On June 24, 2016, Republicans released a tax reform blueprint, "A Better Way for Tax Reform." This blueprint proposes to consolidate the seven individual income tax brackets under current law into three, and to eliminate the alternative minimum tax (AMT). Statutory rates also provide limited information on the economic incentives created by the tax code. The analysis in this report relies on the 2010 Internal Revenue Service (IRS) Statistics of Income (SOI) individual public use file. The focus of this report is on the federal individual income tax. Statistics are provided to show how these rates vary for taxpayers at different income levels. Average Tax Rates

A taxpayer's average tax rate is the percentage of total income that is paid in taxes. The average of average tax rates (or mean average tax rate) for taxpayers in the second income decile is less than the mean average tax rate for taxpayers in the lowest 10% of the income distribution, reflecting the phase-in of certain refundable credits (e.g., the EITC). For taxpayers in the top income decile, or those with incomes above $123,230 in 2010, the mean average tax rate was 13.6%. Effective Marginal Tax Rates

Effective marginal tax rates are the amount paid in tax on the next dollar of income. In an uncomplicated tax system, the effective marginal rate would equal the statutory rate. While effective marginal tax rates tend to rise with income, there is substantial variation in the effective marginal tax rates faced by taxpayers within income groups. For low- and middle-income taxpayers, family composition explains much of the variation in average tax rates within income groups. Statutory Tax Rates Do Not Necessarily Reflect Tax Burden

While statutory tax rates are often highlighted in tax reform debates, statutory tax rates are often not a good measure of either taxes paid on additional earnings or overall tax burden. Table 4 provides more information on the magnitude of differences between effective marginal and statutory rates, as well as average and statutory rates. Approximately 36% of taxpayers in the 10% bracket in 2010 faced effective marginal tax rates that were at least 5 percentage points higher than 10% (faced an effective marginal tax rate of at least 15%), while 20% of taxpayers in the 10% bracket faced effective marginal tax rates that were at least 10 percentage points higher than 10% (faced an effective marginal tax rate of at least 20%). Of the less than 1% of taxpayers in 2010 that filed returns that placed them in the top statutory bracket (the 35% bracket), nearly half of those taxpayers face an effective marginal tax rate that is less than the statutory rate, and for most of those taxpayers, the effective marginal tax rate was 30% or less. As a result, some higher-income taxpayers have average tax rates that are less than the average tax rate faced by lower-income taxpayers. Looking at Figure 8 , the distribution of average tax rates for single filers in the top income decile appears roughly similar to the distribution of average tax rates for married filers without children that are in the top 10% of that family type group. Since statutory tax rates provide limited information about tax burdens, questions of equity are often better addressed by using average rates. Since effective marginal tax rates do not equal statutory tax rates for a large proportion of taxpayers, statutory rates provide limited information on the incentives created by the tax code. In a progressive tax system, average tax rates rise with income. Exemptions, deductions, exclusions, credits, and other features of the tax code mean that, even for taxpayers with similar incomes, average tax rates can vary substantially. Further, controlling for family composition tends to expose differences in average tax burdens and effective marginal tax rates between taxpayers with and without children in the lower and middle parts of the income distribution. However, as illustrated in this report, under the current individual income tax system, there is substantial variation in tax burdens within income groups. Under the current system, however, a taxpayer's effective marginal tax rate often differs from the statutory rate. The most recent public use file available at the time this report was written was for tax year 2010.
Tax reform is a stated priority of the 115th Congress. In June 2016, Ways and Means Committee Republicans released the "Better Way" tax reform blueprint. The proposal seeks to make the individual income tax system "simpler, flatter, and fairer" by consolidating the number of individual income tax brackets. Looking at statutory tax rates alone, however, provides limited information regarding the simplicity or fairness of the tax system. Average tax rates and effective marginal tax rates are frequently used by economists and policy analysts to evaluate the fairness of the tax system, as well as various economic incentives created by the system.
This report provides background information on alternative tax rate metrics, and discusses how these measures of the tax burden inform the tax reform debate.
Under current law, there are seven statutory tax rate brackets in the federal individual income tax system. Very few taxpayers, less than 1% in 2014, face the top statutory rate. A taxpayer's average tax rate is the percentage of total income that is paid in taxes. This metric is useful when comparing tax burdens across taxpayers, as well as certain economic incentives created by the tax system. For nearly every taxpayer, average tax rates are less than the statutory rate. A taxpayer's effective marginal tax rate is the amount of income tax paid on the next dollar of earnings. Effective marginal tax rates are determined by statutory rates, as well as various other provisions. Effective marginal tax rates also provide information on the economic incentives created by the tax code for different taxpayers.
As illustrated in this report, under the current system, statutory, average, and effective marginal tax rates can differ substantially for any given taxpayer. Since statutory tax rates provide limited information about tax burdens, questions of equity are often better addressed by using average rates. Since effective marginal tax rates do not equal statutory tax rates for a large proportion of taxpayers, statutory rates provide limited information on the incentives created by the tax code.
One way to evaluate average tax rates is to examine them across the income distribution. This report uses the 2010 Internal Revenue Service (IRS) Statistics of Income (SOI) public use file, the most recent publicly available sample of individual taxpayer returns available when this report was written, to complete this analysis. When taxpayers are divided into income deciles (grouped such that there are 10 equal-sized groups of taxpayers, ranked by income), average tax rates are negative for the first four income deciles. Negative average tax rates are the result of refundable tax credits, generally provided to working families with children. For the top income decile, taxpayers with income above $123,210 in 2010, the average of the average tax rates was 13.6%.
In an uncomplicated tax system, marginal tax rates would generally equal the statutory tax rate. For 46% of taxpayers in 2010, effective marginal tax rates differed from the statutory rate. Twenty-nine percent of taxpayers had an effective marginal tax rate that exceeded their statutory rate, while 16% had an effective marginal tax rate that was less than the statutory rate.
Both average and effective marginal tax rates vary both across and within income groups. Average tax rates tend to rise with income, reflecting the overall progressivity of the tax system. However, the substantial variation of average tax rates within income groups illustrates that higher-income taxpayers do not necessarily face higher average tax rates. For lower- and middle-income taxpayers, family composition explains much of the difference in average tax rates for taxpayers with similar incomes.
Unlike average tax rates, effective marginal tax rates do not always rise with income. The phase-ins and phaseouts associated with tax benefits for families with children mean that for these family types, effective marginal tax rates in the lower and middle parts of the income distribution are similar to those faced by taxpayers near the top of the income distribution.