What if all the txs inside tornado cash were executed from KYC verified users? 

Private transactions but with KYC guarantee.

Would it solve the legal controversy behind Tornado cash?

ZK Identity @polygonID @iden3 | Powered by Damon Albarn and David Hockney

https://github.com/enricobottazzi

Tornado already kind of has this, you can prove that you are *not* one of the given list of addresses. The government does not care.

20. hacking @ https://www.spire.dev/ 
previously intern Nethermind, epns.io

Which addresses are included in this list? 

and would the government care if they had the guarantee that all the deposits come from KYC'd addresses?

Whatever addresses you wish to include.
You can include every hacker's address in there and prove that you are not among them using ZK proof

Hard to say anything about gov's reactions but strongly feel we shouldn't lower our standards of privacy based on what gov thinks is right

I too was curious about the same questions and had asked this to Micah on our merge stream, you might enjoy it
https://youtu.be/_87HylU9r_Y (at 6.43)