Tax bracket vs. tax rate: They're two different things
Ask most Americans how much they pay in taxes, and they'll probably refer to their tax bracket, a series of rates that ranges from 10% to 35%. By that measure, Mitt Romney's tax rate sounds outrageously low.
But when the Republican presidential candidate revealed earlier this week that he pays about 15% in taxes, he was referring to his effective tax rate, not his tax bracket. And by that measure, he's paying a higher tax rate than the majority of taxpayers.
Under the United States' progressive tax system, income is taxed at graduated rates. An individual's tax bracket, sometimes referred to as the marginal tax rate, refers to the percentage of income that's taxed at the top tax rate — not the rate for the entire amount.
The effective tax rate, meanwhile, is the amount a taxpayer pays in taxes as a percentage of total income. The average effective federal tax rate for American taxpayers is 11%, according to an analysis of 2009 IRS data by the Tax Foundation, a non-profit research organization. For individuals with adjusted gross income of $50,000 or less, the average effective tax rate is less than 5%, according to the Tax Foundation.
That rate doesn't include the amount taxpayers pay in Social Security and Medicare taxes.
Confusion about the difference between marginal and effective tax rates often causes taxpayers to overestimate their tax liabilities, tax professionals say. Francis Degen, an enrolled agent based in Setauket, N.Y., says a retired client recently asked him whether withdrawing some money from his savings to pay for a trip to Italy would bump him into a higher tax bracket. The client feared that all his income would be taxed at the higher rate, Degen says.
While Romney's effective tax rate is higher than the national average, it's lower than the percentage paid by most high-income taxpayers. The average effective tax rate for taxpayers with AGI of $1 million or more is 25%, according to the Tax Foundation analysis.
Former House Speaker Newt Gingrich said this week that his effective tax rate was 31% in 2010.
Romney's rate is lower than average for high-income taxpayers because most of his income comes from capital gains on his investments, which are taxed at a 15% rate, says Clint Stretch, tax principal at Deloitte Tax in Washington, D.C. Given the nature of Romney's income, he says, "It would have surprised me if it (his tax rate) had been something much higher."
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