Question

With a traditional tax shelter (Spreadsheet 21.5), compare the effect on real consumption during retirement of a 1% increase in the rate of inflation to a 1% increase in the tax rate.

Short answer

The tax rates affect only part of the income while increase in rates of inflation affects all savings.

Step-by-step solution

Definition of tax shelter

The strategy to arrange the finance of a business in such a way that they have less to pay in tax is known as a tax shelter.

Comparison of the effect

Retirement Years	Income growth	Rate of inflation	Exemption Now	Tax rate	Savings rate	ROR
25	0.07	0.04	15000	0.25	0.15	0.06	0.0192
Age	Income	Defactor	Exemption	Taxes	Savings	Cumulative savings	rConsumption
30	50,000	1.00	15,000.00	5,016.00	9922	9922	35,063
31	53,500	1.04	15,600.00	5,518.00	10309	20826	36,224
35	70,128	1.22	18,250.00	8,005.00	11852	75503	41,319
45	1,37,952	1.80	27,004.00	19,299.00	14442	312148	57,864
55	2,71,372	2.67	39,988.00	44,501.00	8877	7,28,674	81,773
65	5,33,829	3.95	59,191.00	99,999.00	-25356	12,46,974	1,16,365
	74,45,673			12,03,168.00	2,65,856	Retirement annuity	16,040

Retirement	Nom withdraw	Deflator	Exemption	Taxes	Fund left	rconsumption
66	65827	4.1	61599	1.07	1255966	15780
70	77008	4.8	72015	1.25	1268594	15780
75	93692	5.84	87618	1.52	1210836	15780
80	113991	7.11	106600	1.85	1028069	15780
85	138688	8.65	129696	2.25	655161	15780
90	168735	10.52	157794	2.74	0	15780
	2741427			44437

From the spreadsheet it is evident that the 1% increase in the rate of inflation reduces real consumption during retirement to $15780.

The 1% increase in the after tax reduces real consumption during retirement to $58983.

This implies that the tax rates affect only part of the income while increase in rates of inflation affects all savings.