This Site Requires Javascript
Burger Menu

Laffer Curve

Additional Resources

  1. Exploring The Laffer Curve: Behavioral Responses To Taxation [scholarworks.uvm.edu]
  2. How Far Are We From The Slippery Slope? The Laffer Curve Revisited [economics.missouri.edu]
  3. The Laffer Curve Revisited [home.uchicago.edu]
  4. Predicting The Top Of The Laffer Curve [faculty.georgetown.edu]

Definition

In economics, the Laffer curve is a representation of the relationship between rates of taxation and the resulting levels of government revenue. The Laffer curve claims to illustrate the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation. It postulates that no tax revenue will be raised at the extreme tax rates of 0% and 100% and that there must be at least one rate which maximises government taxation revenue.

Laffer Curve

The Laffer curve is an important concept in economics that explains the relationship between the rates of taxes and the amount of revenues generated from it by a government. The curve claims that tax rates cause an elastic increase in the amount of tax revenues up to an elastic point. The revenues start to go down once the rates go above this magical number.

How the Curve is Drawn?

The curve starts from the origin, which shows that no tax can be collected at 0% tax rate. Tax collections increase with the increase in rate until the elusive tax rate is achieved. People lose interest after this percentage according to the theory of the Laffer curve and they generate less income which significantly decreases the amount of collected tax.

Is It Real?

Laffer curve is an imaginative concept used to explain the negative effects of excess taxation. It is hard to find the data required to draw out a real Laffer curve. Certain values are imagined by economists for different countries, but none of these values can be backed up by real data as it is simply not possible.

The Laffer curves are imagined for different economies and may have multiple peaks according to the situation in a particular economy. Some models predict that the maximum point of the curve is around 65-70% of the tax rate which means that most countries around the world are still on the left side of the curve and can generate more revenues by increasing taxes.

Tax Complications

Tax generation is a complex matter and does not depend on just the single factor of the tax rate. There is also the concept of tax avoidance. Economists believe that people will find ways to avoid tax when it goes beyond a certain value, thus undermining the concept of no revenue generated at 100% tax rate. Some theorists also believe that forcing the economy on the right side of the Laffer curve will simply trigger a barter system where people will start to exchange goods rather than trying to earn highly taxable income.