Deck 23: Taxes on Risk Taking and Wealth

Question 1

Assume that investment earnings are taxed,losses can be deducted,and the tax structure is progressive.Which statement is TRUE?

A) Winning gambles are taxed at the same rate as the rate at which losing gambles are deducted.
B) Winning gambles are taxed at a lower rate than the rate at which losing gambles are deducted.
C) Winning gambles are taxed at a higher rate than the rate at which losing gambles are deducted.
D) There is more incentive to take on risk than if taxation were proportional.

Answer 1

Winning gambles are taxed at a higher rate than the rate at which losing gambles are deducted.

Question 2

Who supports the estate tax,saying that it is "…in keeping with the idea of equality of opportunity in this country"?

A) William Nordhous
B) Warren Buffet
C) Sam Walton
D) Grover Norquist

Answer 2

Warren Buffet

Question 3

Which of the following assets CANNOT have a capital gain?

A) a share of a mutual fund
B) a piece of art
C) a savings account
D) real estate

Answer 3

a savings account

Question 4

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,a 25% chance that the investment will remain at $1,000,and a 50% chance that the investment will fall in value to $500.The government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate is 50%).What is the expected return on the investment?

A) -$75
B) -$125
C) $85
D) $150

Question 5

Suppose that the government taxes income and investment earnings at 25% and allows half of investment losses to be deducted from taxable income,up to a maximum of $3,000 per year.Which of the following amounts is equal to the tax loss offset for someone who lost $5,000 on investments last year?

A) $2,500
B) $3,000
C) $3,750
D) $5,000

Question 6

A capital gain is best defined as the:

A) accumulation of assets that comes from increased saving.
B) difference between an asset's purchase price and its sale price.
C) portion of investment earnings that is not taxed.
D) portion of investment earnings that is taxed.

Question 7

Suppose that there is a 75% chance that an investment of $1,000 will rise in value to $1,500,and a 25% chance that the investment will fall in value to $700.What is the expected return on the investment?

A) -$125
B) $25
C) $200
D) $300

Question 8

The basic model of taxation and risk taking was developed by Domar and Musgrave in 1944; it reached the conclusion that:

A) it is not fair to tax the returns from risky assets.
B) taxing the returns from risky assets has no impact on risk taking.
C) taxing the returns from risky assets will actually increase risk taking.
D) taxing the returns from risky assets will discourage risk taking.

Question 9

Suppose a person buys a share of stock for $10.The day before the person dies,the stock is worth $20,as it is the day after the person dies.If the stock were sold the day before the person died,the basis would be ________; if the stock were sold the day after the person died,the basis would be _________,assuming earnings on assets are taxed as they are in the current U.S.system.

A) $10; $20
B) $10; $0
C) $20; $10
D) $20; $0

Question 10

Suppose a person buys a share of stock for $10.The rate of taxation on accrual is 50% and the rate of taxation on realization is 25%.The day before the person dies,the stock is worth $20,as it is the day after the person dies.If the stock were sold the day before the person died,the government would receive ________ in taxes; if the stock were sold the day after the person died,the government would receive ________ in taxes.Assume that earnings on assets are taxed as they are in the current U.S.system.

A) $5; $5
B) $0; $5
C) $2.50; $0
D) $5; $2.50

Question 11

If an individual purchases an asset and sells it before he dies,the capital gains tax burden is based on the:

A) sale price minus the basis.
B) sale price.
C) purchase price.
D) basis.

Question 12

Suppose that the government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate on taxable income is also 50%).Which statement is TRUE?

A) This tax policy reduces the incentive to invest in risky assets.
B) If an investment loses money,the investor bears only half the loss.
C) If an investment makes money,the investor keeps the entire payoff.
D) The investor pays less in taxes if the return is positive.

Question 13

Which of the following assets could yield a capital gain?

