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Laffer Curve

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Definition

In economics, the Laffer curve illustrates a theoretical relationship between rates of taxation and the resulting levels of government revenue. It illustrates the concept of taxable income elasticity—i.e., taxable income changes in response to changes in the rate of taxation. The Laffer curve assumes that no tax revenue is raised at the extreme tax rates of 0% and 100%, and that there is a rate between 0% and 100% that maximizes government taxation revenue. The Laffer curve is typically represented as a graph that starts at 0% tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate. However, the shape of the curve is uncertain and disputed among economists. Under the assumption that revenue is a continuous function of the rate of taxation, then the maximum illustrated by the Laffer curve is due to Rolle's theorem, which is a standard result in calculus.

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.

Laffer Curve FAQ

What is Laffer curve theory?

The Laffer Curve is a hypothesis created by financial specialist Arthur Laffer to show the connection between charge rates and the measure of duty income gathered by governments. The curve is utilized to represent Laffer's contention that occasionally reducing government expenditure rates can expand all out assessment income. May 1, 2020

Why is the Laffer Curve important?

The Laffer Curve expresses that in the event that duty rates are expanded over a specific level, at that point charge incomes can really fall on the grounds that higher expense rates dishearten individuals from working. ... The significance of the hypothesis is that it gives a financial avocation to the politically well known arrangement of reducing government expenditure rates. May 18, 2018

How do you plot a Laffer curve?

It is fundamentally evident that sooner or later in the reach where charge income is positive, it must arrive at a most extreme point. This is spoken to by T* on the diagram underneath. To one side of T* an expansion in charge rate raises more income than is lost to counterbalancing laborer and financial specialist conduct. Expanding rates past T* anyway would cause individuals not to fill in so much or not in the least, along these lines decreasing all out expense income.

How does the Laffer Curve Work?

The Laffer Curve depends on the monetary thought that individuals will change their conduct despite the motivators made by annual expense rates. Higher annual duty rates decline the impetus to work and contribute analyzed lower rates. ... At a 0% charge rate, charge income would clearly be zero. May 1, 2020

Why is the Laffer curve shaped the way it is?

The state of the curve is an element of available pay flexibility – i.e., available pay changes in light of changes in the pace of tax assessment. ... One ramifications of the Laffer curve is that decreasing or expanding charge rates past a specific point is counter-gainful for raising further duty income.

What does the Laffer curve demonstrate?

The "Laffer Curve,” suggests lowering tax rates might increase tax revenue. May 1, 2020

Further Reading

The Laffer curve revisitedThe Laffer curve revisited
www.sciencedirect.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

On the analytics of the dynamic Laffer curveOn the analytics of the dynamic Laffer curve
www.sciencedirect.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

Taxes, revenues, and the Laffer curveTaxes, revenues, and the Laffer curve
search.proquest.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

Steady state Laffer curve with the underground economySteady state Laffer curve with the underground economy
journals.sagepub.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

Sweden's Laffer curve: Taxation and the unobserved economySweden's Laffer curve: Taxation and the unobserved economy
www.jstor.org [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

IMF programmes: Is there a conditionality laffer curve?IMF programmes: Is there a conditionality laffer curve?
ideas.repec.org [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

The debt laffer curve: Some estimatesThe debt laffer curve: Some estimates
www.sciencedirect.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

What's wrong with the Laffer Curve?What's wrong with the Laffer Curve?
www.tandfonline.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

How far are we from the slippery slope? The Laffer curve revisitedHow far are we from the slippery slope? The Laffer curve revisited
www.nber.org [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

Financial sector inefficiencies and the debt Laffer curveFinancial sector inefficiencies and the debt Laffer curve
onlinelibrary.wiley.com [PDF]
… Volume 58, Issue 4, May 2011, Pages 305-327. Journal of Monetary Economics … depends on the joint tax wedge created by consumption and labor taxes, the Laffer curves do not … Ireland (1994) shows that there exists a dynamic Laffer curve in an AK endogenous growth model …

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