The laffer curve (named after American economist Arthur Laffer) indicates the relationship between the tax rate and the revenue gained by the government. If you charge a high tax rate it is unlikely that you will encourage people into work and therefore the tax revenue for the government is a lot lower if taxes had been lower. The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.
Economists have long used the Laffer curve to justify tax cuts, including:
Ronald Reagan in 1981 – resulted in lower revenues
George W. Bush in 2001 – resulted in lower revenues.
Donal Trump in 2017 – resulted in lower revenues
The Congressional Budget Office, a government watchdog, now reckons that US national debt will hit 95% of GDP by 2027, up from 89% two years ago before the tax cuts.
America (see graphic above) is not the only country that appears to be on the wrong side of Mr Laffer’s curve. A paper published in 2017 by Jacob Lundberg, estimates Laffer curves for 27 OECD countries. He found that only Austria, Belgium, Denmark, Finland and Sweden have top income-tax rates that exceed their revenue-maximising levels. However only Sweden could meaningfully boost revenue by cutting tax rates on high-income earners. Most countries, in other words, appear to have set their highest tax rates at or below the optimal rate suggested by the Laffer curve.
Source: The Economist – 19th June 2019 – Graphic detail