Why does the double taxation of saving occur? Provide a numerical exam

Why does the double taxation of saving occur? Provide a numerical example of the double taxation of saving under a traditional income tax.

What will be an ideal response?

ANSWER

The double taxation of saving occurs because under our current tax system saving is made out of income that has already been taxed and then savings is taxed again. For example, assume a 10 percent tax rate on income and saving. An individual earning $1,000 would take home $900 in after-tax income. If the individual saves $100 any income on that saving during the year will be taxed at 10 percent. Assuming a 5 percent return on saving that would mean an additional tax of 50 cents in the first year alone.