of fruit is 8:14.

Percentage Number or ratio as a fraction of 100

In mathematics, a percentage is a number or ratio expressed as a fraction of 100. It is often denoted using the percent sign, "%", or the abbreviations "pct.", "pct"; sometimes the abbreviation "pc" is also used. A percentage is a dimensionless number.

Contents

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. [1]

The statutory tax rate is expressed as a percentage and will always be higher than the effective tax rate. [2]

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. [1]

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.

A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or decreases. The amount of the tax is in proportion to the amount subject to taxation. "Proportional" describes a distribution effect on income or expenditure, referring to the way the rate remains consistent, where the marginal tax rate is equal to the average tax rate.

Tax brackets are the divisions at which tax rates change in a progressive tax system. Essentially, they are the cutoff values for taxable income—income past a certain point will be taxed at a higher rate.

A progressive tax is a tax in which the average tax rate increases as the taxable amount increases. The term "progressive" refers to the way the tax rate progresses from low to high, with the result that a taxpayer's average tax rate is less than the person's marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability to pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the average tax rate or burden decreases as an individual's ability to pay increases.

Marginal

A marginal tax rate is the tax rate on income set at a higher rate for incomes above a designated higher bracket, which in 2016 in the United States was $415,050. For annual income that was above cut off point in that higher bracket, the marginal tax rate in 2016 was 39.6%. For income below the $415,050 cut off, the lower tax rate was 35% or less. [3] [4] In the United States in 2016, for example, the highest marginal federal income tax rate was 39.6%, applying to earnings over $415,050. Earnings under $415,050 that year had a lower tax rate of 35% or less. [3]

The marginal tax rate on income can be expressed mathematically as follows:

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. Marginal tax rates are applied to income in countries with progressive taxation schemes, with incremental increases in income taxed in progressively higher tax brackets.

In economics, one theory is that marginal tax rates will impact the incentive of increased income, meaning that higher marginal tax rates cause individuals to have less incentive to earn more. This is the basis of the Laffer curve theory, which theorizes that population-wide taxable income decreases as a function of the marginal tax rate, making net governmental tax revenues decrease beyond a certain taxation point.

With a flat tax, by comparison, all income is taxed at the same percentage, regardless of amount. An example is a sales tax where all purchases are taxed equally. A poll tax is a flat tax of a set dollar amount per person. The marginal tax in these scenarios would be zero.

Implicit marginal tax rate

For individuals who receive means tested benefits, benefits are decreased as more income is earned. This is sometimes described as an implicit tax. [5] These implicit marginal tax rates can exceed 90% [6] or even greater than 100%. [7] Some economists argue that these issues create a disincentive for work or promotion and may result in a structural income inequality.

Effective

The term effective tax rate has different meanings in different contexts. Generally its calculation attempts to adjust a nominal tax rate to make it more meaningful. It may incorporate econometric, estimated, or assumed adjustments to actual data, or may be based entirely on assumptions or simulations. [8]

The term is used in financial reporting to measure the total tax paid as a percentage of the company's accounting income, instead of as a percentage of the taxable income. International Accounting Standard 12, [9] define it as income tax expense or benefit for accounting purposes divided by accounting profit. In Generally Accepted Accounting Principles (United States), the term is used in official guidance only with respect to determining income tax expense for interim (e.g. quarterly) periods by multiplying accounting income by an "estimated annual effective tax rate", the definition of which rate varies depending on the reporting entity's circumstances. [10]

In U.S. income tax law, the term is used in relation to determining whether a foreign income tax on specific types of income exceeds a certain percentage of U.S. tax that would apply on such income if U.S. tax had been applicable to the income. [11]

The popular press, Congressional Budget Office, and various think tanks have used the term to mean varying measures of tax divided by varying measures of income, with little consistency in definition. [12]

Investors usually modify a statutory marginal tax rate to create the effective tax rate appropriate for their decision.

