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Definition

Laffer Curve

The Laffer Curve is an economic theory that analyzes how tax reductions may affect government expenditure, income, and long-term growth. The correlation between tax rates and total tax revenue is described by this curve in a line graph, with an optimum rate of taxation that maximizes total tax revenue.

This curve was designed in 1974 by an Economist, Arthur Laffer. This curve is driven by the economic concept that people's behavior will alter in response to the incentives given by income tax rates.

When compared to lower rates, higher income tax rates reduce the motivation for labor and investment. If this effect is significant enough, it means that at some point, increasing the rate further will result in a drop in overall tax revenue. Putting the stats in a line graph would result in a particular curved line and that is the Laffer curve.

Every sort of tax has a threshold value at which the incentives to produce more ultimately result in a decrease, limiting the amount of income collected by the government.

Theoretically speaking, tax revenue would be zero under a 0% tax rate. Tax income received by the government rises when tax rates rise from low levels. If tax rates exceed 100%, as indicated by the Laffer curve, all people would opt out of getting jobs since all they earned would go to the government.

 

Use of the Term in a Sentence

  • The Laffer curve shows how tax rate changes impact government income.
  • Government revenue becomes zero at the top of the Laffer curve when tax rates are 100%.
  • The Laffer curve is associated with the economic assumption that people will modify their behavior in response to the incentives provided by income tax rates.

 

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