Suppose the government introduces a tax on interest earnings so that lenders earn an interest rate (1 153)?" on their savings. Assume borrowers do not pay any taxes so that their interest rate remains 7". We compare outcomes for consumers when is > 0 or t3 : 0. A) On a single plot, graph the lifetime budget constraint of the consumer for both tax rates. Briey explain how positive taxes on interest income impact the budget constraint of the consumer. Suppose the consumer is a borrower when the tax rate is t3 2 0. On your plot from Part (A), show the consumer's optimal choice of c and 0'. Explain whether the consumer's choice changes when the tax on savings increases to t3 > 0. Now suppose the consumer is a lender. On a new graph, show how the consumer's optimal choice of c and 6' change when the government chooses a positive tax on interest income versus zero tax. Explain this change using income and substitution effects, both on your graph and in words. If the consumer is a lender, does the increase in the tax on interest income cause savings to rise or fall? What does this result imply about the savings rate? Budget constraint today cts= y-t Budget constraint tomorrow (recall denotes tomorrow's variable) d' = y' -t'+ (1+r)s Lifetime budget constraint (in terms of today's c) ct Sy+ t+ 1tr 1+r 1+r present value of consumption ...of income ...of taxes