Scenario 1: suppose savers either buy bonds or make deposits in savings accounts at banks. initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. now suppose there is an increase in the tax rate on interest income, from 20% to 25%.

The change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to increase and the level of investment spending to decrease. If the interest increase, it follows that the spending would decrease.