What is Laffer Curve Analysis?

In terms of economics, the Laffer curve was popular among those economists who were or who belonged to the supply side of the economic peripheral.  This concept was popularized by the famous supply-side economist known as Arthur Laffer. This curve illustrated the relationship between the tax rates and government revenue. It is already known that the tax which the public or individuals residing in an economy bear is the revenue or income of the government with the help of which the government does all the necessary works in the society, which is beneficial for the economy.

The Laffer curve represents or shows the relationship between the tax that has been imposed by the government and the income of the government. In this case, it is seen that at zero percent tax rate which is imposed by the government, the income of the government or the revenue of the government is also zero percent. The revenue or the income of the government rises as the tax imposed by the government on the public also rises but to an intermediate level and at this point, the income of the government is at its maximum.

Government Revenue and Tax Rate

Any marginal tax rates that are imposed after the phenomenon of the government income is at its maximum, the income or revenue or the rate of revenue of the government starts falling and ultimately reaches 0 when the tax imposed by the government reaches 100%. Therefore, it can be said that marginal tax rates are not beneficial for the government because the marginal tax rates ultimately lead to a decrease in the revenue of the government. This can affect the society in turn because if the government income is not sufficient enough to provide the benefits or necessities or essentialities to the society then slowly and gradually the standard of living of the society declines and ultimately the growth of the economy will fall. 

It is important to keep in mind that to maximize the income of the government or the revenue of the government, the tax rate should not be maximized but rather it should be optimized by keeping in mind that how can it benefit the society without putting any kind of pressure on the individuals with regards to tax. Also, it is important to know that the marginal tax rates after reaching the point of maximum revenue of the government, which the government can incur after imposing an intermediate level of taxation, can ultimately lead to a decline in the revenue of the government till 0%.

This means that the relationship of the tax revenue and the rate of taxation that is being imposed by the government is having a positive relationship till the intermediary level of taxation when the tax rate is optimal but not maximum and it is imposing a further tax which are the marginal tax rates that can ultimately lead to a negative relationship between the tax revenue and the income or revenue of the government. 

Therefore, it can be said that the capital gains or the revenue or the income of the government is highly dependent on the government itself because it is seen that there is a relationship between the tax imposed by the government and the revenue of the government. The government should impose the taxation rate at an intermediary level to have a beneficial economic effect and also to keep in mind that the aggregate demand of the economy does not fall because they just need to pay a higher tax rate. Therefore, the tax rate of the government which is imposed should be at an intermediary level so that there is a social-economic effect that is beneficial for the economy for its growth.

The Laffer curve advocates the fact that if more money is taken away from the individual in terms of taxation, which is the corporate tax, the individuals or the owners of the business or company will not be willing to invest further because they know that a major portion of their money is going to be taken away by the government and a time will come when if the corporate taxes or corporate tax is charged at a top rate of taxation, the individuals or the investor will not be paying the tax which can lead to a decrease in the income or revenue of the government. 

While constructing the framework of the taxation rate, the government also should consider the capital gains of the corporate sector by determining an intermediary level of corporate tax rate which will not only benefit the businesses or the start-up of the economy, that will gradually become one of the most important factors determining the growth of the economy as well but also will lead to an increase or result in maximization of the revenue or income of the government. 

Laffer Curve Supply-Side Economics

The Laffer curve is given from the point of view of the supply side of the economy because the economic effect of the growth is distributed or stimulated by the policies which are undertaken by the government out of which the tax rate is one of the most important factors playing a crucial role in determining the economic effects of growth.

Is the Laffer Curve Correct?

Whether the Laffer curve is correct or wrong really depends on the country and also on the type of tax rate that the government is undertaking. But one of the most important things is that the Laffer curve analysis is way too simple along with its assumption as well. The optimal tax rate that the government is deciding to impose has to be a stable rate of the tax that is not possible because in a country there are different groups of people in the economy who have different levels of income. If an individual having lower income has to pay that optimum level of taxation that is being imposed by the government,  then after a certain point of time that individual will no longer be interested in paying the tax rate. As a result of which the income of the government from that particular individual or that group of individuals getting an income of lower level will gradually decline. As a result of which the aggregate demand of the economy will also fall.  

Context and Applications  

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for  

• BA in economics
• MA in economics
• BBA
• B.Com