Question

You put money into an account and earn a real interest rate of 4 percent. inflation is 2 percent, and your marginal tax rate is 25 percent. what is your after-tax real rate of interest? group of answer choices

a. 1.5%
b. 2.5%
c. 5%
d. 4.5%

Answer 1

The after-tax real rate of interest is calculated by adjusting the real interest rate for taxes on the nominal interest. After applying the marginal tax rate to the nominal interest rate and adjusting for inflation, the resulting after-tax real rate of interest is 2.5%.

Step-by-step explanation:

The question asks us to find the after-tax real rate of interest given a real interest rate of 4%, inflation of 2%, and a marginal tax rate of 25%.

To calculate this, we must first understand that taxes are applied to the nominal interest rate, not the real interest rate.

So, we need to calculate the nominal interest rate first by adding the inflation rate to the real interest rate: 4% + 2% = 6%.

Next, we calculate the amount of interest that will be taxed by applying the marginal tax rate: 6% * 25% = 1.5%. This is the portion of interest that is taxed away.

Now, to find the after-tax real interest rate, we take the original real interest rate and subtract the taxed away portion: 4% - 1.5% = 2.5%.

Therefore, the after-tax real rate of interest is 2.5%, which corresponds to option B.