Question

Suppose in some country that the first $5,000 of interest income is exempt from income tax. if the government then removed this exemption

Answer 1

hello your question lacks the required options here are the options

a.the interest rate and investment would rise.

b.the interest rate would rise and investment would fall.

c.the interest rate and investment would fall.

d.the interest rate would fall and investment would rise.

Answer : The interest rate and investment would fall

Step-by-step explanation:

If the Government removes the exemption of not taxing the first $5000 of interest income then the demand for loanable funds would be reduced and therefore the supply of loanable funds will be greater than the demand hence the interest rate will fall.

Once the demand for loanable funds are reduced the rate of investment by investors will as well be affected hence investment would fall as well because no Investor will be willing to take out loans because of the tax imposed by the government.

Answer 2

The below multiple choices are missing:

a. the interest rate and investment would rise.

b. the interest rate would rise and investment would fall.

c. the interest rate and investment would fall.

d. the interest rate would fall and investment would rise.

Option B is the correct answer, the interest rate would rise and investment would fall

Step-by-step explanation:

The rationale for interest rate increase is that the removal exemption means that investor returns on the investment whose return was previously exempted has now reduced,hence investors would demand fro compensation for such reduction by expecting increase in the rate of return.

Also, the some investors would terminate their existing investments so as to avoid paying more in taxes on investment returns thereby reducing level of investment.