Laffer curve

The Laffer curve plots total long-term tax revenues against the rate of tax.

It illustrates the observation that when tax rates are raised too high, tax revenues (tax yield) will decline.

This is because tax revenues are a product of the rate of tax, and the tax base.

When tax rates are higher, the tax base tends to decline.

In the extreme case of a 100% tax rate, the tax revenue is likely to be zero, because there is no economic incentive for undertaking the activities to earn taxable income.

However, if tax rates are very low, this will also erode tax revenues.

For example, if tax rates are 0%, then tax revenue will of course be zero.

If the purpose of setting tax rates were to maximise long-term tax revenues, there would be a theoretically 'optimal' rate of tax, somewhere between 0% and 100%, that would maximise total tax revenues.

A complicating factor in setting tax rates is the likelihood of time lags between changing rates of tax, and consequential changes to the tax base.

See also

• Phillips curve
• Reaganomics
• Tax yield
• Tax rate
• Tax base
• Trussonomics