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The Laffer curve

  • Political Science


Some recent attention has been given to the so called 'Laffer Curve'. This analysis begins from the observation that tax rates of zero and tax rates of one hundred per cent can both be expected to yield no government revenue. There is therefore a function relating tax revenue and tax rate-the Laffer curve-and if this function is continuous it achieves a maximum at a tax rate which is positive but less than 100 per cent. This observation is somewhat trite, and it has practical significance only if it can be shown that real economies are, or might be, close to the point at which increases in tax rates produce reductions rather than increases in the revenue obtained. The tax rate which yields maximum revenue-which we will call the maximum average tax rate- is certainly less than 100 per cent and the corresponding figure for the UK is 36 per cent. OECD statistics show only one country-Sweden-in which the average tax rate reaches 50 per cent and the corresponding figure for the UK is 36 per cent. This paper examines whether evidence gives any support to the proposition that the maximum average tax rate might be found in this range. Could disincentives to effort now be so great that tax cuts would lead to only modest reductions, or even increases, in the tax revenue obtained?

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