Question

Holding other factors constant, if the consumption tax is replaced with an income tax so that saving is taxed, then the real interest rate will ________ and the equilibrium quantity of saving and investment will ________.

Answer 1

Increase, decrease

Step-by-step explanation:

One can answer the above case by applying simple concepts of demand and supply. If the savings are taxed in an economy then individuals will spend more as they will get more benefit from their income by spending rather than by saving, this will lead to more consumption and demand which further leads to more supply of money leading to decrease in the interest rates.

As people will spend more from their income due to higher taxes the savings in the economy will automatically decrease. Such decisions are usually made by governments to tackle recession in the economy.