Excludable forms of income Interest on state and local bonds For example, if the return in the private market is r, then investors will purchase state bonds as long as the return is higher than (1-t)r, where t is the marginal tax rate on investment income
11 Excludable Forms of Income: Interest on State and Local Bonds • For example, if the return in the private market is r, then investors will purchase state bonds as long as the return is higher than (1-t)r, where t is the marginal tax rate on investment income
Excludable forms of income Interest on state and local bonds The state save money(by paying less interest) while the federal government loses(by collecting less tax revenue) It is not usually the case that the states gains exactly offset the federal government's losses- it will usually be the case that the federal governments loss is greater 12
12 Excludable Forms of Income: Interest on State and Local Bonds • The state save money (by paying less interest) while the federal government loses (by collecting less tax revenue). • It is not usually the case that the state’s gains exactly offset the federal government’s losses – it will usually be the case that the federal government’s loss is greater
Excludable forms of income Interest on state and local bonds · lllustration Suppose the private market return is r=20% Progressive tax system · Low income-t=0% Moderate income -t=15% High income -t=28% 13
13 Excludable Forms of Income: Interest on State and Local Bonds • Illustration – Suppose the private market return is r=20% – Progressive tax system • Low income – t=0% • Moderate income – t=15% • High income – t=28%
Excludable forms of income Interest on state and local bonds ·| lustration With this information, the return necessary to induce a person to invest in the state bond is (1-tLowr= 20% for low income group (1-tMoD)r=17% for moderate income group (1-tHiGHr= 14.4% for high income group Thus, people in higher tax brackets are more likely to benefit from buying state bonds 14
14 Excludable Forms of Income: Interest on State and Local Bonds • Illustration – With this information, the return necessary to induce a person to invest in the state bond is: • (1-tLOW)r = 20% for low income group • (1-tMOD)r = 17% for moderate income group • (1-tHIGH)r = 14.4% for high income group • Thus, people in higher tax brackets are more likely to benefit from buying state bonds
Excludable forms of income Interest on state and local bonds · lllustration Assume each group has some amount of capital that can be invested in either a private bond or state bond (each with equal riskiness) Low income: $100, 000 to invest Moderate income: $75,000 to invest High income: $250,000 to invest 15
15 Excludable Forms of Income: Interest on State and Local Bonds • Illustration – Assume each group has some amount of capital that can be invested in either a private bond or state bond (each with equal riskiness). • Low income: $100,000 to invest • Moderate income: $75,000 to invest • High income: $250,000 to invest