A) a savings account
B) a bank certificate of deposit
C) a house
D) a checking account

Question 14

Taxation on accrual is best defined as:

A) the extent to which taxpayers can deduct net losses on investments from their taxable income.
B) taxes paid on an asset's return only when that asset is sold.
C) taxes paid each period on the return earned by an asset in that period.
D) capital gains tax cuts that apply only to investments made from this day forward.

Question 15

Suppose that there is a 50% chance that an investment of $1,000 rises in value to $1,200,and a 50% chance that the investment falls in value to $900.What is the expected return on the investment?

A) -$100
B) $50
C) $100
D) $200

Question 16

Suppose you put $10 into a savings account.A year later the account has $12 in it,all of which you withdraw.The tax rate on accrual is 50% and the tax rate on realization is 25%.How much tax on accrual do you owe? Assume that both taxation on accrual and taxation on realization apply as they do under current U.S.tax policy.

A) $6
B) $1
C) $2
D) No tax is owed

Question 17

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,and a 75% chance that the investment will fall in value to $900.What is the expected return on the investment?

A) -$125
B) -$25
C) $25
D) $100

Question 18

Assets that earn interest are taxed on _____; capital gains are taxed on _____.

A) realization; accrual
B) accrual; realization
C) accrual; accrual
D) realization; realization

Question 19

Suppose that the government taxes any positive return on an asset and allows a full deduction of a negative return against taxable income.Which statement is TRUE under this scenario,versus one under which there are no taxes?

A) These tax policies do not affect risk taking so long as the expected value of the investment is positive.
B) These tax policies increase risk taking.
C) These tax policies reduce risk taking.
D) These tax policies do not affect risk taking regardless of the expected value of the investment.

Question 20

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,a 25% chance that the investment will remain at $1,000,and a 50% chance that the investment will fall in value to $900.What is the expected profit associated with the investment?

A) $25
B) $50
C) $75
D) $100

Question 21

Discuss the views of supporters and opponents of estate taxes.

Question 22

Henry George advocated a tax on land,rather than on the improvements or structures built on the land,because lowering tax rates on buildings but raising them on land:

A) does not discourage effort.
B) discourages effort.
C) discourages people from owning land.
D) has no effect on the decisions made by landowners.

Question 23

Many county fairs have auctions at which the animals raised by children are sold to the highest bidders and the children get to keep the proceeds.For various reasons,the prices received by the children are typically much higher than the market prices would be for similar animals.
(a)Suppose many of the bids were won by the grandparents of the children.Why might this behavior be caused by the existence of transfer taxes?
(b)On the other hand,perhaps the grandparents just wished to support the agricultural endeavors of their grandchildren.Describe a way in which an empirical researcher could distinguish between this explanation and the tax explanation in part (a).

Question 24

What are the two fundamental reasons a tax preference for capital gains is hard to eliminate for many capital goods?

Question 25

What are the three ways in which capital gains are subsidized over interest-bearing savings accounts in the U.S.tax code?

Question 26

Which statement about transfer taxes in the United States is TRUE?

A) The estate tax is not very progressive.
B) Gifts up to $100,000 per person per year are not taxed.
C) Gifts up to $14,000 per person per year are not taxed.
D) Estate taxes were abolished in 2010 and have not been reinstated.

Question 27

Explain why a lower tax rate on capital gains might be justified as a way to protect investors against inflation.Is there an alternative approach to deal with the inflation problem? Explain.

Question 28

Which statement about capital gains tax rates is TRUE?

A) The top tax rate on capital gains is higher than the top tax rate on other income in the United States.
B) There has always been widespread agreement concerning how capital gains should be taxed.
C) The 2003 Jobs and Growth Act reduced the top tax rate applied to capital gains realized after May of 2003.
D) Income on a capital gain is taxed the same as labor income in the United States.

