Final answer:
The average tax rate is determined by dividing an individual's total tax paid by their taxable income, whereas the marginal tax rate is applied to the last dollar of taxable income, based on current tax brackets. Interest from city bonds like Birmingham Bonds is typically tax-exempt, and when investment rates vary from market interest rates, the valuation of bonds adjusts accordingly.
Step-by-step explanation:
Understanding the concepts of average tax rate, effective tax rate, and marginal tax rate is crucial in the realm of taxation. To calculate the average tax rate, one would divide the total taxes paid by the total taxable income. For instance, if an individual has a taxable income of $20,000 and pays taxes amounting to $2,581.25, the average tax rate would be 0.129, or 12.9%. This rate represents the fraction of income paid in taxes.
Marginal tax rate, on the other hand, refers to the tax rate applied to the last dollar of income. For example, if the income tax brackets are 10% for income up to $9,075, 15% for income between $9,075 and $36,900, and 25% for income beyond $36,900, an individual earning $35,000 will have a marginal tax rate of 15%, as that is the rate applied to their highest bracket of income.
When considering investment in city bonds, such as Birmingham Bonds, the interest earned is often tax-exempt, which won't affect the calculation of taxable income. In case of existing market interest rates, for instance at 12%, an investor would expect to pay less for a bond offering less than the market interest rate. A $1,000 bond with a final year payout of $1,080 (including principal and final interest payment) would only be worth $964 if discounted at the market interest rate of 12%.