Tax revenue falls to zero at both a zero rate and a confiscatory rate, so a revenue-maximising rate exists between them.
The shape is uncontroversial and the location is not. Where any real economy sits on the curve is an empirical question, and most estimates put revenue-maximising top rates well above current US levels. The curve is a restatement: Ibn Khaldun set out the same relationship in 1377, and Laffer credited him for it.
In practice
- A finance minister told that a rate cut will pay for itself asks at what rate revenue peaks, and finds nobody in the room has an estimate.
- A 98% top rate and a 0% top rate both raise nothing, which settles the shape and says nothing about whether 45% sits above or below the peak.
- Possible explanations
- The mechanism is behavioural: higher rates reduce the taxed activity through less work, more avoidance and relocation, so revenue rises and then falls rather than climbing without limit.
- In its favour
- The shape follows from its endpoints and is not disputed, and estimates of a revenue-maximising top rate do exist, which is what the curve asserts.
- Against it
- Most estimates put that rate far above the top rates in current American and European law, and budget offices have repeatedly found large rate cuts losing revenue, so the claim that cuts pay for themselves has little support.
- Standing
- The shape is uncontroversial; where real economies sit on it is heavily disputed. Ibn Khaldun stated the relationship in the Muqaddimah in 1377, and Laffer credited him rather than claiming originality.
- Further reading
- Wikipedia
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money