Question

Which type of tax rate, marginal or average, should be used in analyzing the expansion of a product line, and why? Explain and provide an example

Answer 1

In case of analyzing the expansion of a product line,the tax rate that should be used is marginal tax rate.

Since marginal tax rate is the amount of tax paid on additional dollar of income,hence it is relevant to evaluate the expansion of a product line which generate incremental income.Avearge tax rate is not suitable as it represent total tax paid against total income.It will not help in determining the tax paid on additional income generated by new product line.

For example,if the new product line increased the total taxable income by $1000 and marginal tax rate is 10%,then its means that net income generated by new producct line is $900 [$1000*(1-0.10).