There will be a lot of debate about tax policy in the coming months, and you may even here the term “Laffer Curve.” So, I wanted to spend a little time de-mystifying the terminology at bit. First, the Laffer Curve is named for the economist Arthur Laffer who served on the Council of Economic Advisors under Ronald Reagan. The curve is used to explain the relationship between tax rates and tax revenue.
Quite simply, there are two points where tax revenue is $0…0% and 100% tax rates. 0% is obvious, but at 100%, everyone quits working or does not report income. The equilibrium point does not have to be 50%…in fact, that is the matter of debate. The curve can be skewed to the right or left giving more or less emphasis to tax increases or decreases.
What the Laffer Curve says is that at any tax rate lower than the rate that generates maximum total revenue, raising taxes will increase revenue. But, once you go beyond that point raising taxes decreases revenue. The Democrats will contend that we are at point A, where our taxes are “too low” to generate maximum total revenue. Republicans will contend that we are at point B (or at least we are not farm from the equilibrium point) so that raising taxes will actually lower overall revenue.
Where are we? Well, nobody really knows. I suspect we are just to the right of the equilibrium point. That means that incremental decreases in tax rates are not going to get you much additional revenue (and let me be clear that we are talking about individual income taxes, not corporate taxes; corporate taxes, I believe are to the right of point B). But, incremental increases in tax rates will have proportionally larger impacts on tax policy.
At any rate…there you have it. When the debate about taxes is raging, you can refer to this simple diagram to understand that arguments that are being made.