For example: If capital gains are only taxed when realized by a sale, the effective tax rate is the yearly rate that would have applied to the average yearly gain so that the resulting after-tax profit is the same as when all taxed at statutory rates on sale. It will be lower than the statutory rate because unrealized profits are reinvested without tax.

For example: When dividends are both taxed as income, and also generate a tax credit in the UK and Canadian system, the effective tax rate is the net effect of both - the net tax divided by the actual dividend's value.

For example: When contributions are made to Tax Deferred Accounts the reduced tax base will result in reduced taxes calculated at the statutory marginal rate. But the reduction in the tax base may also affect qualification for other government benefits. The difference in those benefits is added to the numerator to increase the effective marginal rate due to the contribution.

Inclusive and exclusive

Mathematically, 25% income tax out of $100 income yields the same as 33% sales tax on a $75 purchase. Tax rate example.svg
Mathematically, 25% income tax out of $100 income yields the same as 33% sales tax on a $75 purchase.

Tax rates can be presented differently due to differing definitions of tax base, which can make comparisons between tax systems confusing.

Some tax systems include the taxes owed in the tax base (tax-inclusive, Before Tax), while other tax systems do not include taxes owed as part of the base (tax-exclusive, After Tax). [13] In the United States, sales taxes are usually quoted exclusively and income taxes are quoted inclusively. The majority of Europe, value added tax (VAT) countries, include the tax amount when quoting merchandise prices, including Goods and Services Tax (GST) countries, such as Australia and New Zealand. However, those countries still define their tax rates on a tax exclusive basis.

For direct rate comparisons between exclusive and inclusive taxes, one rate must be manipulated to look like the other. When a tax system imposes taxes primarily on income, the tax base is a household's pre-tax income. The appropriate income tax rate is applied to the tax base to calculate taxes owed. Under this formula, taxes to be paid are included in the base on which the tax rate is imposed. If an individual's gross income is $100 and income tax rate is 20%, taxes owed equals $20.

The income tax is taken "off the top", so the individual is left with $80 in after-tax money. Some tax laws impose taxes on a tax base equal to the pre-tax portion of a good's price. Unlike the income tax example above, these taxes do not include actual taxes owed as part of the base. A good priced at $80 with a 25% exclusive sales tax rate yields $20 in taxes owed. Since the sales tax is added "on the top", the individual pays $20 of tax on $80 of pre-tax goods for a total cost of $100. In either case, the tax base of $100 can be treated as two parts—$80 of after-tax spending money and $20 of taxes owed. A 25% exclusive tax rate approximates a 20% inclusive tax rate after adjustment. [13] By including taxes owed in the tax base, an exclusive tax rate can be directly compared to an inclusive tax rate.

Inclusive income tax rate comparison to an exclusive sales tax rate:
The revenue that would go to the government:
The revenue remaining for the seller of the good:
To convert the tax, divide the money going to the government by the money the company nets:
Therefore, to adjust any inclusive tax rate to that of an exclusive tax rate, divide the given rate by 1 minus that rate.

See also

Related Research Articles

A flat tax is a tax system with a constant marginal rate, usually applied to individual or corporate income. A true flat tax would be a proportional tax, but implementations are often progressive and sometimes regressive depending on deductions and exemptions in the tax base. There are various tax systems that are labeled "flat tax" even though they are significantly different.

In finance, the net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount rate. NPV accounts for the time value of money. It provides a method for evaluating and comparing capital projects or financial products with cash flows spread over time, as in loans, investments, payouts from insurance contracts plus many other applications.

In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is always less than or equal to the future value because money has interest-earning potential, a characteristic referred to as the time value of money, except during times of negative interest rates, when the present value will be more than the future value. Time value can be described with the simplified phrase, "A dollar today is worth more than a dollar tomorrow". Here, 'worth more' means that its value is greater. A dollar today is worth more than a dollar tomorrow because the dollar can be invested and earn a day's worth of interest, making the total accumulate to a value more than a dollar by tomorrow. Interest can be compared to rent. Just as rent is paid to a landlord by a tenant without the ownership of the asset being transferred, interest is paid to a lender by a borrower who gains access to the money for a time before paying it back. By letting the borrower have access to the money, the lender has sacrificed the exchange value of this money, and is compensated for it in the form of interest. The initial amount of the borrowed funds is less than the total amount of money paid to the lender.

