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What Does Effective Tax Rate Mean

what does effective tax rate mean

By Dale K. Geeslin, CPA, CFE

Since last year’s Presidential election, there has been an intense interest in comparing effective tax rates. What does effective tax rate mean? To understand its meaning you must first know how it is calculated. The typical formula divides total Federal income taxes by adjusted gross income. President Obama’s 2012 rate was 18.4% while Vice President Biden’s was 22.8%. Does this seem fair since the President’s salary was $394,840 as compared to the Vice President at $225,540? What about Mitt Romney’s 2011 effective tax rate at 14.1%? And billionaire Warren Buffet lamenting that his rate is only 15% but his administrative assistant’s rate in more than 25%

One issue relates to the items not taken into consideration. The Obama’s were substantially more charitable than the Biden’s with donations of $150,034 as compared to $7,190. Mitt and Ann Romney contributed more than $4 million

dollars to charity in 2011 but decided to deduct only $2.25 million in order to maintain a self-imposed minimum tax rate of 13%. Another issue is the type or character of income. Nearly all of the income reported by Obama and Biden was from wages. However, substantially all of the reportable income for Warren Buffet and Mitt Romney was from dividends which are taxed at a favorable rate.

What does the effective tax rate analysis really mean? Not as much as most believe. In my opinion, a more meaningful conclusion is derived from going behind the rate of the four taxpayers discussed. Buffet and Romney are living off of investment income from earning assets acquired during their lifetime. Obama and Biden have nominal earning investments and live off of salaries paid for their elected positions. Draw your own conclusions as to which family has achieved more financial success.

Category: Taxes

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