1. The Laffer Curve Hal W. Snarr

2. 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 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 Bueller’s Day Off, economist Ben Stein’s character--Bueller’s infamous teacher--drew this curve on the white board and was discussing it as his student’s slept and drooled on their desks. The Laffer Curve

3. Hence, Tax Revenue = 0 If no one works and nothing is produce, the economy generates no income. People will not work and firms will not produce anything if the tax rate is 100%. Hence, Tax Revenue = 0 0 0.5 1.0 1.5 2.0 2.5 020406080100 tax rate (percent) Tax Revenue (in trillions of $) The Laffer Curve People pay no income taxes when the tax rate is 0%.

4. 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. 0 0.5 1.0 1.5 2.0 2.5 020406080100 tax rate (percent) Tax Revenue (in trillions of $) 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. This tax rate generates $2.5 trillion in tax revenue. According to the diagram below, the optimal tax rate is 30%. 30 2.5

5. tax revenue is $1.7 trillion. 0 0.5 1.0 1.5 2.0 020406080100 tax rate (percent) Tax Revenue (in trillions of $) The Laffer Curve If the tax rate is 60%, 2.5 30 tax revenue increases to $2.5 trillion. 60 1.7 If the tax rate is cut to 30%,

6. 2.5 tax revenue is $2.5 trillion. 0 0.5 1.0 1.5 2.0 020406080100 tax rate (percent) Tax Revenue (in trillions of $) The Laffer Curve If the tax rate is 30%, 2.5 30 tax revenue decreases to $1.7 trillion. 60 1.7 If the tax rate is raised to 60%,

7. 0 0.5 1.0 1.5 2.0 020406080100 tax rate (percent) Tax Revenue (in trillions of $) The Laffer Curve The Laffer Curve also suggests that when tax rates are too “low,” a tax cut lowers tax revenue. 2.3 20 2.5 1.6 10

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