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, both the federal government and many of the states, uses a progressive tax rate system, 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 greater incomes.

Understanding Tax Rates

To help build and maintain the infrastructure, the government commonly 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 many other countries around the world, a tax rate is applied to money received by a taxpayer.

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 the taxpayer’s earnings or money is taken and remitted to the government.

When it comes to income tax, the tax rate is the percentage of an individual's taxable income or a corporation's earnings that is owed to state, federal, and, in some cases, municipal governments. In certain municipalities, city or regional income taxes are also imposed.

The tax rate that is applied to an individual’s earnings depends on the marginal tax bracket that the individual falls under. The marginal tax rate is the percentage taken from the next dollar of taxable income above a pre-defined income limit. 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 are:

The marginal tax brackets for 2023:

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; and the second will pay 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 don’t only apply to earned income and corporate profits. Tax rates can also apply on other occasions when taxes are imposed, including 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. For example, the state sales tax rate in Georgia is 4%, while the tax rate in California is 7.25%.

Since additional income gained from investments is categorized as earnings, the government also applies tax rates on capital gains and dividends. 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 s/he held the asset. The tax rate on the capital gain of a short-term investment (an investment held for one year or less) is equal to the investor’s ordinary income tax. So, an individual who falls into the 22% marginal tax bracket will pay 22% on his or her 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 that applies to 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, that is irrespective of income level. Bolivia and Greenland are examples of countries that have this system of taxes in place.