Question

Vivian has $500,000 to invest in a bond fund. A taxable fund is expected to have a return of 5% and a non-taxable fund is expected to have a return of 3.4%. Calculate the after-tax income for each income tax rate.

	Taxable Bond Fund	Non-taxable bond fund
Tax Rate
25%
32%
45%

A. Assume Vivian is in the 25% tax bracket. Calculate the tax revenue to the government.

B. Assume the government raises tax rates so that Vivian is in the 45% tax bracket.

i. Calculate the amount of increase or decrease in Vivian's after-tax income

ii. Calculate the amount of increase or decrease in tax revenue to the government.

Answer 1

Investment - $500,000

A 1 i) Taxable Bond Fund @ 5% and Tax Rate @ 25%

Before-Tax Income - $ 500,000*5%

- $ 25,000

After-Tax Income - $ 25,000 - ($ 25,000*25%)

- $ 18,750

A 1 ii) Non-Taxable Bond Fund @ 3.4% and Tax Rate @ 25%

Before-Tax Income - $ 500,000*3.4%

- $ 17,000

After-Tax Income - $ 17,000    

A 2 i) Taxable Bond Fund @ 5% and Tax Rate @ 32%

Before-Tax Income - $ 500,000*5%

- $ 25,000

After-Tax Income - $ 25,000 - ($ 25,000*32%)

- $ 17,000

A 2 ii) Non-Taxable Bond Fund @ 3.4% and Tax Rate @ 32%

Before-Tax Income - $ 500,000*3.4%

- $ 17,000

After-Tax Income - $ 17,000

A 3 i) Taxable Bond Fund @ 5% and Tax Rate @ 45%

Before-Tax Income - $ 500,000*5%

- $ 25,000

After-Tax Income - $ 25,000 - ($ 25,000*45%)

- $ 13,750

A 2 ii) Non-Taxable Bond Fund @ 3.4% and Tax Rate @ 45%

Before-Tax Income - $ 500,000*3.4%

- $ 17,000

After-Tax Income - $ 17,000

B. Assume the government raises tax rates so that Vivian is in the 45% tax bracket.

i. Calculate the amount of increase or decrease in Vivian's after-tax income:

Answer: Decrease of $5,000 in after-tax income

ii. Calculate the amount of increase or decrease in tax revenue to the government.

Answer: Increase of $5,000 in Tax Revenue