In the consumption savings model, assume that lump-sum taxes are zero and the utility function is given by U(c, c') = log c + β log c'. Suppose the government taxes on interest earnings i.e. borrowers face interest rate r while lenders face interest rate (1 - t)r.
What is the effect of introducing the tax rate on the consumer's budget constraint? Draw the constraint for borrow and lender.
What is the effect of the tax on a consumer who was initially a lender and is still a lender after the tax? (explain in terms of income and substitution effect)