Question

A taxpayer is in a 33-percent tax bracket and itemizes deductions. He obtains a mortgage from a bank at 9-percent interest. The actual rate of interest he pays is: a. 6 percent. b. 9 percent. c. 20 percent. d. 25 percent The reduction in marginal tax rates will: a. increase the excess burden of tax preferences. b. increase tax expenditures. c. decrease the excess burden of tax preferences. d. have no effect of tax expenditures.

Answer 1

Taxpayer Tax bracket: 33%

Mortgage interest rate: 9%

As interest Paid can be claimed as deduction from the income the tax expenditure will be decreased, which can be termed as savings in interest paid on the mortgage and the effective tax rate will be -

Effective rate of interest = 9% - (9%*33%) = 6.03%

So this will have an effect on tax expenditures i.e Decrease in tax expenditures.

If there is an reduction in the marginal tax rates the savings on the interest paid will be less which effectively increase the excess burden of tax preferences.

For example, if tax rate is 33% and mortgage rate is 9% interest savings will be 2.97%. if tax rate is reduced to 20% then interest savings will be 1.08% which increases the tax burden.