Tax Rate Definition, Effective Tax Rates, and Tax Brackets

What Is a Tax Rate?

A tax rate is a percentage at which an individual or corporation is taxed. The United States uses a progressive tax rate system imposed by the federal government and many states in which the percentage of tax charged increases as the amount of the person's or entity's taxable income increases. A progressive tax rate collects more from taxpayers with higher incomes.

Understanding Tax Rates

To help build and maintain the infrastructure, a government taxes its residents. The tax collected is used for the betterment of the nation, society, and all living in it. In the U.S. and other countries, a tax rate is applied to taxpayer income.

Whether earned from wages or salary, investment income like dividends and interest, capital gains from investments, or profits made from goods or services, a percentage of earnings are remitted to the government.

For income tax, the tax rate is the percentage of an individual's taxable income or a corporation's earnings owed to state, federal, and, in some cases, municipal governments. The tax rate applied to an individual’s earnings depends on the marginal tax bracket. The marginal tax rate used by the U.S. government is indicative of its progressive tax system.

Effective Tax Rates

For individuals, the dollar threshold for each tax rate is dependent upon the status of the filer, whether they are single, the head of a household, married filing separately, or married filing jointly. The marginal tax brackets for 2022 and 2023 are:

A single individual who earns $62,000 in 2023 will be taxed as follows: 10% on the first $11,000; 12% on the next $33,725 (the amount over $11,000 up to $44,725); then 22% on the remaining $17,275 (the amount over $44,725 up to $95,375), all of which equals $8,947.50.

Another individual who earns $160,000 will be taxed 10% on the first $11,000; 12% on the next $33,725; 22% on the next $50,650 (the amount over $44,725 up to $95,375); then 24% on the remaining $64,625 (the amount of income that falls between $95,375 and $182,100), all of which equals $31,800.

Following this example, the single taxpayer who falls under the third marginal tax bracket will pay less tax than the single filer who falls in the fourth and higher bracket.

Although these taxpayers fall in the third and fourth marginal brackets, they do not pay flat rates of 22% and 24%, respectively, on all of their income due to the nature of the marginal tax calculation. If they did, the first individual would pay 22% x $62,000 = $13,640; the second pays 24% x $160,000 = $38,400. In total, individual A pays an effective rate of 14.4% ($8,947.50 ÷ $62,000), and the individual with the higher income pays a rate of 19.9% ($31,800 ÷ $160,000). These rates are called effective tax rates and represent the actual percentage at which the tax is levied during a tax year.

Sales and Capital Gains Tax Rates

Tax rates also apply as sales tax on goods and services, real property tax, short-term capital gains tax, and long-term capital gains tax. When a consumer purchases certain goods and services from a retailer, a sales tax is applied to the sales price of the commodity at the point of sale. Since sales tax is governed by individual state governments, the sales tax rate will vary from state to state. In Georgia, the rate is 4%, while the tax rate in California is 7.25%.

Income gained from investments is categorized as earnings, and tax rates on capital gains and dividends apply. When the value of an investment rises and the security is sold for a profit, the tax rate that the investor pays depends on how long they held the asset. The tax rate of a short-term investment held for one year or less is equal to the investor’s ordinary income tax. Individuals in the 22% marginal tax bracket will pay 22% on short-term capital gains.

The tax rate on profits from investments held longer than a year ranges from 0% to 20%. For the taxable year 2023, individuals with taxable income below $44,625 pay 0%. Individuals with taxable income between $44,625 and $492,300 pay 15%, and investors with income above $492,300 pay a 20% tax rate on capital gains.

Qualified dividends are subject to the same tax rate schedule for long-term capital gains. Non-qualified dividends have the same tax rates as short-term capital gains.

Tax Rates Abroad

Tax rates vary from country to country. Some countries implement a progressive tax system, while others use regressive or proportional tax rates. A regressive tax schedule is one in which the tax rate increases as the taxable amount decreases.

The proportional or flat tax rate system applies the same tax rates to all taxable amounts, regardless of income level. Bolivia and Greenland are examples of countries that have this system of taxes in place.

The Bottom Line

A tax rate is a percentage at which an individual or corporation is taxed. The U.S. imposes a progressive tax, where the higher the individual's income, the greater percentage of tax is paid. Tax rates are also applied as sales tax on goods and services or as capital gains tax on investments. Other nations may impose a progressive tax, while others charge a flat tax rate or a regressive tax rate.