Suppose that instead of taxing nominal capital income, the...

Name: Problem 5, Chapter 30: Economics
Uploaded: 2020-07-25T10:22:15-08:00
Duration: 3 min 37 s
Channel: Alejandro Ruiz
Description: Suppose that instead of taxing nominal capital income, the government taxed real capital income. Use appropriate graphs to explain and illustrate the effect that this change would have on a. The tax rate on capital income. b. The supply of and demand for loanable funds. c. Investment and the real interest rate.

Suppose that instead of taxing nominal capital income, the government taxed real capital income. Use appropriate graphs to explain and illustrate the effect that this change would have on a. The tax rate on capital income. b. The supply of and demand for loanable funds. c. Investment and the real interest rate.

Suppose that instead of taxing nominal capital income, the government taxed real capital income. Use appropriate graphs to explain and illustrate the effect that this change would have on
a. The tax rate on capital income.
b. The supply of and demand for loanable funds.
c. Investment and the real interest rate.

Key Concepts

Real vs Nominal Variables

This concept involves understanding the distinction between real and nominal measures. In the context of economics, 'real' values are adjusted for inflation and reflect actual purchasing power, while 'nominal' values are measured in current prices. Knowing the difference is crucial when analyzing the impact of taxes since the burden and behavior of economic agents may vary based on whether the tax is applied before or after adjusting for inflation.

Tax Policy Effects on Capital Income

This concept refers to the impact that registering taxes on capital income has on economic decisions. Taxing real capital income means that taxes are paid on the inflation-adjusted return rather than the higher nominal returns, which changes the effective tax rate that capital owners face. Understanding this concept helps in analyzing the incentives for investment and savings as well as the overall efficiency of the tax system.

Loanable Funds Market

The loanable funds market represents the interaction between those who supply funds (typically savers) and those who demand funds (typically investors). Graphically depicted by supply and demand curves, this market determines the equilibrium real interest rate and the quantity of funds exchanged. Analyzing shifts in this market is key to understanding the macroeconomic effects of changes in taxation on capital income.

Investment and Real Interest Rate

This concept involves studying how changes in tax policy affect investment decisions by altering the cost of borrowing and the incentives for saving. When the effective tax rate on capital income changes, it can shift the supply and demand in the loanable funds market, which in turn influences the equilibrium real interest rate and the level of investment. This understanding is essential for anticipating the broader economic consequences of fiscal policy adjustments.

Transcript

00:01 So in this situation, we have the government is going to tax real capital income instead of nominal capital.

00:10 So real capital income is the same as nominal capital income, but it's adjusted for inflation.

00:17 And since there's usually almost always going to be inflation, this number is going to be much lower than the nominal capital income.

00:26 So therefore, real capital income is going to be lower.

00:29 And we know that lower incomes usually have lower tax rates according to the tax code so we have to figure out what's going to happen for each of the following scenarios in the first scenario we have what is what is the effect what is this effect going to be on the tax rate on capital income well since capital income is going to be lower it's going to follow a lower tax rate and therefore the tax rate is going to decrease because real income is going to be lower than the nominal income.

01:04 And then what about what's going to be the effect on supply and demand for the loanable funds? so we can look at the graph here.

01:13 We have real interest rate on the left and loanable funds on the right.

01:17 And then we have demand for loanable funds on this black curve here.

01:22 And then supply of loanable funds on this other black curve here.

01:26 So the black curves are without any taxes.

01:31 Without any capital income taxes.

01:35 And for the first one, there's going to be no effect on the demand for loanable funds.

01:42 That only depends on how productive capital is...