How income may change savings behavior

Assignment Help Macroeconomics
Reference no: EM132033

Question 1: The lecture described how taxing income may change savings behavior. Suppose instead that the government taxed consumption.

To be specific, suppose we have a two-period model. An individual earns labor income Y0 =$100k at time zero, and earns no labor income at time 1. The individual may consume or save that income. Savings grow at rate r=.03. For every dollar of consumption, the individual pays the tax rate τ=.30 to the government.

a. Graph the two-period budget constraint for consumption. What is the slope? Is this tax distortionary?

b. The government modifies the consumption tax somewhat so that the first $20k of consumption in each period is tax free.  Now graph the budget constraint.

Question 2: Claim: "The Mortgage Interest Tax Deduction is a regressive policy.  A simpler, better policy that could achieve the same goals would be a home ownership tax credit that applies equally to all homeowners regardless of income or the value of the home."  In a mini-essay (300 words) state whether you agree or disagree with that claim and explain your reasoning.

Question 3: In lecture, we assumed that when a homeowner borrows, the entire the value of a home would be borrowed.  In fact, a borrower would need to put a "down payment" on the mortgage - a cash payment up front for part of the value of the home.  An additional simplification of the lecture was to not take into account the fact that for a mortgage you pay the interest + some fraction of the principal.  This is so at the end of the loan all the money borrowed will have been repaid. Take a look at the following mortgage calculator linked below to help answer the following.

The value of the property is $500k, the interest rate is 3% (approximately the correct interest rate as of this writing), and the length of the loan is 30 years (360 months).   The marginal tax rate for the homeowner is 33%. Leave other values on the table at the default settings.  Assume the individual has $500k cash on hand, and any of this money that remains after taking the mortgage/making mortgage payments is invested at the interest rate 3%.  The value of the property also grows at rate 3% per year, and this growth is not taxed.  This means that as the borrower repays the loan and starts building principal, the value of that principal goes up at the same rate as other investments.  Finally, assume that the year's mortgage payment is paid to the bank from cash on hand at the START of the year.  This turns out to be important if we want to make comparisons.

i. Suppose there is no MITD, and the homeowner borrows the full value of the property. For the first year:

a) How large is the annual mortgage payment? How much interest has been paid on the mortgage?

b) How much principal has been accumulated by the borrower?  What is the value of the principal at the end of the year?

c) The amount of the annual mortgage payment from part a) was paid at the beginning of the year.  That reduces the cash available to invest.  How much cash gets invested? What is the pre-tax value of the cash investment at the end of the year?  How much tax is owed on this investment?  What is the after-tax value of the investment after one year?

d) Add up the values of all the investor's assets at the end of year one.   How has this value changed over the year?

ii. Suppose there is a MITD, the homeowner borrows the full value of the property.

iii. Not surprisingly, you hopefully saw in ii that the deduction is a boon to the homebuyer.  Now, suppose the buyer makes a down payment of 20%, or $100k.  Assume the MITD is not available. She invests the remaining cash at 3%.  Repeat a-d from part i. in this case.

iv. Once again, suppose the buyer makes a down payment of 20%.  Assume the MITD is available.

v. Comment on/compare your results for the different cases.

Question 4. A corporation produces output with a market price of $200 per unit.  The marginal product of capital is 1/(2K), where K is units of capital, with each unit assumed to cost $1.  (So when we talk about capital in this problem, units and $ value are equivalent.)  The life span of the capital is 5 years, implying the straight line depreciation rate δ=.2.  The financing cost of capital is ρ=.05.

a. If depreciation and financing costs are not included in accounting costs, what is the optimal level of capital for the firm?

b. If the corporate tax is 35%, what is the optimal level of capital?

c. If depreciation at a rate δ=.2 is included in accounting costs, what is the optimal level of capital? [Hint: remember to calculate the present value of the deduction.  Use .05 for the discount rate.]

d. For c., what is the effective corporate tax rate?

e. The firm is going to borrow the money for its capital purchases.  The interest paid on the debt can be added to accounting costs.  Suppose it turns out that the present value of this expense is .10 for every dollar of capital purchased.  What is the optimal level of capital now?

f. For e., what is the effective corporate tax rate?

Reference no: EM132033

Previous Q& A

  Multiple regression analysis

Multiple regression analysis based on the assumptions of linearity and normality.

  Entrepreneurship and capital venturing

Describe the Schumpeterian notion of "creative destruction"

  Determine distribution of shear force and bending moment

Determine distribution of shear force and bending moment

  Describing the purpose of database an its functionality

Describing the purpose of database an its functionality, plus a detailed E-R diagram.

  The total inventory holding cost for the plan

The total inventory holding cost for the plan

  Find out about your company''s forecasting system

Find out about your company's forecasting system

  Design and implement a small and simple email server

Design and implement a small and simple email server

  Traditional view of business responsibility

Traditional View of Business Responsibility

  Formulate a reasonable investment policy statement

Formulate a reasonable Investment Policy Statement

  Compute the eigenvalues and eigenvectors of the matrix

Compute the eigenvalues and eigenvectors of the matrix


Write a Review


Similar Q& A

  In using the taylor rule

In using the Taylor Rule as a guideline for monetary policy, what are the pros and cons of using forecasted values of inflation and output rather than observed values of these variables?

  Prepare a project summary

Overview of the project's objectives and scope

  Application of nash equilibrium and game theory

Application of Nash Equilibrium and Game Theory with examples

  Macroeconomics fourth canadian edition

Answer the following questions as these general questions pertain to the specific issue selected.The questions that you will cover with respect to your choice of broad social issue in the paper are given.

  Canadian economy

When the Bank of Canada sells the government bonds to a commercial bank, the commercial bank experiences a decline in reserves and in increase in bonds. Total assets are unchanged; this is just a portfolio switch between bonds and cash.

  Capital structure decisions in perfect capital markets

In a perfect capital market, advices for  a corporate financial manager on making capital structure decisions.

  Derive and compare demand curve

Question based on Derive and compare demand curve,  Derive Ambrose's demand function for peanuts. How does it compare with Johnny's demand curve for peanuts?

  Which of the happing tends to occur during recessions

Which of the followings tends to occur during recessions Cyclical unemployment tends to fall The stock markets tends to surge (experience a rapid rise in prices) Interest rates tend to fall Gross Domestic Product rises Consumer ..

  Find out the real wage rate

Plot the wage- setting and price setting equation or a property labelled graph and identity the nature rate of unemployment.

  Market imperfection associated with negative externalities

An essay on Market imperfection associated with negative externalities.

  What is bill''s opportunity cost of producing one hat

What is Bill's opportunity cost of producing one hat, In which of the two activities does Mary have a comparative advantage.

   Problem on standard deviation

Problem on standard deviation

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd