If the current yield on tax-exempt bonds is 8 percent and comparable taxable bonds carry a 12 percent yield, the break-even marginal tax rate must be 33.3 percent.

Question

Quizplus · Accepted Answer

The break-even marginal tax rate is calculated by dividing the tax-exempt yield by the taxable yield. So, 8% / 12% = 0.6667, or 66.67%. This means you would need to be in a marginal tax bracket higher than 66.67% to benefit from the tax-exempt bond. However, the question seems to have intended to ask for the calculation that determines the tax rate at which both options are equivalent in terms of after-tax yield, which is actually calculated as the tax-exempt yield divided by (1 - the tax rate) = taxable yield. The correct interpretation of the calculation to find the break-even tax rate should be: tax rate = 1 - (tax-exempt yield / taxable yield), leading to 1 - (8% / 12%) = 33.3%. My initial explanation contained a misunderstanding of the question's intent regarding the calculation for the break-even tax rate.

If the Current Yield on Tax-Exempt Bonds Is 8 Percent