LAFFER CURVE

Laffer’s argument is that if the income tax rate were 100%, nobody would be willing to work since all wages and salaries would go in taxes; government tax revenue would therefore be zero. As tax rates decreased, some people would begin to work and tax revenues would increase, to some maximum at some point; below that point, decreasing tax rates would begin to result in decreased revenues, again reaching zero when the tax rate is zero. Some tax rate X exists where maximum revenue is achieved. If the government is already taxing at this rate, any change, positive or negative will result in reduced revenues. Moreover, if the government is already taxing above this rate, an increase in tax rates will be accompanied by a decrease in revenues; the budget-balancing action in this case would be to reduce tax rates. Hence Reaganomics and ‘voodoo economics.’ If you believe in the Laffer curve, then any increase or decrease in the tax rate must be based on a good estimate of where the economy is currently positioned.