Effective Tax Rate: Not As Simple As It Seems

Posted on | January 22, 2012 | 1 Comment

Mitt Romney recently expressed the belief that his effective tax rate is roughly 15 percent. Most people become incredulous upon hearing this claim.

Their initial thought is that most people pay a much higher rate than that.

The reality is that they really don’t, however.

In fact, based on the specific calculation methodology, Mr. Romney’s effective rate is significantly higher than that of most Americans’.

Comprehending why this is true requires understanding that “effective tax rate” does not equate to your maximum income tax bracket. Those rates range between 10 and 35 percent, depending upon gross annual income.

This figure can be calculated in various ways, however, as no single means of defining tax liability exists. For instance, one might consider only federal income taxes or all federal taxes. Income may likewise be measured in more ways than one. It may be expressed in terms of “gross,” “taxable,” or “adjusted gross.”

In truth, it is impossible to arbitrarily ascertain Romney’s true effective tax rate to any degree of certainty. That can only be accomplished with a detailed review of his reported income and deductions as reflected within his tax returns.

Even if Romney is right, however, a very simple explanation exists for why his effective rate is most likely much higher than most others’: Effective tax rate is invariably lower than maximum income tax bracket. Moreover, about 80 percent of US taxpayers’ maximum top rate is 15%. This figure is according to Tax Policy Center Senior Fellow Roberton Williams.

Per Williams, four-fifths of all Americans’ effective tax rate is already less than 15 percent.

When income tax liability is considered by itself, taxpayers whose gross annual income is between $40k and $50k per year is only 3.2 percent, per estimates of the Tax Policy Center.

Even households with gross annual incomes that exceed $1,000,000 can expect to pay only 18.9 percent of this amount in 2012 taxes.

This is due to the fact that many high-income households earn much of their money via tax-advantaged investment vehicles like bonds or other sheletered capital gains.