Comparing Effective Tax Rates

The top marginal tax rate, as we explained earlier, only applies to earnings above the highest income level. The real percentage that Americans pay in taxes -- called the effective tax rate -- is considerably lower than the marginal rate. In our example above, the marginal tax rate on $35,350 was 15 percent, but the effective tax rate was 13.7 percent. So how does our current effective tax rate compare to the past? As the Congressional Budget Office helps explain:

  • The total effective federal tax rate, which includes personal and corporate income tax, Social Security (payroll tax) and excise tax (taxes on certain goods like tobacco and alcohol), was 20.5 percent in 2005, the most recent year for statistics.
  • The top 1 percent of earners pays an effective tax rate of 31.2 percent and the lowest fifth of earners only pays 4.3 percent.
  • In 1979, when the top marginal tax rate was 70 percent, the total effective tax rate was 22.2 percent, only 1.7 percent higher than 2005, when the highest marginal tax rate was 35 percent -- half the 1979 rate.
  • Even though the top marginal tax rate fluctuated wildly from 1979 to 2005, the effective tax rate was never higher than 23 percent (2000) or lower than 20.1 percent (2004). And interestingly, there was only a 4.6 percent difference between the top marginal tax rates in those two years [sources: CBO and Tax Policy Center].

The lesson from those numbers is that the marginal tax rate, although an interesting reflection on how much we tax the wealthiest Americans, doesn't reflect the average amount that Americans pay in taxes. The effective tax rate is a much better indicator, as is another statistic called the total tax burden as percentage of GDP. Gross domestic product (GDP) is defined as the "output of goods and services produced by labor and property located in the United States" [source: Bureau of Economic Analysis]. GDP isn't the same as total income, but it's a reliable number we can use to compare with the total amount of revenue collected in taxes.

Like the effective tax rate, the total tax burden as a percentage of GDP has remained virtually unchanged over the past five decades. In 2009, when the top marginal tax rate was 35 percent, the total tax burden for U.S. taxpayers equaled 24 percent of GDP. In 1965, when the top marginal rate was 70 percent, the tax burden was 24.7 percent of GDP, almost exactly the same. The tax burden peaked in 2000 at 29.5 percent[sources: Calabresi and Tax Policy Center].

Why do we continue to pay roughly the same amount in taxes, even though the marginal tax rates have changed considerably? The best answer is that tax law is constantly changing and accountants in different decades have exploited different tax loopholes -- numerous tax breaks, credits, subsidies, deductible income and expenses -- to maintain a steady effective tax rate even as marginal rates fluctuate [source: Kocieniewski].

For lots more information on income tax and accounting, explore the related links on the next page.