Song earns $330,000 taxable income as an interior designer and is taxed at an av

Question

Song earns $330,000 taxable income as an interior designer and is taxed at an average rate of 20 percent (i.e., $66,000 of tax).

a. If Congress increases the income tax rate such that Song’s average tax rate increases from 20 percent to 25 percent, how much more income tax will she pay assuming that the income effect is descriptive? (Round your intermediate calculations and final answer to 2 decimal places.)

b. If the income effect is descriptive, the tax base and the tax collected will increase.

Explanation / Answer

Solution:

Under existing provisions, song has income after tax = $330,000 - $66,000 = $264,000

If the income effect is descriptive and Congress increases tax rates so that Song’s average tax rate is 25 percent, Song will need to earn income so that Song;'s after tax income will be equal to $264,000

After tax income = Pre tax income (1-tax rate)

$264,000 = Pre tax income (1-0.25)

Pre tax income = $264,000 / 0.75 = $352,000

Tax will be paid by song = $352,000*25% = $88,000

Increase in income tax paid = $88,000 - $66,000 = $22,000

Solution b:

Therefore, if the income effect is descriptive, the tax base and the tax collected will increase. The statement holds true.

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