Answer
a) If we reduced taxes on private saving, then the government would have a decrease in tax revenue. Assuming the government would keep their budget the same, the government would be unable to afford their entire budget. If the decrease in government spending forces the government to borrow more money, then the budget deficit would actually increase.
If we reduce the budget deficit, then the government has more money coming into its budget. If the government has more money in its budget, then, assuming the GDP of the country didn't change, there must have been an increase in tax rates. The increased tax rates would negatively affect private saving.
Work Step by Step
b) One item we would need to know is how elastic private saving is (and compare it to the interest rate that is received after the government taxes the interest). This would show how much private saving would be affected by government taxation.
Another item we would want to know is how changes in the government budget deficit affect changes in private saving. Also, knowing the elasticity of investment (with concern to the interest rate) would be helpful. If the demand is elastic, then there is a large change in the quantity of loanable funds with a small change in the interest rate. If the demand is inelastic, then there would be a large change in the interest rate with a small change in the amount of loanable funds.
