Deck 22: Taxes on Savings

Question 1

Suppose that in the first period,a woman works,earns income Y,and saves S of the income.In the second (and last)period,the woman consumes her savings plus whatever interest it earned (r is the interest rate).What is the opportunity cost of first-period consumption?

A) Y(1 + r)²
B) 1 + r
C) Y - S
D) Y(1 + r)

Answer 1

1 + r

Question 2

Which of the following descriptions best defines the intertemporal budget constraint?

A) an amount equal to the person's total income
B) the measure of the person's preference for consumption in one period relative to his or her preference in other periods
C) the measure of the rate at which people can trade off consumption in one period for consumption in another period
D) the opportunity cost of first-period consumption

Answer 2

the measure of the rate at which people can trade off consumption in one period for consumption in another period

Question 3

Suppose that in the first period,a woman works,earns income Y,and saves S of the income.In the second (and last)period,the woman consumes her savings plus whatever interest it earned (r is the interest rate).How much does the woman consume in the second period if S = 0?

A) 0
B) Y - S
C) Y + S
D) Y(1 + r)

Answer 3

0

Question 4

Suppose that in the first period,a man works,earns income Y,and saves S of the income.In the second (and last)period,the man consumes his savings plus whatever interest it earned (r is the interest rate).Suppose that the government taxes interest income at a rate of t.What is the man's consumption in the second period?

A) S
B) S(1 + r - t)²
C) S(1 + r - rt)
D) S(1 + r - t)

Question 5

Assume that the nominal rate of interest is 10% and that the inflation rate is 10%.The real rate of interest:

A) cannot be determined from the given information.
B) is 0%.
C) is 10%.
D) is 20%.

Question 6

An individual's savings is defined as the difference between:

A) current income and current consumption.
B) cumulative income and cumulative consumption to the present time,EXCLUDING interest gained or lost over that time.
C) cumulative income and cumulative consumption to the present time,INCLUDING interest gained or lost over that time.
D) lifetime spending and lifetime income.

Question 7

Suppose that in the first period,a man works,earns income Y,and saves S of the income.In the second (and last)period,the man consumes his savings plus whatever interest it earned (r is the interest rate).How much does the man consume in the second period?

A) Y(1 + r)
B) 2Y - S
C) Y - S
D) S(1 + r)

Question 8

Which statement is TRUE?

A) The nominal rate of interest is approximately equal to the real rate of interest plus the rate of inflation.
B) The nominal rate of interest measures a person's actual improvement in purchasing power due to savings.
C) The real rate of interest is approximately equal to the rate of inflation times two.
D) The real rate of interest is larger than the nominal rate of interest when there is inflation.

Question 9

Which of the following phrases refers to the taxation of the return from savings?

A) payroll taxation
B) sales taxation
C) value-added taxation
D) capital income taxation

Question 10

Suppose that the government starts taxing interest on savings.The substitution effect ________; the income effect __________.

A) induces the person to save more; induces the person to save more
B) induces the person to save more; induces the person to save less
C) induces the person to save less; induces the person to save more
D) does not affect savings; does not affect savings

Question 11

Suppose that in the first period,a woman works,earns income Y,and saves S of the income.In the second (and last)period,the woman consumes her savings plus whatever interest it earned (r is the interest rate).How much does the woman consume in the first period?

A) Y
B) 2Y - S
C) Y - S
D) Y(1 + r)

Question 12

Suppose that in the first period,a woman works,earns income Y,and saves S of the income.In the second (and last)period,the woman consumes her savings plus whatever interest it earned (r is the interest rate).Suppose that the government taxes interest income at a rate of t.As a result of the tax:

A) the woman must save more in the first period to maintain a given level of consumption in the second period.
B) the woman can afford more second-period consumption for a given level of first-period consumption.
C) the price of first-period consumption has risen.
D) the price of first-period consumption has not changed.

Question 13

Suppose the government was to eliminate taxes on interest from savings.Which of the following statements is NOT consistent with economic theory?

A) People would save more as a result.
B) People would save less as a result.
C) The substitution effect of the policy induces people to save less.
D) The substitution effect of the policy induces people to save more.

Question 14

Which of the following makes it difficult to empirically find the connection between after-tax interest rates and savings?

A) Finding tax rates that apply to people is difficult.
B) It is hard to measure a given worker's wage.
C) Determining the appropriate interest rate to use is difficult.
D) It is hard to measure the value of savings.

Question 15

Assume that the nominal rate of interest is 10% and the inflation rate is 10%.The tax rate on interest from savings is 25%; in the first period,Wes has $100 in savings.After taxes,what will Wes's nominal savings be one year from now?

