>Higher Taxes – Lower Tax Revenue – The Laffer Curve
In economics, the Laffer curve is a theoretical representation of the relationship between government revenue raised by taxation and all possible rates of taxation. It is used to illustrate the concept of Taxable Income Elasticity (that taxable income will change in response to changes in the rate of taxation). The curve is constructed by thought experiment. First, the amount of tax revenue raised at the extreme tax rates of 0% and 100% is considered. It is clear that a 0% tax rate raises no revenue, but the Laffer curve hypothesis is that a 100% tax rate will also generate no revenue because at such a rate there is no longer any incentive for a rational taxpayer to earn any income, thus the revenue raised will be 100% of nothing. If both a 0% rate and 100% rate of taxation generate no revenue, it follows that there must exist a rate in between where tax revenue would be a maximum . The Laffer curve is typically represented as a stylized graph which starts at 0% tax, zero revenue, rises to a maximum rate of revenue raised at an intermediate rate of taxation and then falls again to zero revenue at a 100% tax rate.
One potential result of the Laffer curve is that increasing tax rates beyond a certain point will become counterproductive for raising further tax revenue because of diminishing returns. A hypothetical Laffer curve for any given economy can only be estimated and such estimates are sometimes controversial. The Laffer curve is associated with supply side economics, where its use in debates over rates of taxation has also been controversial.