Suppose that the government introduces a tax on interest earnings. That is, borrowers face a real interest rate of r before and after the tax is introduced, but lenders receive an interest rate of (1-x)r on their savings, where x is the tax rate. Therefore, we are looking at the effects of having x increase from zero to some value greater than zero, with r assumed to remain constant.(a) Show the effects of the increase in the tax rate on a consumer's lifetime budget constraint.(b) <b style="color:black;background-color:#ffff66">How does the increase in the tax rate affect the optimal choice of consumption</b> ) in the current and future periods) and saving for the consumer? Show how income and substitution effects matter for your answer, and show how it matters whether the consumer is initially a borrower or a lender.
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