Solution:

Increases in top Personal rate on interest and dividends to 35%

Tax on realized capital gains at 15%. Corporate tax stays at 35%.

Assumption:

It is assumed that the investor is in top personal bracket.

Answer a: All capital gains are realized immediately

If the investor gets $1 as interest, it is taxed at the rate of 35% for the investor.

Realization for the individual will be

= ($1 - 35%) or $ (1-0.35)

= $ 0.65

If a corporate pays an individual $0.50 as dividend and $0.50 as capital gain, then,

A?·         * for corporate the tax will be 35%,

A?·         * dividend income for individual will be taxed at 15% and

A?·         * for capital gains, if realized immediately, will be 35%.

On the basis of above the amount received by investor after tax will be:

            = $0.50*(1-0.35)*(1-.015) + $0.50*(1-0.35)*(1-.035)

            = $0.50*0.65*0.85 + 0.50*0.65*0.65

            = $0.4875

Answer b: If Capital gains are deferred forever

If $1 interest is paid by corporate the tax rate is 35% for individual and the realization will be $0.65.

If the individual is paid $0.50 as dividend and $0.50 as capital gain deferred forever, then,

A?·         * for corporate tax will be 35% on dividends,

A?·         * dividend income for individual will be taxed at 35% and

A?·         * for investor tax will be 15% on capital gain deferred.

On the basis of above the amount received by investor after tax will be:

= $ 0.50*(1-0.35)*(1-0.15) + $ 0.5*(1-0.35)*(1-0.15)

= $0.5*0.65*0.85 + $0.5*0.65*0.85

= $ 0.27625 + 0.27625

= $ 0.56