Lara, a single taxpayer with a 30 percent marginal tax rate, desires health insurance. The health insurance would cost Lara $5,000 to purchase if she pays for it herself (Lara's AGI is too high to receive any tax deduction for the insurance as a medical expense). Lara's employer has a 40 percent marginal tax rate. Ignoring payroll taxes, what is the maximum amount of before-tax salary Lara would give up to receive health insurance?

Question

Quizplus · Accepted Answer

Since Lara has a 30 percent marginal tax rate and the health insurance costs $5,000, Lara's after-tax cost of health insurance is $3,500 ($5,000 x (1 - 0.30)). If Lara gives up some before-tax salary to receive health insurance through her employer, she will save taxes on the amount she gives up. Therefore, she would be willing to give up before-tax salary up to the point where the tax savings equal $3,500. The additional before-tax salary that she gives up is subject to a 40 percent tax rate, so the amount she gives up is: $3,500/0.6 = $7,143. This means Lara can give up up to $7,143 of before-tax salary to receive the health insurance and still be better off than if she purchased the health insurance herself.

Lara, a Single Taxpayer with a 30 Percent Marginal Tax