The Laffer curve and economic policy

The Laffer curve indicates that increases in direct taxes may create a disincentive to work to the extent that fewer tax revenues are received by the government. But is the Laffer curve useful as a policy tool?

Statistical models may help determine if it a tax rate creates a disincentive effect.

The Laffer curve and tax policy

For example, with an income tax rate of 60%, and government revenue of $77bn at point z, a policy to reduce tax to 50%, might reasonably expect revenue to rise to $80bn at point t. If the actual gradient is for Curve 2, not Curve 1, then revenues may fall to point x, with no disincentive at z.

Hence, trying to set tax rates based on a theoretical Laffer curve is extremely difficult for several reasons - none the least of which is because there may be imperfect knowledge regarding the specific level of taxation required to maximise revenue and have a largely neutral effect on work and effort.

This problem is compounded by the problem of time lags between the implementation of a policy (say, reducing income tax) and its effect on government revenues.

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