Internal, External and Effective Tax Rates: Understanding the Differences

​In the world of taxation, the terms "internal" and "external" rates describe how the tax is calculated.  

​

1. The Internal Rate (Tax-Inclusive)

Definition: An internal rate calculates the tax as a percentage of the total amount (the Gross). The tax is "inside" the number you start with.  Federal income rates are internal rates and the FAIRtax rate of 23% is an internal rate.

Federal Income Tax

If you are in the "24% tax bracket," the government takes 24% of your Gross Income from your salary. 

​Assume these facts:
 

• Your salary is $100,000
• Your top tax bracket is 30% on the last amounts you earned
• Because portions of your income are taxed starting at 10% and then at increasing rates you owe $20,000 in federal income taxes
• $20,000 is taken from your salary leaving you $80,000
• Payroll taxes reduce the $80,000 by another $7,650
• So, federal taxes consumed $27,650 of your $100,000 income.   
• This is an effective rate of 27.65%.

In the case of the FAIRtax, the internal rate is 23%. 
 

• For every dollar you spend on the retail purchase of new goods and services, $.23 is the FAIRtax share and $.77 is the amount you apply to the cost of the purchase.
• If you are spending the entire $100,000 on  new  retail goods and services, $77,000 will go to the retailers, and $23,000 in FAIRtax goes to the government.
• In that case, the FAIRtax comprised $23,000 of the $100,000 you spent.  That’s an effective (internal) rate of 23%.

​2. The External Rate (Tax-Exclusive)

​Definition: An external rate tax is not included in the price of an item.  It is added onto a base amount.

State sales taxes as we know them are external rate taxes.
 

• If you make a $5 purchase in a state with a 5% external sales tax, the price tag on the item will say $5.  The tax will be 5% of $5, or 25 cents.  The tax is then added to the purchase price bringing your total cost at the register to $5.25.
• Quoted as an external rate, the FAIRtax is 30%.
• You pay the retailer $5 and $1.50 FAIRtax will be paid by the retailer to the government.
• Expressed as a percentage of the $5 the retailer keeps, the FAIRtax amount of $1.50 is 30%, but expressed as a percentage of the $6.50 total you paid, the FAIRtax is 23%.

Income Tax

Here is an example of the external rate calculation for the same $5 purchase under the income/payroll tax.
 

• Assume a family making $63,128, the median income for 2025.
• The combined income/payroll tax rate is 23%.
• You divide 0.23 / (1 - 0.23) and you get 0.30 (or 30%). 
• To have the $5 net after withholding, you multiply $5 x 1.30 =$6.50.
• So, in order to get the $5 you need to make your purchase, you must earn $6.50.
• This is the same cost to the family as the FAIRtax.
• When you do this calculation, you see that you are already paying a “sales tax” because you can only make purchases from your net income.

 

3. The Effective Rate

​Definition: The actual percentage of your total income that goes to the IRS.

The Effective Tax Rate is the most practical number for a taxpayer when understanding the real impact of the income/payroll tax and comparing it to other options—like the FAIRtax.

Income/Payroll Tax Examples

Single Person

Federal Income Tax
 

• Assume a single person with $116,100 in gross income. 
• The calculation is:

• Deduct $16,100—the standard deduction
• This leaves a taxable income of $100,000
• 10% on the first $11,600 = $1,160
• 12% on income between $11,601 and $47,150 ($35,550) = $4,266
• 22% on income between $47,151 and $100,000 ($52,850) = $11,627
• Total Federal Income Tax: $17,053

Federal Payroll Taxes

$116,100 times 7.65% is $8,882 of federal payroll taxes.

This person will pay $17,053 in income tax plus $8,882 in payroll taxes for a total tax of $25,935.

Divide that $25,935 by the gross income of $116,100 and you get an effective tax rate of 22.34 percent.   That’s how much of this person’s total income was consumed by federal taxes.

Married Couple
 

• Assume a married couple with two children earns $70,000 a year
• The calculation is:

• Subtract the standard deduction of $35,100 leaving $34,900 in taxable income
• 10% of the first $23,850 = $2,385
• 12% of the remaining $11,050 = $1,326
• Total Tax: $3,711

Tax Credits
Child Tax Credit (CTC):

• $2,200 per child = $4,400.
• The first $3,711 of the credit wipes out the tax liability completely.
• $4,400 – 3,711 of income taxes owed = $689 refunded to the family.
• Final Federal Income Tax is a refund of $689

 

The payroll taxes are $70,000 x 7.65% = $5,355

The total federal income/payroll taxes owed is $5,355 minus the $689 refund = $4,666.

$4,666 in total federal taxes divided by the $70,000 gross income yields an effective tax rate of 6.67%.

The single person making $116,100 has an effective tax rate of 22.34% and the family of four making $70,000 has an effective federal tax rate of 6.67% under the income/payroll tax system.


FAIRtax Effective Tax Rate Compared to the Federal Income/Payroll Tax Effective Tax Rate

Once the FAIRtax is enacted, the single person making $116,100 receives his/her entire paycheck.  Let’s calculate this person’s effective FAIRtax rate.
 

• Assume this person spends his/her entire  income on new goods and services.
• 23% of $116,100 is $26,703.  This is the total amount of FAIRtax this person will pay at the cash register.
• The FAIRtax Family Consumption Allowance for a single person household is $15,960.  This is the amount of spending that is not subject to being taxed.
• 23% of $15,960 is $3,671.  That’s how much of the tax this person paid at the register will be refunded in the prebate.
• $26,703 minus $3,671 is $23,032.  That’s how much FAIRtax this person pays out of his/her own pocket
• Divide the $23,032 by the total spending of $116,100 and you get an effective FAIRtax rate of $19.84%   That’s 2.5% less than the 22.34% effective rate under the income/payroll tax system.
• The actual FAIRtax rate will be lower since it’s extremely unlikely that this person will spend his/her entire income on new retail goods and services.

