The lecture described how taxing income may change savings behavior. Suppose instead that the government taxed...

 

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The lecture described how taxing income may change savings behavior. Suppose instead that the government taxed consumption. D To be specific, suppose we have a two-period model. An individual earns labor income Y =$100k at time zero, and earns no labor income at time 1. The individual may consume or save that income. Savings grow at rate r. 03. For every dollar of consumption, the individual pays the tax rate 1.30 to the government. a. Graph the two- period budget constraint for consumption. Is this tax distortionary? What is the slope? b. The government modifies the consumption tax somewhat so that the first $20k of consumption in each period is tax free. Now graph the budget constraint. 2. (20 points) Claim: "The Mortgage Interest Tax Deduction is a regressive policy. A simpler, better policy that could achieve the same goals would be a home ownership tax credit that applies equally to all homeowners regardless of income or the value of the home." In a mini- essay (300 words) state whether you agree or disagree with that claim and explain your reasoning. 3. (40 points) In lecture, we assumed that when a homeowner borrows, the entire the value of a home would be borrowed. In fact, a borrower would need to put a "down payment" on the mortgage - a cash payment up front for part of the value of the home. An additional simplification of the lecture was to not take into account the fact that for a mortgage you pay the interest + some fraction of the principal. This is so at the end of the loan all the money borrowed will have been repaid. Take a look at the following mortgage calculator linked below to help answer the following. http://finance.yahoo.com/ calculator real estate/ hom03/ The value of the property is $500k, the interest rate is 3% (approximately the correct interest rate as of this writing), and the length of the loan is 30 years (360 months). The marginal tax rate for the homeowner is 33%. Leave other values on the table at the default settings. Assume the individual has $500k cash on hand, and any of this money that remains after taking the mortgage/ making mortgage payments is invested at the interest rate 3%. The value of the property also grows at rate 3% per year, and this growth is not taxed. This means that as the borrower repays the loan and starts building principal, the value of that principal goes up at the same rate as other investments. Finally, assume that the year's mortgage payment is paid to the bank from cash on hand at the START of the year. This turns out to be important if we want to make comparisons. i. Suppose there is no MITD, and the homeowner borrows the full value of the property. For the first year: a) How large is the annual mortgage payment? How much interest has been paid on the mortgage? b) How much principal has been accumulated by the borrower? What is the value of the principal at the end of the year? c) The amount of the annual mortgage payment from part a) was paid at the beginning of the year. That reduces the cash available to invest. How much cash gets invested? What is the pre- tax value of the cash investment at the end of the year? How much The lecture described how taxing income may change savings behavior. Suppose instead that the government taxed consumption. D To be specific, suppose we have a two-period model. An individual earns labor income Y =$100k at time zero, and earns no labor income at time 1. The individual may consume or save that income. Savings grow at rate r. 03. For every dollar of consumption, the individual pays the tax rate 1.30 to the government. a. Graph the two- period budget constraint for consumption. Is this tax distortionary? What is the slope? b. The government modifies the consumption tax somewhat so that the first $20k of consumption in each period is tax free. Now graph the budget constraint. 2. (20 points) Claim: "The Mortgage Interest Tax Deduction is a regressive policy. A simpler, better policy that could achieve the same goals would be a home ownership tax credit that applies equally to all homeowners regardless of income or the value of the home." In a mini- essay (300 words) state whether you agree or disagree with that claim and explain your reasoning. 3. (40 points) In lecture, we assumed that when a homeowner borrows, the entire the value of a home would be borrowed. In fact, a borrower would need to put a "down payment" on the mortgage - a cash payment up front for part of the value of the home. An additional simplification of the lecture was to not take into account the fact that for a mortgage you pay the interest + some fraction of the principal. This is so at the end of the loan all the money borrowed will have been repaid. Take a look at the following mortgage calculator linked below to help answer the following. http://finance.yahoo.com/ calculator real estate/ hom03/ The value of the property is $500k, the interest rate is 3% (approximately the correct interest rate as of this writing), and the length of the loan is 30 years (360 months). The marginal tax rate for the homeowner is 33%. Leave other values on the table at the default settings. Assume the individual has $500k cash on hand, and any of this money that remains after taking the mortgage/ making mortgage payments is invested at the interest rate 3%. The value of the property also grows at rate 3% per year, and this growth is not taxed. This means that as the borrower repays the loan and starts building principal, the value of that principal goes up at the same rate as other investments. Finally, assume that the year's mortgage payment is paid to the bank from cash on hand at the START of the year. This turns out to be important if we want to make comparisons. i. Suppose there is no MITD, and the homeowner borrows the full value of the property. For the first year: a) How large is the annual mortgage payment? How much interest has been paid on the mortgage? b) How much principal has been accumulated by the borrower? What is the value of the principal at the end of the year? c) The amount of the annual mortgage payment from part a) was paid at the beginning of the year. That reduces the cash available to invest. How much cash gets invested? What is the pre- tax value of the cash investment at the end of the year? How much

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Answering Your Questions with Information from Yahoo Finance 1 Consumption Tax and Budget Constraints a Distortionary Tax and Slope The consumption ta... View the full answer