Final answer:
The interest rate on non-taxable government bonds would be 3.75% since investors would equate the after-tax return of taxable and non-taxable bonds. By using the given marginal tax rate of 50% and the interest rate of 7.5% on taxable bonds, we apply the formula to find the equivalent non-taxable rate.
Step-by-step explanation:
If everyone’s marginal tax rate is 50% and if the interest rate on taxable government bonds is 7.5%, the interest rate on non-taxable government bonds would be calculated by considering the after-tax return to be equivalent for an investor. Given that investors are indifferent between taxable and non-taxable bonds after taxes, we can find the equivalent non-taxable interest rate using the formula:
Inon-taxable = Itaxable * (1 - Tax Rate)
Substituting the given values:
Inon-taxable = 7.5% * (1 - 0.50)
Inon-taxable = 3.75%
Therefore, the non-taxable interest rate would be 3.75%, which is the after-tax yield that a taxpayer would receive from a taxable bond at 7.5% marginal tax rate.