Question

Suppose that, in an effort to reduce the federal deficit, Congress increases the top personal tax rate on interest and dividends to 35% but retains a 15% tax rate on realized capital gains. The corporate tax rate stays at 35%. Assume capital gains are 50% of equity income a. Compute the total corporate plus personal taxes paid on each $1 of debt income. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Total tax $ b. Compute the total corporate plus personal taxes paid on each $1 of equity income if all capital gains are realized immediately. (Do not round intermediate calculations. Round your answer to 4 decimal places.) Total tax $ c. Compute the total corporate plus personal taxes paid on each $1 of equity income if all capital gains are deferred forever. (Do not round intermediate calculations. Round your answer to 4 decimal places.) Total tax $

Answer 1

a). For $1 of debt income:

Corporate tax = $0

Personal tax = Personal Tax Rate * Debt Income = 0.35 * $1 = $0.35

Total Taxes = Corporate Tax + Personal Tax = $0 + $0.35 = $0.35

b). For $1 of equity income, with all capital gains realized immediately:

Corporate tax = Corporate Tax Rate * Equity Income = 0.35 * $1 = $0.35

Personal tax = [Personal Tax Rate * Weight of Dividend Income * Residual Income after Corporate Taxes] + [Capital Gains Tax Rate * Weight of Capital Gains Income * Residual Income after Corporate Taxes]

= [0.35 * 0.5 * [$1 - $0.35)] + [0.15 * 0.5 * [$1 - $0.35)]

= [0.175 * $0.65] + [0.075 * $0.65] = $0.11375 + $0.04875 = $0.1625

Total Taxes = Corporate Tax + Personal Tax = $0.35 + $0.1625 = $0.5125

c). For $1 of equity income, with all capital gains deferred forever:

Corporate tax = Corporate Tax Rate * Equity Income = 0.35 * $1 = $0.35

Personal tax = Personal Tax Rate * Weight of Dividend Income * Residual Income after Corporate Taxes

= 0.35 * 0.5 * [$1 - $0.35] = 0.175 * $0.65 = $0.11375

Total Taxes = Corporate Tax + Personal Tax = $0.35 + $0.11375 = $0.46375, or $0.4638