Question

You put money into an account and earn a real interest rate of 4 percent. Inilation is 2 percent, and your marginal tax rate is 25 percent. What is your after-tax real rate of interest?

a. 1.5 percent b. 2.5 percent c. 5.0 percent d. 4.5 percent

Answer 1

The after-tax real interest rate, given a nominal rate of 4%, inflation of 2%, and a marginal tax rate of 25%, would be 1%. However, this option is not provided in the choices, indicating a potential mistake in the question.

Step-by-step explanation:

The student asked what their after-tax real rate of interest would be given they have a nominal interest rate of 4 percent, an inflation rate of 2 percent, and a marginal tax rate of 25 percent.

To calculate the after-tax real interest rate, we must first understand that the real interest rate is the nominal interest rate corrected for the effects of inflation. In this case, the real interest rate before taxes would be 4% - 2% = 2%.

Next, we determine the after-tax nominal interest rate by considering the marginal tax rate: 4% * (1 - 25%) = 3%. Finally, we adjust this after-tax nominal interest rate for inflation to find the after-tax real interest rate, which would be 3% - 2% = 1%.

Since none of the answer choices match this calculation, there might be a possibility that the question contains a typo or error. However, based on the given information and typical calculations, the correct after-tax real interest rate would be 1%, which is not listed among the choices provided.

Answer 2

The after-tax real rate of interest is 2.5%.

Step-by-step explanation:

The after-tax real rate of interest is calculated by adjusting the nominal interest rate for inflation and then accounting for taxes.

We are provided with information that

Real interest rate: 4%

Inflation rate: 2%

Marginal tax rate: 25%

Calculations:

Nominal Interest Rate (before taxes):

Nominal interest rate = Real interest rate + Inflation rate

Nominal interest rate = 4% + 2% = 6%

After-Tax Nominal Interest Rate:

After-tax nominal interest rate = Nominal interest rate × (1 - Tax rate)

After-tax nominal interest rate = 6% × (1 - 0.25) = 6% × 0.75 = 4.5%

Therefore, the after-tax nominal interest rate is 4.5%.

After-Tax Real Rate of Interest:

The after-tax real rate of interest = After-tax nominal interest rate - Inflation rate

After-tax real rate of interest = 4.5% - 2% = 2.5%

Hence, the after-tax real rate of interest is 2.5% (option b)