Question

Song earns $180,000 taxable income as an interior designer and is taxed at an average rate of 30 percent (i.e., $54,000 of tax). a. If Congress increases the income tax rate such that Song’s average tax rate increases from 30 percent to 40 percent, how much more income tax will she pay assuming that the income effect is descriptive?

Additional income tax?

If the income effect is descriptive, the tax base and the tax collected will increase. true or false

Answer 1

Solution:

Current income after tax = $180,000 - ($180,000*30%) = $126,000

If the income effect is descriptive and Congress increases tax rates so that Song’s average tax rate is 40%, then Song continue to have $126,000 income after tax.

After-tax income = Pretax income (1 – tax rate)

$126,000 = Pretax income (1 -0.40)

Pretax income = $210,000

Hence song need to earn $210,000 pre tax income to have $126,000 after income tax.

Song will pay $84,000 in tax ($210,000 x 40%)

Additional income tax to be paid by Song = $84,000 - $54,000 = $30,000

Therefore, if the income effect is descriptive, the tax base and the tax collected will increase.