Final answer:
The correct approach is to multiply the tax rate of each future year by the amounts reversing in each of those years. This takes into account the distinct tax rates applicable in the future. Understanding tax rate changes, including phased-in changes, is integral to effective financial planning. b) The tax rate in the current year is multiplied by the amounts reversing in all future years.
Step-by-step explanation:
When a phased-in change in tax rates is scheduled to occur, the correct approach to determining the taxes paid in future years is to apply option (c), which states that the tax rate of each future year is multiplied by the amounts reversing in each of those years. This approach takes into consideration the varying tax rates that may apply to income in the future and calculates the taxes owed in each specific year based on those rates.
Tax policies and rates can change for a variety of reasons, often to support the social and economic goals of current government administrations. For example, the United States uses a progressive tax system, where individuals with higher incomes are subject to higher marginal tax rates. When changes in tax rates are anticipated, it becomes important for individuals and businesses to plan accordingly, as these changes can impact disposable income and the overall budget constraint.
To give an historical context, until the late 1970s, bracket creep was an issue where inflation would push people into higher tax brackets without a real increase in income, resulting in a higher proportion of taxes paid. This was corrected in 1981 when tax brackets were indexed to rise with inflation. This historical issue highlights the importance of understanding how tax rate changes, including phased-in changes, affect financial planning.