Question

The real interest rate is 4%, inflation is 2%, and the marginal income tax rate is 25%. What is after-tax real rate of interest? 1) 2%?

2) 4%
3) 6%
4) 8%

Answer 1

The after-tax real rate of interest is calculated by subtracting inflation from the nominal rate and adjusting for taxes. With a nominal rate of 4%, inflation at 2%, and a marginal tax rate of 25%, the after-tax real rate is 1.5%.

Step-by-step explanation:

To calculate the after-tax real rate of interest, we follow these steps: First, we find the real interest rate by subtracting the inflation rate from the nominal interest rate. In this case, with a nominal interest rate of 4% and inflation at 2%, the real interest rate is 2% (4% - 2%). Then, we adjust this rate for taxes to find the after-tax real rate of interest. As the marginal tax rate is 25%, we multiply the real interest rate by (1 - marginal tax rate), which in this case is (1 - 0.25) or 0.75. Therefore, the after-tax real rate of interest is 2% * 0.75, which equals 1.5%.