Suppose that in some tax year you earned a nominal interest rate of 4 percent. During the time you held these funds inflation was 1 percent. You compute that you made a real after-tax interest rate of 2 percent. What was your tax rate?

Question

Quizplus · Accepted Answer

To calculate the real after-tax interest rate, we need to subtract the inflation rate (1 percent) and the tax rate (unknown) from the nominal interest rate (4 percent). Let's assume the tax rate is x:

real after-tax interest rate = (1 + nominal interest rate - inflation rate) * (1 - tax rate)
2% = (1 + 4% - 1%) * (1 - x)
2% = 3% * (1 - x)
1 - x = 2/3
x = 1/3 = 33.3%

However, the question asks for the after-tax interest rate, so we need to subtract this tax rate from 100% and get:
after-tax rate = 100% - 33.3% = 66.7%

But the question asks for the tax rate, so we need to reverse the calculation:
tax rate = 100% - after-tax rate = 100% - 66.7% = 33.3%

This answer is not listed, but we made an assumption that the tax rate is a constant percentage. If it varies depending on the income level or other factors, the answer may be different.

Suppose That in Some Tax Year You Earned a Nominal