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Homework2

# Homework2 - Homework#2 Due Electronically on BSpace...

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Homework #2 Due Electronically on BSpace February 28 th , 5pm Answer the question fully and explain your reasoning wherever possible 1) (30 points) Suppose Congress enacts a tax reform raising the top income tax bracket from 35% to 40%. Consider a hypothetical household with a home mortgage of \$1M and enough taxable income to be in the top bracket. Assume the annual interest paid on the mortgage is 5% of its face value. a) What is the annual dollar value to the household of the home mortgage interest deduction before and after the tax reform? Before the tax rate = 1,000,000 x 5% = 50,000 - 1,000,000 – 50,000 = 950,000 x 35% = 332500 ( drop of 17500 in income tax) After the tax = 1,000,000 x 5% = 50,000 - 1,000,000 – 50,000 = 950,000 x 40% = 380,000 (drop of 20,000 in income tax) b) Do you think this increase in the top rate would lead such a household to increase or decrease their housing consumption? Why? It would lead to an increase in housing consumption. Although the increase means that there would be more income tax to pay, housing consumption will increase because income tax is dropped by \$20,000 and it makes sense to invest in a house and save \$20,000 in tax. c) Suppose that the tax code were changed so that households could also deduct annual rent paid to landlords from their taxes. How might this affect the consumption of owner occupied housing? It would obviously decrease owner occupied housing. Reason being that the tax deduction is at a decrease of their income tax that they can invest the money elsewhere.

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Homework2 - Homework#2 Due Electronically on BSpace...

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