Canadian Finance Blog

Posted: 04 Oct 2010 02:00 AM PDT

The amount of tax you pay can be expressed in two different ways, marginal tax rate and average tax rate. While marginal tax rate is the tax rate paid on the last dollar you earn, your average tax rate is simply calculated as your total income tax divided by your total taxable income.

What Is Your Average Tax Rate?

Using are example from the marginal tax rate post, our Albertan went from an income of $40,000 (paying $6,760 in taxes) to now making $45,000 (paying $8,291 in taxes). In that example, this person went from a marginal tax rate of 25% to his new marginal tax rate of 32%.

However, as an average tax rate, the percentage would be calculated as:

$6,760 divided by $40,000 = 16.9%
$8,291 divided by $45,000 = 18.4%

So while the marginal tax rate increased by 7%, the 32% rate is only taxed on the final $4,030. The average tax rate only went up by 2.5%.

How To Use Average Tax Rate

Average tax rate is not really as useful of a number as marginal tax rate. With marginal tax rate, you can look to reduce your taxes by eliminating the highest rate of taxes you pay. It also lets you know what you’ll owe in taxes on the next dollar earned.

The only real benefit of knowing your average tax rate is that you can see how much of you money is paid in federal and provincial taxes. This can help you create a budget showing how every dollar of your gross income is spent, not just your net income; what you get on your pay cheque. Including your taxes, benefits paid, CPP, etc. in your gross income budget can be a great way to truly see where all your money goes.

Average Tax Rate Explained originally appeared on Canadian Finance Blog on October 4, 2010.

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