Edited by Mark Blaug and Peter Lloyd
Chapter 54: The Laffer Curve
Roger Middleton The Laffer curve represents graphically the principle that tax revenue (T) does not peak at the highest tax rate available to the fiscal authority but at t*, some way short of the maximum, this irrespective of whether it be an individual tax on a good, service or factor income, or a hypothetical aggregate tax system. In the case of an income tax, and most but not all Laffer curve applications have been such cases, revenue T is thus zero when t is zero and 100 per cent (at which point – rationally – all production in the money economy would cease), with t* the point of maximum revenue and the shaded area the ‘prohibitive range’ (Figure 54.1, which follows Laffer’s unorthodox presentation of the dependent variable on the horizontal axis). This embodies the long-established ‘proposition that increases in tax rates discourage market-sector production and may therefore, beyond a certain level, be counterproductive in raising tax revenue’ (Laffer 1981, p. 1). In Laffer’s (2004) retrospective formulation,1 taxation has two effects on revenue: one purely arithmetic, whereby a change in tax rates alters the revenue per unit of tax base, and the other economic, allowing for the potential impact that tax rates have on incentives and thus the level of economic activity. 1. HISTORY AND SIGNIFICANCE The proximate origins of this fiscal precept as the Laffer curve are somewhat shrouded in mystery, but are dated to 1974 and involve a Californian professor of business economics (Arthur Laffer), two presidential aides, a...
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