If investment yield = 5%, corporate tax rate = 30%, and personal tax rate = 20%, what is the after-tax cost of double taxation?

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Multiple Choice

If investment yield = 5%, corporate tax rate = 30%, and personal tax rate = 20%, what is the after-tax cost of double taxation?

The concept here is how taxes at both corporate and personal levels reduce an investment’s pre-tax yield. The after-tax cost of double taxation is the portion of the original yield that ends up being taxed twice. With a corporate tax rate of 30% and a personal tax rate of 20%, the portion of the yield that suffers double taxation is the corporate tax burden adjusted by the fact that personal taxes on the dividends reduce the impact of that corporate tax by a factor of (1 − personal tax). So the double-tax portion of the yield is Y × t_c × (1 − t_p) = 0.05 × 0.30 × 0.80 = 0.012, or 1.2 percentage points. For reference, the total after-tax yield if you account for both taxes on the distribution is 0.05 × (1 − 0.30) × (1 − 0.20) = 0.028, i.e., 2.8%. The key takeaway is that the after-tax cost of double taxation, given these rates, is 1.2%.

The concept here is how taxes at both corporate and personal levels reduce an investment’s pre-tax yield. The after-tax cost of double taxation is the portion of the original yield that ends up being taxed twice. With a corporate tax rate of 30% and a personal tax rate of 20%, the portion of the yield that suffers double taxation is the corporate tax burden adjusted by the fact that personal taxes on the dividends reduce the impact of that corporate tax by a factor of (1 − personal tax). So the double-tax portion of the yield is Y × t_c × (1 − t_p) = 0.05 × 0.30 × 0.80 = 0.012, or 1.2 percentage points.

For reference, the total after-tax yield if you account for both taxes on the distribution is 0.05 × (1 − 0.30) × (1 − 0.20) = 0.028, i.e., 2.8%. The key takeaway is that the after-tax cost of double taxation, given these rates, is 1.2%.

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