## What is the difference between marginal and average tax rates?

The marginal and average tax rate distinction/calculation is secondary in terms of importance for the CFA Level 3 exam. Nevertheless, we have seen multiple choice problems in the past asking you to either (1) calculate one or the other, (2) distinguish between them, or (3) identify how a tax regime will change the rate.

## Calculating the marginal and average tax rate for the CFA exam

The **marginal tax rate** is the tax rate on the last dollar of income earned.

So, if your income is $105,000 and the tax rate for the $100,000 to $150,000 bracket is 30% then your marginal tax rate is 30%. Simple right?

The **average tax rate** on the other hand is the total taxes you’ve paid divided by your income.

In a progressive tax regime the average tax rate should always be lower than your marginal tax rate because as your income increases each tranche of income gets taxed at a progressively higher rate. In other words, under a progressive system not all income is taxed at the same rate. Instead each dollar you earn is taxed at a different rate depending on the marginal tax rate schedule in your tax jurisdiction.

This graphic illustrates the concept:

As you can see, the first $27,800 of the families income is not taxed. The next $17,850 (or dollars $27,801 - $45,650) is taxed at 10%, then dollars $45,651 - $100,300 are taxed at 15% and so on. The marginal tax rate, or tax rate on the last dollar of income earned is 25%.

To get the average tax rate we take the blended or weighted average of each tranche and sum them together. In this case the average tax rate of 9.5% is calculated as:

- Dollars paid in taxes: ($27,800 * 0) + ($17,850 * .10) + ($54,650 * .15) + ($9,700*0.25) = $12,407.50
- Average tax rate: ($12,407.50 / $110,000) = 11.28%

If the regime was a flat one, the average and marginal tax rates would be the same.

**Summary**

For the CFA Level 3 exam marginal and average tax rates are (1) straightforward and (2) much less important than other material related to taxes. Still it's worth practicing a few problems and internalizing this lesson so that you earn any points where this comes up.