Payroll tax

Payroll taxes are taxes imposed on employers or employees, and are usually calculated as a percentage of the salaries that employers pay their staff. Payroll taxes generally fall into two categories: deductions from an employee’s wages, and taxes paid by the employer based on the employee's wages. The first kind are taxes that employers are required to withhold from employees' wages, also known as withholding tax, pay-as-you-earn tax (PAYE), or pay-as-you-go tax (PAYG) and often covering advance payment of income tax, social security contributions, and various insurances. The second kind is a tax that is paid from the employer's own funds and that is directly related to employing a worker. These can consist of fixed charges or be proportionally linked to an employee's pay. The charges paid by the employer usually cover the employer's funding of the social security system, medicare, and other insurance programs. The economic burden of the payroll tax falls almost entirely on the worker, regardless of whether the tax is remitted by the employer or the employee, as the employers’ share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid. Because payroll taxes fall exclusively on wages and not on returns to financial or physical investments, payroll taxes may contribute to underinvestment in human capital such as higher education.

The FairTax is a proposal to reform the federal tax code of the United States. It would replace all federal income taxes, payroll taxes, gift taxes, and estate taxes with a single broad national consumption tax on retail sales. The Fair Tax Act would apply a tax, once, at the point of purchase on all new goods and services for personal consumption. The proposal also calls for a monthly payment to all family households of lawful U.S. residents as an advance rebate, or "prebate", of tax on purchases up to the poverty level. First introduced into the United States Congress in 1999, a number of congressional committees have heard testimony on the bill; however, it has not moved from committee and has yet to have any effect on the tax system. In 2005, a tax reform movement has formed behind the FairTax proposal. Attention increased after talk radio personality Neal Boortz and Georgia Congressman John Linder published The FairTax Book in 2005 and additional visibility was gained in the 2008 presidential campaign.

In business, operating margin—also known as operating income margin, operating profit margin, EBIT margin and return on sales (ROS)—is the ratio of operating income to net sales, usually presented in percent.

Income tax in the United States form of taxation in the USA

Income taxes in the United States are imposed by the federal, most state, and many local governments. The income taxes are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. An alternative tax applies at the federal and some state levels.

In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows which the investor receives from the investment, such as interest payments or dividends. It may be measured either in absolute terms or as a percentage of the amount invested. The latter is also called the holding period return.

Taxation in the Netherlands is defined by the income tax, the wage withholding tax, the value added tax and the corporate tax.

The Fair Tax Act is a bill in the United States Congress for changing tax laws to replace the Internal Revenue Service (IRS) and all federal income taxes, payroll taxes, corporate taxes, capital gains taxes, gift taxes, and estate taxes with a national retail sales tax, to be levied once at the point of purchase on all new goods and services. The proposal also calls for a monthly payment to households of citizens and legal resident aliens as an advance rebate of tax on purchases up to the poverty level. The impact of the FairTax on the distribution of the tax burden is a point of dispute. The plan's supporters argue that it would decrease tax burdens, broaden the tax base, be progressive, increase purchasing power, and tax wealth, while opponents argue that a national sales tax would be inherently regressive and would decrease tax burdens paid by high-income individuals.

Tax deferral refers to instances where a taxpayer can delay paying taxes to some future period. In theory, the net taxes paid should be the same. Taxes can sometimes be deferred indefinitely, or may be taxed at a lower rate in the future, particularly for deferral of income taxes.

The marriage penalty in the United States refers to the higher taxes required from some married couples with both partners earning income that would not be required by two otherwise identical single people with exactly the same incomes. There is also a marriage bonus that applies in other cases. Multiple factors are involved, but in general, in the current U.S. system, single-income married couples usually benefit from filing as a married couple, while dual-income married couples are often penalized. The percentage of couples affected has varied over the years, depending on shifts in tax rates.

