Marginal & Average Tax Calculations

A tax is a mandatory financial charge imposed on a taxpayer (an individual or other legal entity) by a governmental organization in order to fund various public expenditures. Failure to pay, or evasion of or resistance to taxation, is punishable by law.

It is one of the largest cash outflows that a Corporate firm experiences. The size of tax is determined through the tax schedule issued by the Central Board of Revenue. Taxes for partnerships and proprietorship are computed using the personal income tax schedules.

Average vs. Marginal Tax Rates

Average tax rate is tax bill divided by the taxable income or the percentage of the income that goes to pay taxes

Marginal tax rate is the extra tax you would pay if you earn one more dollar.

Suppose a Corporation has a taxable income of $200,000. So the Tax calculation will be:

We see that the more a firm makes, the grater is the percentage of taxable income paid in taxes. So the average tax rate never goes down, even though the marginal rate does. It will normally be the marginal tax rate that is relevant for financial decision making, since any new cash flows will be taxed at the marginal rate.