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Interest income and willingness to save

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How does a tax on interest income influence a person's willingness to save? Can the impact of the tax on savings be unequivocally predicted from theory? Explain why or why not. How can we encourage Americans to be more willing to save?

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Solution Summary

The predicted effects of taxation on interest income; how Americans can be encouraged to save more.

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It would be expected that if interest income is taxed more people will be less inclined to save. In fact, the opposite can be true: people may save more in an attempt to bolster savings that are reduced by taxation. We call these competing forces the substitution effect and the income effect. No theory can completely explain how much people will save in a given tax environment. People save for emotional reasons, not just economic reasons. If ...

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