Question

You put money into an account and earn an after-tax real interest rate of 2.5 percent. If the nominal interest rate on the account is 8 percent and the inflation rate is 2 percent, then what is the tax rate?
a. 28.00 percent
b. 36.25 percent
c. 43.75 percent
d. 67.50 percent

Answer 1

Answer:

c. 43.75%

Explanation:

The nominal interest rate = 8% = 0.08

The after tax real rate of interest = 2.5%= 0.025

Inflation rate = 2% = 0.02

Let r% represent the real tax rate

{0.08(1- r%)} - 0.02 = 0.025

(0.08 - 0.08r%)= 0.025+0.02

0.08 - 0.08r% = 0.045

0.08r% = 0.045 - 0.08

r% = 0.035/0.08

r% = 0.4375

r = 43.75/100

r = 43.75%

So,  the tax rate is 43.75%