A) $10
B) $105
C) $107.50
D) $110

Question 16

Assume that the nominal rate of interest is 10% and the inflation rate is 10%.The tax rate on interest from savings is 25%; in the first period Wes has $100 in savings.Which of the following statements is TRUE?

A) The real after-tax rate of interest Wes earns is negative.
B) Wes's savings will have more buying power in the second period than they had in the first.
C) The real after-tax rate of interest Wes earns is zero.
D) Wes will not have to pay taxes on interest since his real rate of interest was zero.

Question 17

If banks raise nominal interest rates to fully offset inflation,the purchasing power of savings will:

A) remain the same when capital income is taxed.
B) decrease when capital income is not taxed.
C) increase when capital income is not taxed.
D) increase when capital income is taxed.

Question 18

Suppose the government were to eliminate taxes on interest from savings.According to economic theory,individuals:

A) will definitely save more.
B) might save more or less.
C) will definitely save less.
D) will definitely save the same amount as before.

Question 19

Which statement about the standard intertemporal choice model is TRUE?

A) People save in order to smooth consumption over time.
B) People gain utility directly by working.
C) For most people,it is optimal to set consumption equal to income each year.
D) A dollar to be received in 10 years is worth the same amount as a dollar received today.

Question 20

Suppose that in the first period,a man works,earns income Y,and saves S of the income.In the second (and last)period,the man consumes his savings plus whatever interest it earned (r is the interest rate).What is the price of first-period consumption in this two-period model?

A) S(1 + r)²
B) 1 + r
C) Y - S
D) Y(1 + r)

Question 21

Which is a retirement savings account specifically designed for the self-employed,under which up to a set amount can be saved each year on a tax-free basis?

A) defined contribution pension plan
B) Roth IRA
C) Keogh account
D) 401(k)account

Question 22

Which statement regarding tax-subsidized saving for retirement is TRUE?

A) Tax subsidies for saving unambiguously increase saving.
B) The income effect of tax subsidies for saving induces individuals to save more.
C) The substitution effect of tax subsidies for saving induces individuals to save less.
D) The income effect of tax subsidies for saving induces individuals to save less.

Question 23

Which of the following is an employer-sponsored plan through which workers accrue certain rights during their tenure at the firm and on retirement are paid a benefit by the firm that is based on tenure at the firm and employee earnings?

A) defined contribution pension plan
B) defined benefit pension plan
C) Keogh account
D) 401(k)account

Question 24

Suppose an Individual Retirement Account (IRA)has a contribution limit of $3,000 per year and that prior to the passage of the law establishing IRAs,Carlos was saving $2,500 per year.After the IRAs were established,Carlos saved $2,000 per year.Which statement is TRUE?

A) The tax subsidy in the IRA had a marginal effect on Carlos's saving.
B) The tax subsidy in the IRA had an inframarginal effect on Carlos's saving.
C) The substitution effect exceeded the income effect.
D) The income and substitution effects cancelled each other out.

Question 25

Which statement reflects a prediction of the precautionary saving model and the empirical evidence?

A) Empirical research suggests that expansions of social insurance programs cause savings to increase.
B) Empirical research suggests that expansions of social insurance programs cause savings to decrease.
C) The precautionary saving model predicts that an expansion of a social insurance program should cause savings to increase.
D) The prediction of the precautionary saving model is consistent with empirical evidence.

Question 26

Which of the following best describes liquidity constraints?

A) limits on how easily assets can be used for immediate cash needs
B) geographic and political barriers that limit a person's ability to invest overseas
C) government restrictions on minimum levels of saving
D) a barrier to credit availability that limits a person's ability to borrow

Question 27

How does the precautionary saving model differ from the intertemporal choice model of saving? Discuss the importance of the functioning of credit markets with respect to the precautionary saving model.

Question 28

Suppose an Individual Retirement Account (IRA)has a contribution limit of $3,000 per year and that prior to the passage of the law establishing IRAs,Hamilton was not saving any of his income.After IRAs became available,Hamilton saved $2,000 per year.Which statement is TRUE?

A) The tax subsidy in the IRA had a marginal effect on Hamilton's saving.
B) The tax subsidy in the IRA had an inframarginal effect on Hamilton's saving.
C) The income effect exceeded the substitution effect.
D) The income and substitution effects cancelled each other out.

Question 29

Which of the following is a tax-preferred retirement savings vehicle primarily for low- and middle-income taxpayers in which the taxpayers make pretax contributions and are then taxed on future withdrawals?

