Again, in the consumption savings model, assume that lump-sum taxes are zero. But suppose the government taxes on interest earnings. I.e. borrowers face interest rate r while the lenders face an interest rate (1 - t)r.
What is the effect of introducing the tax rate on the consumer's budget constraint? Draw the constraint for borrower 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.