Question 29

A prospective capital gains tax reduction would:

A) have a smaller inframarginal effect on risk taking than would a similar reduction in the standard capital gains tax rate.
B) reduce government revenues by more than would a similar reduction in the standard capital gains tax rate.
C) have the same marginal effect on risk taking as would a similar reduction in the standard capital gains tax rate.
D) reward past risk taking more than future risk taking.

Question 30

Suppose Jack owns a warehouse in a rapidly expanding part of a town.Because of the location of the warehouse,it has increased in value from $300,000 (the price Jack paid)to $400,000 (the price Jack would get if he were to sell it).The doctor has recently told Jack that he has one year to live-and the doctor is always right about such things.The capital gains tax rate is 25%.Jack's wealth will be distributed among his children when he dies.The warehouse is not being used.Jack must decide whether to sell the warehouse now and pass the cash on to his children.Assume that there is no estate tax but that the capital gains tax code is the same as that in place in the United States.
(a)What is the socially efficient thing for Jack to do? Explain your answer.Be sure to describe the tax implications of your answer as well.
(b)What would you advise Jack to do? Explain your answer.Be sure to describe the tax implications of your answer as well.

Question 31

According to the lock-in effect,individuals may:

A) sell capital assets too quickly in order to avoid the risk that policy makers will increase the capital gains tax rate.
B) delay selling capital assets to minimize the present discounted value of capital gains tax payments.
C) sell capital assets just before they die so their heirs will not be forced to pay tax on the gains.
D) leave cash to their children rather than capital assets in order to minimize the tax complications.

Question 32

The primary source of wealth for most entrepreneurs comes from:

A) interest on the income earned early in the life of the business.
B) an increase in the value of the business asset over time.
C) tax deductions against other sources of income enabled by owning a business.
D) tax credits earned by starting a business.

Question 33

Which statement about transfer taxes in the United States is TRUE?

A) Your estate is defined as whatever is left of your wealth when you die.
B) For 2006 through 2009,the estate tax exempted the first $350,000 of your wealth from taxation.
C) Transfers to spouses on death are deductible from estate taxes.
D) Wealthy individuals who will be subject to the estate tax are not allowed to avoid taxation by transferring wealth to heirs before death.

Question 34

Suppose you have a wealthy friend who is 60 years old and wants to know how to pass on her wealth to her children without paying more than necessary in taxes.What are some good strategies for minimizing her tax burden?

Question 35

If a town is in a perfect Tiebout equilibrium (all residents value public goods at their tax cost),then:

A) there is no burden associated with property taxation,it is simply a price residents voluntarily pay.
B) the burden of property taxation falls on homeowners since those with more expensive homes must pay more in taxes.
C) the burden of property taxation is much higher in communities with superior public goods (education and city services).
D) the burden of property taxation is split between land and improvements (structures).

Question 36

Those who advocate reducing or eliminating the capital gains tax believe that:

A) the tax discourages risk taking,and risk taking leads to economic growth and job creation.
B) the tax encourages risk taking,and risk taking leads to more corporate bankruptcies.
C) people who have a high tolerance for risk pay no attention to the effect of taxation on returns.
D) there are equity reasons not to tax capital gains,but not efficiency reasons.

Question 37

Which statement regarding transfer taxation is NOT true?

A) The gift tax and the estate tax are two types of a transfer tax.
B) Any gift above $14,000 is subject to gift tax.
C) The estate tax currently exempts the first $5.43 million of your gifts and estate.
D) The United States raises about 0.6 percent of its revenues from transfer taxes.

Question 38

Which statement would be TRUE of a prospective capital gains tax reduction?

A) A prospective capital gains tax reduction would reduce government revenues more than would a similar reduction in the standard capital gains tax rate.
B) A prospective capital gains tax reduction would reward past risk taking without rewarding future risk taking.
C) A prospective capital gains tax reduction would have a larger marginal effect than would a similar reduction in the standard capital gains tax rate.
D) A prospective capital gains tax reduction would be much less expensive because it does not deliver a tax break to investments made in the past.