A) defined contribution pension plan
B) defined benefit pension plan
C) 401(k)account
D) traditional Individual Retirement Account (IRA)

Question 30

Jesse earns income equal to $82,000 in the first period,but his income will drop to $19,170 in the second period.
(a)Sketch his intertemporal budget constraint,assuming a 6.5% rate of interest.Add an indifference curve that assumes he optimally chooses to save $40,000 in the first period.
(b)Show the effect of a 50% tax on interest income,assuming the substitution and income effects cancel each other out.

Question 31

Which of the following is NOT one of the four major tax incentives for retirement savings?

A) defined contribution pension plan
B) precautionary saving
C) simplified employee pension plan
D) 401(k)account

Question 32

Which of the following is a tax-preferred retirement savings vehicle primarily for low- and middle-income taxpayers in which the taxpayers make after-tax contributions but then make tax-free withdrawals later in life?

A) defined contribution pension plan
B) Roth IRA
C) Keogh account
D) 401(k)account

Question 33

What is a tax-preferred retirement savings vehicle offered by employers to which the employers often match part or all of employees' contributions?

A) defined contribution pension plan
B) defined benefit pension plan
C) Social Security
D) 401(k)account

Question 34

What four initiatives did President Obama introduce to help Americans save? What are common criticisms of the initiatives?

Question 35

What is an employer-sponsored plan in which the employer sets aside a certain proportion of a worker's earnings in an investment account,which the worker will receive with investment earnings at retirement?

A) defined contribution pension plan
B) defined benefit pension
C) Keogh account
D) Individual Retirement Account (IRA)

Question 36

Suppose an Individual Retirement Account (IRA)has a contribution limit of $4,000 per year and that prior to the passage of the law establishing IRAs,Rachel was saving $5,500 per year.Which of the following is the most likely effect?

A) The income effect of the tax subsidy will cause her to save more.
B) The tax subsidy in the IRA will have an inframarginal effect on Rachel's saving.
C) The substitution effect of the tax subsidy will induce Rachel to save less.
D) The tax subsidy in the IRA will have no effect on Rachel's decision to save.

Question 37

Suppose that the government proposes to eliminate unemployment insurance.Which model,the intertemporal choice model of saving or the precautionary saving model,would predict the larger change in savings in consequence? Explain your answer and be sure to note any empirical evidence that might be relevant.

Question 38

A model of savings that accounts for the fact that individual savings serve to smooth consumption over future uncertainties can be defined as a(n):

A) precautionary savings model.
B) intertemporal budget constraint.
C) capital income taxation.
D) liquidity constraint.

Question 39

Saving money in a retirement account with many withdrawal restrictions at an interest rate of 5% while simultaneously borrowing money at 10% is consistent with the:

A) self-control model of saving.
B) precautionary saving model.
C) intertemporal choice model of saving.
D) liquidity model of saving.

Question 40

Which statement is TRUE?

A) The precautionary saving model,unlike the intertemporal choice model,assumes that all saving is motivated by a desire to self-insure against risk.
B) The precautionary saving model,unlike the intertemporal choice model,assumes that some saving is motivated by a desire to self-insure against risk.
C) The precautionary saving model,unlike the intertemporal choice model,assumes that saving is motivated by a desire to smooth consumption.
D) The intertemporal choice model,unlike the precautionary saving model,assumes that saving is motivated by a desire to smooth consumption.

Question 41

Suppose that Lilistan has two types of citizens: low-income citizens (income = $20,000)and high-income citizens (income = $80,000).Interest income is taxed,and each type of citizen saves 10% of his or her income for retirement.The government is proposing to allow citizens to put money into an IRA,where the contributions would be tax deductible and interest would accumulate tax free.Withdrawals would be taxed as income.The government wants to set a $5,000 annual limit on the accounts.Discuss the effect of this policy on the saving choices of both the low-income and high-income citizens in terms of both income and substitution effects as well as the overall effect.

Question 42

Suppose that the President and Congress were to pass a law stating that future shortfalls in the Social Security program would be funded with across-the-board increases in income taxes at the time of the shortfalls (and well after their tenure as elected officials).How would you expect this law to affect the relative attractiveness of traditional IRAs versus Roth IRAs to a 25-year-old today? Explain.

Question 43

Suppose that you are going to save $1,000 of your income for one year,after which you will spend it along with any accumulated interest you earned.Assume that your marginal income tax rate is 50%.Consider the following two options:
Option 1: Invest in a regular savings account earning 10% interest.
Option 2: Invest in an IRA earning 10% interest.
Determine the after-tax value of your savings a year from now under both options.If the amounts are the same,explain why.If the amounts are different,explain why they are different.