The U.S. state of New Jersey levies a state personal income tax and state corporate income tax and a state sales tax. Property taxes are also levied by municipalities, counties, and school districts.

Financial ratio characteristic number

A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.

Progressivity in United States income tax

In general, the United States federal income tax is progressive, as rates of tax generally increase as taxable income increases, at least with respect to individuals that earn wage income. As a group, the lowest earning workers, especially those with dependents, pay no income taxes and may actually receive a small subsidy from the federal government.

Tax policy and economic inequality in the United States discusses how tax policy affects the distribution of income and wealth in the United States. Income inequality can be measured before- and after-tax; this article focuses on the after-tax aspects. Income tax rates applied to various income levels and tax expenditures primarily drive how market results are redistributed to impact the after-tax inequality. After-tax inequality has risen in the United States markedly since 1980, following a more egalitarian period following World War II.

The Common Consolidated Corporate Tax Base (CCCTB) is a proposal for a common tax scheme for the European Union developed by the European Commission and first proposed in March 2011 that provides a single set of rules for how EU corporations calculate EU taxes, and provide the ability to consolidate EU taxes. Corporate tax rates in the EU would not be changed by the CCCTB, as EU countries would continue to have their own corporate tax rates.

References

  1. 1 2 "What is the difference between statutory, average, marginal, and effective tax rates?" (PDF). Americans For Fair Taxation. Archived from the original (PDF) on 2007-06-14. Retrieved 2007-04-23.
  2. "Statutory vs. Effective Tax Rate". DeaneBarker.net. 2011-12-31. Retrieved 2016-12-28.
  3. 1 2 "2016 Federal Tax Schedules". irs.gov . Retrieved 2017-04-27.
  4. Piper, Mike (Sep 12, 2014). Taxes Made Simple: Income Taxes Explained in 100 Pages or Less. Simple Subjects, LLC. ISBN   978-0981454214.
  5. Folbre, Nancy (28 October 2013). "The Marginal Tax Rate Mess". The New York Times.
  6. http://www.cnn.com/2013/02/08/opinion/mccaffery-marginal-tax-rates/
  7. https://www.epionline.org/wp-content/studies/shaviro_02-1999.pdf
  8. For example, one study provides the caveat that "The effective tax rate calculations utilize information on the median level of assessment within a given geographical area. While a property is likely to be near the median level of assessment, the actual level of assessment for any given property could be greater or lesser than the median."
  9. IAS 12, paragraphs 86.
  10. ASC 740-270-30-6 through -9.
  11. See, e.g., 26 CFR 1.904-4(c).
  12. For example, in CBO tables comparing historical tax rates, "Effective tax rates are calculated by dividing taxes by comprehensive household income", where comprehensive household income "equals pretax cash income plus income from other sources. Pretax cash income is the sum of wages, salaries, self-employment income, rents, taxable and nontaxable interest, dividends, realized capital gains, cash transfer payments, and retirement benefits plus taxes paid by businesses (corporate income taxes and the employer's share of Social Security, Medicare, and federal unemployment insurance payroll taxes) and employee contributions to 401(k) retirement plans. Other sources of income include all in-kind benefits (Medicare, Medicaid, employer-paid health insurance premiums, food stamps, school lunches and breakfasts, housing assistance, and energy assistance). Households with negative income are excluded from the lowest income category but are included in totals." This CBO definition includes in income many items, such as employer share of Social Security tax, not considered income for most purposes. In a different context, CBO uses the term to include total Federal corporate income taxes imputed to individuals based on the assumed level of corporate shareholdings for a class of individuals.
  13. 1 2 Bachman, Paul; Haughton, Jonathan; Kotlikoff, Laurence J.; Sanchez-Penalver, Alfonso; Tuerck, David G. (November 2006). "Taxing Sales under the FairTax – What Rate Works?" (PDF). Beacon Hill Institute. Tax Analysts. Archived from the original (PDF) on 2007-06-14. Retrieved 2007-04-24.