What would happen if a state or municipality suddenly lost its tax base? Explain if this...

What would happen if a state or municipality suddenly lost its tax base? Explain if this would have any impact on it’s cost of borrowing funds. Why?

Solutions

Expert Solution

Answer - Tax base is that amount which is actually applied to tax rate i.e. tax rate is the percentage of tax base that goes to be paid as taxes. Therefore in order to find tax rate knowing the tax base is important.

If the state or municipality suddenly has lost the tax base ; what amount of tax that has to be charged will not be declared or decided.

Impact on cost of borrowing funds

Cost of borrowing funds after tax is charged = interest paid on debt - any income tax savings which rose due to deductable income . Further normally the cost of funds borrowing is calculated before tax however the difference lies in the INTEREST EXPENSES those are DEDUCTIBLE. As tax rate rises the cost of borrowings also rise and it gives more tax shield.

This happens cause : if there are taxes the company can save from the tax returns as it offsets some revenue in the end .

Conclusion:

However is tax base is lost than tax rate can't be decided thereafter the decision that how much to borrow as debt can't b analysed cause as such this TAX REVENUE OFFSET ,can be earned via debt borrowing only not by equity borrowing

Sir/Mam kindly please rate the answer and do feel free to ask in case of any doubt

Rahul Sunny answered 1 year ago

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