Multiple Regression

1
The Laffer Curve
Hal W. Snarr
2
The Laffer Curve
The Laffer Curve describes the relationship
between the tax rate and the tax revenue it
generates
The Laffer Curve implies there is an optimal
tax rate, a tax rate that maximizes tax revenue.
In the movie Ferris Buellers Day Off, economist
Ben Steins character--Buellers infamous
teacher--drew this curve on the white board and
was discussing it as his students slept and
drooled on their desks.

• The Laffer curve gets its name from economist Art
  Laffer even though a 14th century Islamic scholar
  named Ibn Khaldun first conceived it.

Legend has it that Laffer sketched it on a napkin
over coffee to high level advisors to President
Reagan
3
The Laffer Curve
People will not work and firms will not produce
anything if the tax rate is 100.
If no one works and
nothing is produce, the economy generates no
income.

Hence, Tax
Revenue 0
People pay no income taxes when the tax rate is
0.
Hence, Tax
Revenue 0
2.5
2.0
Tax Revenue (in trillions of )
1.5
1.0
0.5
0
0
20
40
60
80
100
tax rate (percent)
4
The Laffer Curve
If tax revenue is 0 when the tax rate is 0 or
100, there is a tax rate where tax revenues
reach a maximum value.
If tax revenue is 0 when the tax rate is 0 or
100, there is a tax rate where tax revenues
reach a maximum value.


This tax rate generates 2.5 trillion in tax
revenue.
According to the diagram below, the optimal tax
rate is 30.
30
2.5
2.5
2.0
Tax Revenue (in trillions of )
1.5
1.0
0.5
0
0
20
40
60
80
100
tax rate (percent)
5
The Laffer Curve
tax revenue is 1.7 trillion.
If the tax rate is 60,
tax revenue increases to 2.5 trillion.
If the tax rate is cut to 30,
2.5
2.5
2.0
Tax Revenue (in trillions of )
1.7
1.5
1.0
0.5
0
30
60
0
20
40
60
80
100
tax rate (percent)
6
The Laffer Curve
tax revenue is 2.5 trillion.
If the tax rate is 30,
tax revenue decreases to 1.7 trillion.
If the tax rate is raised to 60,
2.5
2.5
2.0
Tax Revenue (in trillions of )
1.7
1.5
1.0
0.5
0
30
60
0
20
40
60
80
100
tax rate (percent)
7
The Laffer Curve
The Laffer Curve also suggests that when tax
rates are too low, a tax cut lowers tax revenue.
2.5
2.3
2.0
Tax Revenue (in trillions of )
1.6
1.5
1.0
0.5
0
10
20
0
20
40
60
80
100
tax rate (percent)
8
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