Chapter 14, Problem 3DQ

To determine

The incentive to find loopholes to reduce the federal tax liabilities and its difference from 91% federal personal income tax bracket to 15% federal personal income tax bracket.

Concept introduction:

Marginal income tax rate:

It is defined as the amount of tax paid on every external dollar of income. When the income rises, the marginal tax rate of a person also rises. This means that the person with low income are taxed low and those with high income are taxed high.

Federal income tax rate:

It is a type of progressive tax which is imposed by the federal government, states, and the local body in the United States. This means that as the income increases, the tax rate also increases.

Explanation:

• When the federal tax is 91%, then the people would try to find every possible way to evade taxes. During 1951, 91% of the federal tax meant for every additional income of $1,91 cents were paid as tax and only 9 cents were left as disposable income.

• This meant that the cost associated with the tax evasion is less than the benefit. So, people used to find legal loopholes to evade taxes.

• When the federal tax is 15%, then the people have no incentive to evade taxes. 15% of the federal tax means that for every additional income of $1, 15 cents are paid as tax and 85 cents are left as disposable income.

• This means that the cost associated with the tax evasion is more than the benefit. So, people prefer to pay tax rather than to evade it. The cost of evasion that is fines, punishments, and penalties are very high, as compared to high federal taxes.