Effective vs. Marginal Tax Rate
What is the difference between the effective and marginal tax rate and how do you calculate them both? Which one would you use in a DCF for EBIT*(1-Tax Rate)?
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Your effective tax rate is what you pay. Your marginal is if I give you an additional $1 (and you stay in the same tax bracket) how much do you get to give to Uncle Sam.
Lets take an example: 3 tax brackets: $0-100 - 0% tax $100-$1000 - 10% tax $1000+ - 25% tax
You make $1200 (thx Donald for that Covid paycheck). Your effective tax rate is: what you paid = (1000-100)x0.1+(1200-1000)x0.25=140 and you take that and divide that by your income: 140/1200 = 11.67%
Now if you earn one more dollar you'll be taxed at 25% - thats your marginal tax rate. For companies in many cases Marginal is more or lesss equal to Effective tax rate. So you usually don't have to bother and just plug the historical Effective tax rate.
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