Question

Congress would like to increase tax revenues by 11.5 percent. Assume that the average taxpayer in the United State earns $62,000 and pays an average tax rate of 10 percent. a.if the income effect is in effect for all taxpayers, what average tax rate will result in a 11.5 percent increase in tax revenues? b.this is an example of what type of forecasting? Static or Dynamic

Answer 1

This analysis is an example of dynamic forecasting. Based on the information above, the average taxpayer pays $6,200 of tax (i.e., $62,000 * 10%), leaving $55,800 of income after tax. A 11.50 percent increase in revenues would mean that the average taxpayer pays $6,913 in tax ($6,200 x 1.115). With this new tax amount, we can solve for the tax rate that would generate this tax amount.

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

After-tax income = Pretax income - (Pretax income * tax rate)

After-tax income = Pretax income - Tax

Substituting information from the problem results in:

$55,800 = Pretax income - $6,913

Pretax income = $62,713

We can use the above formula to solve for the new tax rate.

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

$55,800 = $62,713 * (1 – tax rate)

Tax rate = $6,913/$62,713 = 11 %