. The Federal tax code allows businesses but not individuals to deduct the cost of health insurance premiums from their taxable income. Consider a company named HeadBook that could either spend $5000 on an insurance policy for an employee named Vanessa or could increase her annual salary by $5000 instead.
a. As far as the tax code is concerned, HeadBook will increase its expenses by $5000 in either case. If it pays for the policy, it incurs a $5000 health care expense. If it raises Vanessa’s salary by $5000, it incurs a $5000 of salary expense. If HeadBook is profitable and pays corporate profit taxes at a marginal 35 percent rate, by how much will HeadBook’s tax liability be reduced in either case?
b. Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If Head Book increases her salary by $5000, how much of that increase will she have after paying taxes on that raise? If Vanessa can only devote what remains after paying taxes on the $5000 to purchasing health insurance, how much will she be able to spend on health insurance for herself?
c. If HeadBook spends the $5000 on a health insurance policy for Vanessa instead of giving it to her as a raise, how many more dollars will HeadBook be able to spend on Vanessa’s health insurance than if she had to purchase it herself after being given a $5000 raise and paying taxes on that raise?
d. Would Vanessa prefer to have the raise or to have HeadBook purchase insurance for her? Would HeadBook have any profit motive for denying Vanessa her preference?
e. Suppose the government changes the tax law so that individuals can now deduct the cost of health insurance from their personal incomes. If Vanessa gets the $5000 raise and then spends all of it on health insurance, how much will her tax liability change? How much will she be able to spend on health insurance? Will she now have a preference for HeadBook to buy insurance on her behalf?
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