In a simplified tax model, income tax is given by \(T(x) = 0.15x+0.000004x^2\), where \(x\) is annual gross income in dollars and \(T(x)\) is the tax owed in dollars. Net income is \(N(x) = x-T(x)\).
1. Find the marginal tax rate \(T'(x)\), and evaluate it at \(x = \$35{,}000\).
2. Find the average tax rate \(r(x) = \frac{T(x)}{x}\) at \(x = \$35{,}000\), and compare it with the marginal tax rate.
3. Explain why a small percentage increase in gross income produces a smaller percentage increase in net income at this income level.
Hints
- Differentiate the tax function to find the marginal tax rate.
- Divide total tax by gross income to find the average tax rate.
- Compare the fraction of an additional dollar that remains after tax with the current average fraction of income that remains after tax.
- Use \(N(x) = x-T(x)\) to relate the two rates.
Solution
1. Differentiate: \(T'(x) = 0.15+0.000008x\). At \(x = 35{,}000\), \(T'(35{,}000) = 0.15+0.000008(35{,}000) = 0.43\), or \(43\%\).
2. Simplify the average tax rate: \(r(x) = \frac{0.15x+0.000004x^2}{x} = 0.15+0.000004x\). Thus, \(r(35{,}000) = 0.29\), or \(29\%\). The marginal rate is higher than the average rate.
3. The marginal net-income rate is \(N'(x) = 1-T'(x)\), so \(N'(35{,}000) = 0.57\). The current average net-income share is \(\frac{N(35{,}000)}{35{,}000} = 1-r(35{,}000) = 0.71\).
4. Because \(0.57<0.71\), each additional dollar contributes a smaller fraction to net income than the current average. Therefore, a small percentage increase in gross income produces a smaller percentage increase in net income.
Answer
1. \(T'(x) = 0.15+0.000008x\); \(T'(35{,}000) = 0.43 = 43\%\)
2. \(r(35{,}000) = 0.29 = 29\%\); the marginal tax rate is higher.
3. At \(\$35{,}000\), the marginal net-income rate is \(0.57\), while the average net-income share is \(0.71\). Therefore, net income grows proportionally more slowly than gross income.