The Tax Rate You Should Care About Most

We talk a lot about tax rates here, and about whether they might go up in the future and for whom. But to think intelligently about tax policy not to mention your own tax strategy it pays to stop and ask: Which tax rate do you mean? And what tax rate matters most to you?

When most people talk about tax rates these days, what theyre really talking about are marginal tax rates. Your marginal tax rate is the percent youll pay on the last dollar of income you bring in.

Today, those federal marginal tax rates range from 10% to 35%; under the terms of last years tax agreement, theyll expire next year and the one thing you can count on is another big debate over what tax policy should look like.

But looking at marginal tax rates is only one way of looking at taxes. When I talk with friends about taxes (yes, Im geeky enough to do this), I find that a lot of people are confused about what their marginal rate is and what percentage of their income theyre actually paying to the government. The latter number is a mix of tax rates applied to income thats likely been reduced by various deductions, for home mortgage interest, say, or for charitable contributions. No matter how much money you bring home, you get to take advantage of the 10% rate on your first $17,000 of taxable income if youre married (or the first $8,500 of taxable income if youre single). Then, as marginal rates pile one atop another, as your income rises, a slice of it gets taxed at the next highest rate, and so on, and so on, on up to the 35% tax bracket if you make more than $379,150.

The actual rates that people pay as a percent of their income are substantially lower than those marginal tax rates because of the combination of rate layering and deductions. The effective federal tax rate, including Social Security taxes and other individual taxes, for all households was 20.4% in 2007 (the most recent year for which data is available), according to data from the Tax Policy Center. Thats below the 21.6% rate that applied two decades ago. And, today, middle-income taxpayers (that is, the middle quintile) paid 14.3%, while the wealthiest taxpayers (that is, the top 10%) paid 26.7%. Those numbers, too, are below what they were in 1987.

An even broader way to look at tax rates is to simply divide total federal revenues by the gross domestic product. Bruce Bartlett, a top policy adviser under both Presidents Ronald Reagan and George H.W. Bush called the Republican party to task for arguing that tax rates are high in a piece in Tuesdays New York Times:

By this measure, federal taxes are at their lowest level in more than 60 years. The Congressional Budget Office estimated that federal taxes would consume just 14.8% of G.D.P. this year. The last year in which revenues were lower was 1950, according to the Office of Management and Budget & The truth of the matter is that federal taxes in the United States are very low. There is no reason to believe that reducing them further will do anything to raise growth or reduce unemployment.

Before the tax policy debates truly heat up, Im curious how you think about your own tax rate, and if you think theres a right way to look at these rates. Personally, I prefer to think of my tax rate as the percent of my overall income that goes to taxes, rather than the marginal rate that applies to the last dollar I earn: My goal in tax planning is to lower my overall tax burden, not to fuss about where the magic cutoff is between two marginal rates.

What about you? Do you care more about the marginal rate that youll pay on the last dollar that you earn? Or more about the overall percentage of your income that you pay in taxes each year?