Question

You put money into an account that earns a 5 percent nominal interest rate. The inflation rate is 2 percent, and your marginal tax rate is 20 percent. What is your after-tax real rate of interest?

Answer 1

Answer:

The after tax real interest rate of interest is 2%

Explanation:

The after tax real interest rate is computed as follows:

Given,

Nominal interest rate is 5%

Inflation rate is 2%

Computing before tax real interest rate as:

Before tax real interest rate = Nominal interest rate - Inflation rate

= 5% - 2%

= 3%

Computing tax:

= 20% tax on nominal interest rate

= 20% × 5%

= 1%

Now, computing after tax real interest rate as:

After tax real interest rate = Before tax real interest rate - Tax

= 3% - 1%

After tax real interest rate = 2%