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Tax Law & Foundations
Tax Law & Foundations
Solved Problems
Solved Problems
.City of Heflin (Municipal Bond)
After-Tax Return: Since it is tax-exempt, the return is simply the interest rate.
330,000 x 4.8% = $15,840
Return Rate = 4.8%
Explicit Tax: Municipal bonds have no federal tax.
$0
Implicit Tax: This is the interest you give up by choosing the lower-paying tax-free bond.
(8% Corporate Rate - 4.8% Municipal Rate) = 3.2%
330,000 x 3.2% = $10,560
2. Surething Inc. (Corporate Bond)
Explicit Tax: The tax paid on the higher interest.
330,000 x 8% = $26,400 (Total Interest)
26,400 x 40% Tax Rate = $10,560
After-Tax Return: The money left after paying the tax.
$26,400 Interest - $10,560 Tax = $15,840
$15,840 / $330,000 = 4.8%
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Hugh chooses the City of Heflin bond because 7.9% is a higher return than 6.54%.
Investment Amount: $330,000 (Total Principal)
Municipal Bond Rate: 7.3% (State of New York)
Corporate Bond Rate: 10.3% (Surething Inc.)
Marginal Tax Rate: 30%
Corporate After-Tax Yield: 10.3% x (1 - 0.30) = 7.21%
Comparison: 7.3% (Muni) is greater than 7.21% (Corporate)
Final Decision: Fergie earns more with the State of New York bond.
Original Tax Paid: 155,000 x 30% = 46,500
Original Take-Home Pay: 155,000 - 46,500 = 108,500
New Gross Income Needed: 108,500 / 0.60 = 180,833.33
New Total Tax Paid: 180,833.33 x 40% = 72,333.33
Calculation for Increase: 72,333.33 - 46,500 = 25,833.33
Final Additional Tax: 25,833.33
Marinal Income: $155,000 provides a specific standard of living.
Tax Rate Hike: The increase from 30% to 40% threatens that lifestyle.
The Income Effect: Song reacts by working harder to maintain her net pay.
Tax Base: Because she earns more ($180,833 vs. $155,000), the tax base increases.
Tax Revenue: Since the rate is higher and she is earning more, revenue increases.
Comparison: This is the opposite of the "substitution effect," where people work less.
Final Answer: The statement is true.
Current Tax Revenue: 41,000 x 25% = 10,250
Target Revenue Increase: 6% increase on 10,250
= 615
New Total Revenue Goal: 10,250 + 615 = 10,865
Income Effect Logic: Taxpayers work more to keep their after-tax income (30,750) constant.
Calculation for New Rate: 10,865 / (30,750 + 10,865)
Math Result: 10,865 / 41,615 = 26.108...%
Final Answer: Round to 2 decimal places = 26.10%
Initial Base & Revenue: Earnings of $41,000 at a 25% rate generated $10,250 in tax.
Revenue Growth Goal: A 6% increase adds $615, bringing the new target to $10,865.
Constant Net Income: To keep after-tax pay at $30,750, the new gross income must be $41,615.
Calculated Tax Rate: $10,865 divided by the new base of $41,615 equals 26.10%.
Behavioral Shift: The "Income Effect" causes the taxpayer to earn $615 more to cover the tax hike.
Forecasting Method: Because it accounts for this change in the tax base, it is Dynamic Forecasting.
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