The Logic of the Laffer Curve
| The Laffer Curve: Basic algebra combined with common sense regarding economic behavior (responsiveness to incentives of different magnitudes) | |||
| Tax cuts from lower starting points provide LESS incremental incentive to work & invest, LESS incremental reduction in incentive for tax avoidance, and require MORE growth of the tax base to be revenue-neutral. | |||
|
Tax rate prior to cut of 4 percentage points |
New Tax Rate After Cut |
Growth in tax base (taxable income + reduced tax avoidance), ceteris paribus, required for tax cut to be revenue-neutral |
Increase in incentive to work & invest, and Decrease in incremental incentive for tax avoidance: Increase in after-tax income per $1 in declared pre-tax income |
|
95% |
91% |
4.4% |
80.0% |
|
91% |
87% |
4.6% |
44.4% |
|
87% |
83% |
4.8% |
30.8% |
|
83% |
79% |
5.1% |
23.5% |
|
79% |
75% |
5.3% |
19.0% |
|
75% |
71% |
5.6% |
16.0% |
|
71% |
67% |
6.0% |
13.8% |
|
67% |
63% |
6.3% |
12.1% |
|
63% |
59% |
6.8% |
10.8% |
|
59% |
55% |
7.3% |
9.8% |
|
55% |
51% |
7.8% |
8.9% |
|
51% |
47% |
8.5% |
8.2% |
|
47% |
43% |
9.3% |
7.5% |
|
43% |
39% |
10.3% |
7.0% |
|
39% |
35% |
11.4% |
6.6% |
|
35% |
31% |
12.9% |
6.2% |
|
31% |
27% |
14.8% |
5.8% |
|
27% |
23% |
17.4% |
5.5% |
|
23% |
19% |
21.1% |
5.2% |
|
19% |
15% |
26.7% |
4.9% |
|
15% |
11% |
36.4% |
4.7% |
|
11% |
7% |
57.1% |
4.5% |
|
7% |
3% |
133.3% |
4.3% |
Notes:
1. For simplicity of illustration, a flat tax on all forms of income is assumed. Breakeven calculations would be different if rate cuts applied only to some types of taxes or only to some rates in a progressive structure.
2. The breakeven growth in the tax base, ceteris paribus, refers to a point in time rather than cumulative net impact. Therefore, if the initial net impact of a tax cut is negative and at some point, due to subsequent incremental expansion of the tax base, reaches breakeven point, the cumulative net impact on revenues will have been negative up to that point. Additionally, the cumulative net impact does not take into account additional interest expense due to additional national debt, nor the time value of money (i.e., a discount rate), which would add to the cumulative negative impact and, in the case of discounting back to present value, which would reduce the present value of any positive impact in out years and therefore the NPV of all related cash flows.
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Comments :
Very useful table, thanks (nt)
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