What it means
Most people focus on income tax, but it is only one of many taxes. A household also pays sales tax or value added tax when it shops, property tax on a home, payroll contributions for social insurance and perhaps taxes on fuel, vehicles and savings.
For a business, the picture is wider still. Corporate income tax, employer payroll taxes, customs duties, property taxes, sales or VAT collected for the government, and industry-specific levies all add up, and some are paid out of the business's own profit while others are collected from customers and passed on.
Adding them up matters because the single tax rate in the headlines rarely tells the whole story. A person on a modest salary may pay little income tax but a lot in payroll and consumption taxes, so total tax gives a better measure of what the government actually takes.
The total tax is usually expressed as an overall rate, sometimes called the total tax rate or total tax burden, by dividing it by income or profit. For businesses, this ratio is useful when comparing locations for a new factory or office, because the lowest corporate rate does not always mean the lowest overall cost.
It should also be kept separate from the effective income tax rate, which looks only at income tax paid relative to income. Total tax includes taxes that do not depend on income at all, such as property tax, so it is nearly always a larger number.
Rules and rates are set by tax authorities and change often, and treatment differs by country, so planning should rely on up-to-date local advice. The principle of adding everything together does not change, however.
In practice
Real-world examples.
Example
A freelance designer earning $90,000 reviews her tax for the year. After adding income tax, self-employment contributions and property tax, she discovers that her overall burden is much higher than the income tax line on her return.
Example
A restaurant owner adds corporate tax, employer payroll taxes, property tax on the premises and sales tax collected from diners. The total figure shows that taxes consume a larger share of revenue than he realised.
Example
A manufacturer comparing two sites for a new plant finds that one has a lower corporate tax rate but higher property and payroll taxes. The total tax for the second site is lower, so it is chosen.
Formula
Calculation
Total tax = Income tax + Payroll tax + Sales tax + Property tax + Other taxes
Overall tax rate = Total tax / Gross income
Suppose a household has gross income of $170,000 in a year. It pays $18,000 in income tax, $9,000 in payroll taxes, $4,000 in property tax and $3,000 in sales taxes on purchases. Total tax = 18,000 + 9,000 + 4,000 + 3,000 = $34,000. Overall tax rate = 34,000 / 170,000 = 20%, whereas income tax alone is only 18,000 / 170,000 = 10.6%.Case study
Seen in the real world.
Thornfield Engineering is an illustrative, fictional company with annual profit before tax of $2,000,000 that was considering a new factory in one of two regions. Region A advertised a corporate tax rate of 15%, while Region B advertised 22%.
The finance team built a total tax estimate for each site. Region A had corporate tax of $300,000, but also property tax of $250,000 and employer payroll taxes of $400,000, a total of $950,000. Region B had corporate tax of $440,000, property tax of $90,000 and payroll taxes of $320,000, a total of $850,000.
The illustrative conclusion was that Region B, despite the higher headline rate, cost $100,000 a year less in tax. The lesson is that site decisions should compare the full tax burden and not just the headline corporate rate.
Watch out
Common mistakes.
- Looking only at the income tax rate and ignoring payroll, property and consumption taxes.
- Forgetting taxes that a business collects for the government, which affect cash flow and administration even though they are not a cost of the business.
- Comparing the total tax of two years without adjusting for changes in income, which makes the burden look like it changed when it did not.
Questions
People also ask.
Is total tax the same as the effective tax rate?
Not exactly, because the effective rate usually refers to income tax divided by income, while total tax includes all taxes, so the overall rate is typically higher.
Do businesses include sales tax in total tax?
It depends on the purpose, since sales tax collected from customers is not a cost to the business but must be handled in the accounts, while sales tax paid on purchases can be a real cost.
How can total tax be reduced legally?
Through tax planning such as using allowances, deductions, credits and tax-advantaged accounts, and by choosing structures and locations with care, with advice from a qualified adviser.
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