Concepts
- Marginal tax rate: the extra tax on extra income (ΔT/ΔY); under a progressive schedule, the rate of the top bracket the income reaches.
- Average tax rate: total tax divided by taxable or total income (T/Y).
- Effective tax rate: tax actually paid after deductions, exemptions and credits, divided by total income; for firms, often income tax expense over pre-tax profit.
Example
Under a hypothetical schedule of 10% up to 10 million won and 20% above, taxable income of 30 million won owes 1 + 4 = 5 million won. The marginal rate is 20% but the average rate is about 16.7%. Moving into a higher bracket does not raise the rate on all income.
Why the distinction matters
Decisions about working more, saving, investing or claiming deductions are made at the margin, so marginal rates shape behaviour. Effective rates measure the actual burden, fairness and cross-country comparisons; looking only at top statutory rates overstates what people pay.
Tax planning
A deduction saves tax at the marginal rate: a taxpayer at 24% who deducts 1 million won saves about 240,000 won, so planning focuses on marginal rates.
References
- Rosen, H. S., & Gayer, T. (2014). Public Finance (10th ed.). McGraw-Hill.
- Scholes, M. S., Wolfson, M. A., Erickson, M., Hanlon, M., Maydew, E. L., & Shevlin, T. (2015). Taxes and Business Strategy: A Planning Approach (5th ed.). Pearson.
- OECD. (2023). Taxing Wages 2023. OECD Publishing.