The release of Mitt Romney’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. returns, which indicate that he paid an average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. of 14 percent after deductions, has once again prompted a great deal of confusion over marginal and average tax rates. For a moment, let’s set aside the issue that most of Mr. Romney’s income is in the form of capital gains and dividends, which are taxed at 15 percent rather than at the highest marginal rate of 35 percent, and look at the difference between marginal and average (or effective) tax rates.
Our income tax system is progressive, meaning we pay higher tax rates as our income gets higher. As the table below shows, there are six tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. for different bands of income. The “marginal” rate refers to the tax rate that is applied on that band of income.
Say, for instance, our income is $120,000. This would put us in the 25 percent bracket. If the U.S. had a flat rate tax system (and no deduction), we would pay 25 percent of $120,000 in tax, or $30,000.
|
Married Filing Jointly |
||
|
Marginal |
Tax Brackets |
|
|
Tax Rate |
Over |
But Not Over |
|
10.0% |
$0 |
$17,000 |
|
15.0% |
$17,000 |
$69,000 |
|
25.0% |
$69,000 |
$139,350 |
|
28.0% |
$139,350 |
$212,300 |
|
33.0% |
$212,300 |
$379,150 |
|
35.0% |
$379,150 |
– |
However, under our marginal tax system we pay 10 percent on the first $17,000, or $1,700. We then pay 15 percent on the next band of income up to $69,000, or $7,800. We then pay 25 percent on the marginal amount over $69,000, for another $12,750 in taxes. When we total the taxes paid on these three bands of income it comes to $22,250, for an average (or effective) tax rate of 18.5 percent.
Of course, in our simplified example we have not taken account of all the exemptions, credits, and deductions that are available to us. These deductions reduce our taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . So instead of paying taxes on $120,000, the deductions for our children, mortgage, and charitable contributions could easily reduce our taxable income well below $90,000. At this taxable income we would owe a total of $14,750, for an average rate of about 12 percent.
Millionaires go through the same process, meaning they pay 10 percent on the first band of income, 15 percent on the next band, and so forth. As the chart below shows, based on the most recent IRS data for 2009, the average tax rate (after deductions) paid by all Americans is 11 percent. It is also clear that millionaires pay an average of 25 percent, while virtually every taxpayer earning under $100,000 pays an average rate of no more than 8 percent of their income in taxes. [Click here for more detail on the chart’s data.)
There are roughly 123 million taxpayers who earn under $100,000, or about 88 percent of the 140 million Americans who filed a tax return in 2009. In other words, 88 percent of all taxpayers pay 8 percent or less of their income in income taxes.
Which gets us back to Mitt Romney’s effective tax rate of 14 percent, after deductions. As the chart shows, this rate is still higher than the average rate paid by taxpayers earning up to $200,000. There are about 136 million taxpayers who have adjusted gross incomes less than $200,000, or 97 percent of all taxpayers. So even with an average tax rate of 14 percent, Romney paid a higher average rate than 97 percent of his fellow Americans.
