Question

What is the true income tax rate on interest income if the nominal interest rate is 8 percent a​ year, the inflation rate is 5 percent a​ year, and the tax rate on nominal interest is 25​ percent? The true income tax rate is nothing percent.

Answer 1

Answer:

66.67%

Explanation:

First, we need to calculate the Interest paid

Tax Paid = 25% x 8% = 2%

Tax paid is the nominal rate, now we need to calculate the real rate.

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

Before-tax real interest rate = 8% - 5% = 3%

True Income Tax rate = Tax paid / Before-tax real interest rate

True Income Tax rate = 2% / 3%

True Income Tax rate = 66.67%