Question

Suppose you make $200,000 per year before the 3% raise. Rather than spend more money, you take your additional salary and buy $6,000 of Microsoft stock. Suppose the stock increases in value, and you can sell it next year for $6,600. Therefore, you have a $600 capital gain, or a 10% return on your investment. Suppose the tax rate on capital gains is 50%. After taxes, your capital gain is_______.
Given the scenario from Part 1, which of the following inflation costs have you experienced?
a. shoe-leather costs.
b. tax distortions.
c. wealth redistribution .
d. money illusion.

Answer 1

1. After the 50% taxes on your capital gain, your capital gain reduces to $300.

2. The inflation cost that you have experienced by paying a capital gain tax is c. wealth redistribution.

Wealth redistribution can occur when a part of a taxpayer's earnings is paid in taxes.  The inflation costs witnessed in the scenario are not shoe-leather costs, tax distortions, or money illusion.

Data and Calculations:

Earnings per year = $200,000

Increase in earnings = 3%

Investment in Microsoft stock = $6,000

Proceeds from sale of investment = $6,600

Short-term capital gains = $600 ($6,600 - $6,000)

Assumed tax rate on the capital gains = 50%

Capital gain after taxes =$300 ($600 x (1 - 50%)

Thus, your net capital gain (after the deduction of capital gains tax of 50%) is $300.

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