Government taxes income tax on interest income but the interest earned is not always your income. If the inflation is 8% and you are earning interest of 7 % then actually you are loosing 1% income annually. The interest earned is not at all be your income. If you pay tax you loose more. There is no point in keeping money in the bank just to loose your money to bank and government. Instead you buy some good item. The government should tax your interest only if you earn more than inflation rate and on the amount that exceeds inflation rate. That means if you are getting 7% interest and inflation is 6% then the government can tax on your 1 % interest income.
