Excludable forms of income Interest on state and local bonds llustration Equal gains and losses what rate of return should it offer? dise $100.000 If the state government needs to ra It should offer a return r= 14, 4%. because it can induce the high income people to supply enough capital How much does the state government save? Instead of paying r=20% on $100,000, it instead pays r=144%, saving5.6%X$100,000or$5,600 How much does the federal government lose? The federal government would have collected taxes on interest of $20,000(20%x$100,000). It therefore loses 28%X$20,000=$5,600 16
16 Excludable Forms of Income: Interest on State and Local Bonds • Illustration: Equal gains and losses – If the state government needs to raise $100,000, what rate of return should it offer? • It should offer a return r=14.4%, because it can induce the high income people to supply enough capital. – How much does the state government save? • Instead of paying r=20% on $100,000, it instead pays r=14.4%, saving 5.6%x$100,000 or $5,600. – How much does the federal government lose? • The federal government would have collected taxes on interest of $20,000 (20%x$100,000). It therefore loses 28%x$20,000=$5,600
Excludable forms of income Interest on state and local bonds lustration: Unequal gains and losses If the state government needs to raise S325,000, What rate of return should it offer? It should raise the return to r=17%. because it must also induce the moderate income group to provide capital The high income group(which provides $250,000 of capital) receives some economic rents because it would have provided the capital for r=14.4% 17
17 Excludable Forms of Income: Interest on State and Local Bonds • Illustration: Unequal gains and losses – If the state government needs to raise $325,000, what rate of return should it offer? • It should raise the return to r=17%, because it must also induce the moderate income group to provide capital. • The high income group (which provides $250,000 of capital) receives some economic rents because it would have provided the capital for r=14.4%
Excludable forms of income Interest on state and local bonds llustration: Unequal gains and losses How much does the state government save? Instead of paying r=20%on $100,000, it instead pays r=17%, saving3%x$325,000or$9,750 How much does the federal government lose? From the high income group, the federal government would have collected taxes on interest of $50,000 20%x$250,000). It therefore loses 8%X$50,000=514,000 From the moderate income group the federal government would have collected taxes on interest of $15,000(20%x$75, 000).It therefore loses 15%X$15,000=$2,250 18
18 Excludable Forms of Income: Interest on State and Local Bonds • Illustration: Unequal gains and losses – How much does the state government save? • Instead of paying r=20% on $100,000, it instead pays r=17%, saving 3%x$325,000 or $9,750. – How much does the federal government lose? • From the high income group, the federal government would have collected taxes on interest of $50,000 (20%x$250,000). It therefore loses 28%x$50,000=$14,000. • From the moderate income group, the federal government would have collected taxes on interest of $15,000 (20%x$75,000). It therefore loses 15%x$15,000=$2,250
Excludable forms of income Interest on state and local bonds Ilustration: Unequal gains and losses The state government saves $9, 750 in interest payments The federal government loses $16, 250 in tax collections The net effect of tax exempt bonds is zero only for those investors who are just on the margin of choosing tax-exempt versus taxable securities 19
19 Excludable Forms of Income: Interest on State and Local Bonds • Illustration: Unequal gains and losses – The state government saves $9,750 in interest payments – The federal government loses $16,250 in tax collections • The net effect of tax exempt bonds is zero only for those investors who are just on the margin of choosing tax-exempt versus taxable securities
Excludable forms of income Some Dividends In 2003, legislation was passed which lowered the maximal tax rate on dividends to 15% Previously, it was taxed as ordinary Income
20 Excludable Forms of Income: Some Dividends • In 2003, legislation was passed which lowered the maximal tax rate on dividends to 15%. • Previously, it was taxed as ordinary income