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Laffer Curve

In economics, the Laffer curve, popularized by supply-side economist Arthur Laffer, illustrates a theoretical relationship between rates of taxation and the resulting levels of government's tax revenue. The Laffer curve assumes that no tax revenue is raised at the extreme tax rates of 0% and 100%, and that there is a tax rate between 0% and 100% that maximizes government tax revenue. The shape of the curve is a function of taxable income elasticity - i.e., taxable income changes in response to changes in the rate of taxation.

The Laffer curve is typically represented as a graph that starts at 0% tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate. However, the shape of the curve is uncertain and disputed among economists. Under the assumption that the revenue is a continuous function of the rate of taxation, the maximum illustrated by the Laffer curve is a result of Rolle's theorem, which is a standard result in calculus.


One implication of the Laffer curve is that reducing or increasing tax rates beyond a certain point is counter-productive for raising further tax revenue. In the United States, conservatives have used the Laffer curve to argue that lower taxes may increase tax revenue. However, the hypothetical maximum revenue point of Laffer curve for any given economy cannot be observed directly and can only be estimated; such estimates are often controversial. The New Palgrave Dictionary of Economics reports that estimates revenue-maximizing tax rates have varied widely, with a mid-range of about 70%. A 2012 poll of leading economists found none agreed that reducing the US federal income tax rate would result in higher annual tax revenue within five years. According to a 2012 study, "the US marginal top (tax) rate is far from the top of the Laffer curve."

The Laffer curve was popularized in the United States with policymakers following an afternoon meeting with the Ford administration officials Dick Cheney and Donald Rumsfeld in 1974, in which Arthur Laffer reportedly sketched the curve on a napkin to illustrate his argument. The term "Laffer curve" was coined by Jude Winniski, who was also present at the meeting. The basic concept was not new; Laffer himself notes antecedents in the writings of the 14th century social philosopher Ibn Khaldun and others.

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