Average Tax Rate

Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

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Effective Tax Rate

The tax rate one pays assuming that one pays a flat rate rather than under a progressive system. Under progressive tax systems, one pays different rates for different amounts in income. For example, one may pay 10% for the first $10,000 of income and 25% for all additional income. In practice this means that one would pay somewhere between 10% and 25%. One calculates the effective tax rate simply by taking the total tax liability, dividing by one's taxable income and multiplying by 100.

Suppose one makes $20,000 in a year and is taxed under the above system. This person pays $1000 (10%) of the first $10,000 and 2500 (25%) of the second $10,000. The total tax liability is $3500, which when divided by the $20,000 of income and multiplied 100, is found to have an effective tax rate of 17.5%.