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The average rate at which an individual or corporation is taxed. The effective tax rate for individuals is the average rate at which their earned income is taxed. The effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed. An individual's effective tax rate is calculated by dividing total tax expense by taxable income. For corporations, the effective tax rate is computed by dividing total tax expenses by the firm's earnings before taxes. The effective tax rate is the net rate a taxpayer pays if all forms of taxes are included and divided by taxable income.
The statutory corporate tax rate is the rate that is imposed on taxable income of corporations, which is equal to corporate receipts less deductions for labor costs, materials, and depreciation of capital assets. In contrast, the effective corporate tax rate (ETR) measures the taxes a corporation pays as a percentage of its economic profit. Taxable income is less than economic profit when firms can exempt some income from tax, write off the cost of assets faster than their actual decline in value, or claim tax credits for certain business purchases. When taxable income is less than economic profit, a firm’s effective tax rate is less than its statutory rate. A third tax measure is the marginal effective tax rate (METR) on new investment, which assesses how much the corporate tax reduces the rate of return on new investment and is consequently the best measure of how taxes affect a firm’s incentive to invest.
