What Is a Tax Rate?

A tax rate is the 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 results in a higher dollar amount collected from taxpayers with greater incomes.

Key Takeaways

  • A tax rate is the percentage at which an individual or corporation is taxed.
  • The U.S. imposes a progressive tax rate on income, meaning the greater the income, the higher the percentage of tax levied.
  • Since the U.S. applies its tax rate in marginal increments, taxpayers end up being charged at an effective tax rate that is lower than that of the straight bracket rate.
  • Some other nations charge a flat tax rate or a regressive tax rate.

Understanding Tax Rates

To help build and maintain the infrastructures used in a country, the government usually taxes its residents. The tax collected is used for the betterment of the nation, of society, and of all living in it. In the U.S. and many other countries around the world, a tax rate is applied to some form of money received by a taxpayer. The money could be income earned from wages or salary, investment income (dividends, interest), capital gains from investments, profits made from goods or services rendered, etc. The 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

Let’s use an example to illustrate marginal and progressive tax rates. For individuals, the dollar threshold for each tax rate is dependent upon the status of the filer, whether s/he is single, the head of a household, married filing separately, or married filing jointly. The marginal tax bracket for 2019 are:

Tax Rate

Single

Head of Household

Married Filing Separately

Married Filing Jointly

10%

≤ $9,700

≤ $13,850

≤ $9,700

≤ $19,400

12%

$9,701 to $39,475

$13,851 to $52,850

$9,701 to $39,475

$19,401 to $78,950

22%

$39,476 to $84,200

$52,851 to $84,200

$39,476 to $84,200

$78,951 to $168,400

24%

$84,201 to $160,725

$84,201 to $160,700

$84,201 to $160,725

$168,401 to $321,450

32%

$160,726 to $204,100

$160,701 to $204,100

$160,726 to $204,100

$321,451 to $408,200

35%

$204,101 to $510,300

$204,101 to $510,300

$204,101 to $306,175

$408,201 to $612,350

37%

> $510,301

> $510,301

> $306,176

> $612,351

An individual who earns $62,000 in 2019 will be taxed as follows: 10% on the first $9,700; 12% on the next $29,775 (the amount over $9,700 up to $39,475); then 22% on the next $22,525 (the amount over $39,475 up to $62,000), all of which equals $9,498.

Another individual who earns $160,000 will be taxed 10% on the first $9,700; 12% on $29,775 (the amount over $9,700 up to $39,475); then 22% on the next $44,724 (the amount over $39,475 up to $84,200), then 24% on $75,799 (the amount over $84,200 up to his $160,000), all of which equals $32,574.26. 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.

A marginal tax rate means that different portions of income are taxed at progressively higher rates.

Although the individuals fall in the third and fourth marginal brackets, they don’t pay flat rates of 22% and 24%, respectively, 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 effect, individual A in fact pays at a rate of 15.31% ($9,498 ÷ $62,000) and the individual with the higher income pays a rate of 20.35% ($32,574.26 ÷ $160,000). These rates are called the 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 6%, as of 2019.

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 24% marginal tax bracket will pay 24% 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%, with individuals who fall in the 10% and 12% marginal brackets paying 0% taxes, investors in the next three brackets paying 15%, and those in the last two highest brackets paying 20% tax rate on capital gains. Qualified dividends are subject to the same tax rate schedule that applies to long-term capital gains. Nonqualified 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. Countries such as Poland, Belgium, and Iceland use the regressive tax rates structure in which a larger percentage of tax is taken from low-income earners than from high-income earners.

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