The Laffer Curve shows how a government’s tax revenue changes with changes in the average tax rate.
· When the average tax rate is 0%, tax revenues are 0.
· Tax revenues are also 0 when the average tax rate is 100%.
· Tax revenues are maximised at the highest point on the curve, in this case it’s at a 50% average tax rate.
· As the average tax rate increases, tax revenues rise until a certain point whereby after, there is no longer an incentive to produce output and people work less or do more to avoid paying the tax which reduces total revenue because the opportunity cost of paying the tax rises.
· The Laffer Curve suggests that total tax revenues will increase at a lower tax rate, therefore cutting taxes will increase total tax revenues and create a virtuous cycle.
· Reducing the tax rate creates incentives to work and produce output, stimulating economic growth, thus increasing total tax revenues.