Question

In Econoland in 2005, people with incomes between $20,000 and $30,000 paid 12 percent of their income in taxes and people with incomes between $30,001 and $40,000 paid 15 percent. In 2005, the CPI in Econoland equaled 1.20, and it increased to 1.26 in 2006. If the government of Econoland wants to keep households with a given real income from being pushed up into a higher tax bracket by inflation, the $20,000-to-$30,000 bracket will be changed in 2006 to:

Multiple Choice

• $15,873 to $23,810.

• $21,000 to $31,500.

• $24,000 to $37,800.

• $25,200 to $37,800.

Answer 1

Inflation adjustment of the income tax bracket.

In 2005, the income bracket is $20000 to $ 30000

CPI in 2005 was 1.20

CPI in 2016 is 1.26

Inflation adjustment (Change in the income bracket $20000 - $30000 in 2006)

(Income in 2005) * (CPI in 2006 / CPI in 2005) [Formula]

Lower limit of Income bracket = ($20000) * (1.26/1.20)

Lower limit of income bracket = $21000

Upper limit of income bracket = ($30000) * (1.26/1.20)

Upper limit of income bracket = $31500.

Answer: Option (B) i.e., $21000 to $31500.