Congress would like to increase tax revenues by 115 percent

Congress would like to increase tax revenues by 11.5 percent. Assume that the average taxpayer in the United State earns $62,000 and pays an average tax rate of 10 percent. a.if the income effect is in effect for all taxpayers, what average tax rate will result in a 11.5 percent increase in tax revenues? b.this is an example of what type of forecasting? Static or Dynamic

Solution

This analysis is an example of dynamic forecasting. Based on the information above, the average taxpayer pays $6,200 of tax (i.e., $62,000 * 10%), leaving $55,800 of income after tax. A 11.50 percent increase in revenues would mean that the average taxpayer pays $6,913 in tax ($6,200 x 1.115). With this new tax amount, we can solve for the tax rate that would generate this tax amount.

After-tax income = Pretax income * (1 – tax rate)

After-tax income = Pretax income - (Pretax income * tax rate)

After-tax income = Pretax income - Tax

Substituting information from the problem results in:

$55,800 = Pretax income - $6,913

Pretax income = $62,713

We can use the above formula to solve for the new tax rate.

After-tax income = Pretax income * (1 – tax rate)

$55,800 = $62,713 * (1 – tax rate)

Tax rate = $6,913/$62,713 = 11 %