When the FAIRtax is passed, a married couple with two children earning $70,000 a year also receives their entire paycheck. 
 

• Again, assume this family spends their entire income on new retail goods and services.
• 23% of $70,000 is $16,100. This is how much FAIRtax this family will pay at the cash register.
• The Family Consumption Allowance for a family of two adults and two children is $43,280.  This is how much the family can spend tax free
• 23% of $43,280 is $9,954.  This is the amount of their refund (prebate).
• $16,100 minus $9,954 is $6,146.  This is how much FAIRtax this family pays out of their own pocket.
• Divide that $6,146 by total spending of $70,000, and you get an effective FAIRtax rate of 8.7%.  This is actually slightly higher than the 6.67% income/payroll tax rate.
• Again, the actual rate will be lower since it’s quite unlikely that they will spend every penny they make on new retail goods and services.

Conclusion
 

Family Size	Income	Income/Payroll Tax Effective Rate	FAIRtax Effective Rate
1	$116,000	22.34%	19.84%
4	$70,000	6.67%	8.7%

While the effective tax rate for the couple making $70,000 is 2.03% lower today under the income/payroll tax, this comparison assumes:
 

• The present child tax credits remain in place
• If the $4,400 child tax credit was eliminated, the family would have an effective rate of $9,066 divided by $70,000 or 12.95%.
• The family is spending all their money on new retail goods and services.
• This is seldom the case.
• Assume the family spends $10,000 a year for payments on used cars, used furniture and other used goods. 
• Used goods are not subject to the FAIRtax.
• This will reduce the total amount paid under the FAIRtax to $3,840. 
• The effective rate is reduced from 8.7% to 5.4%--less than the 6.67% under the income/payroll tax.

Embedded Income/Payroll Taxes

This also does not factor the increase in purchasing power when the embedded costs of the income/payroll tax are removed from the price of the goods and services they purchase. 
 

• Assume that prices will only reduce 10%--not the 15% to 20% predicted by economists.
• The family of four making $70,000 will be able to purchase $77,000 worth of goods and services.
• The effective rate of the FAIRtax for that family will be even further reduced. 
• $3,840 divided by $77,000 is reduced to 5%.
• The same analysis applies to the single person.

While all alternatives to the income/payroll tax system need to be carefully examined, the best alternative is the FAIRtax, a national retail sales tax on new retail goods and retail services which provides a family consumption credit so that all purchases up to the poverty level for each family are not taxed.

There is no withholding from your paycheck and YOU NEVER HAVE TO FILE A TAX RETURN TELLING THE GOVERNMENT HOW MUCH YOU EARNED AND HOW MUCH YOU SPENT, AND YOU’LL NEVER BE HARASSED BY THE IRS EVER AGAIN.

Many of you have labored tirelessly for freedom from the federal income tax and the IRS.  You deserve a great deal of credit for your efforts to educate the American people on the need to fund the American government in a way that is good for America and returns freedom to the American people.

It is imperative, though, that we don’t replace the current income tax and the IRS with an alternative system that can still be manipulated by the Ruling Elite.  We must let Congress and the President know that the best way to replace the income tax and the IRS is with the FAIRtax. 

Make no mistake about it.  The FAIRtax is a grave threat to the Ruling Elites.  It will strip them of their power and their ability to control us though the tax system.  Their opposition to the FAIRtax will be fierce and unrelenting.  And don’t think for an instant that they won’t use half-truths, deception and downright lies in their desperate attempt to hang on to their power. 

However, with the support of this President, we can finally eliminate the income tax and the IRS!!!

Of course, the best course of action is to not only repeal the income tax and abolish the IRS but to repeal the 16^th Amendment as well so no future administration can ever shackle the American people with an income tax again.

We must come together and ensure that real tax reform, the FAIRtax, is not subverted by the Elites in D.C.

This will take the diligent efforts of all of us.  We need your financial assistance, and we need your grass roots assistance.

If you have contacts that will allow us to get more information to President Trump about the FAIRtax please let us know.

Please email us at info@fairtax.org and we will give you some options on how you can best help us. 

At a minimum, please call your Congressional representative and ask if he or she supports the FAIRtax.  If so, thank him/her for their support and suggest they become a cosponsor of HR-25 if they’re not one already.  If not, ask why not.  If your representative claims to be unfamiliar with the FAIRtax, offer to have someone come to their office and explain it to them. 

Please go to this link to invest in AFFT and help us pass the FAIRtax.  It’s an investment in your and your family’s future. 

THE SOLUTION—PASS THE FAIRTAX!

Why would D.C. pass the FAIRtax and give up this almost unlimited source of donations?  The only way that they will is if the rest of us demand it!
  
Isn’t it time to end this ludicrous tax collection system and the IRS?

HELP BRING ABOUT REAL TAX REFORM AND STOP FUTURE IRS ABUSES

By contributing (investing) $10.40 per month, you help provide a financial base to AFFT.  If you can make larger contributions (investments), these will be used not for salaries, as we are all volunteers, but for the needed updates to our economic studies which will be vital for all future years.
 
Please go to this link to invest in AFFT and help us pass the FAIRtax.  It’s an investment in your and your family’s future.