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The Laffer Curve - Economics 21 Intermediate Microeconomics...

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Economics 21: Intermediate Microeconomics Topic 2: Consumer Theory – The Laffer Curve 1 Economics 21: Intermediate Microeconomics Topic 2: Consumer Theory The Laffer Curve Reference: Varian, p.284-286 Outline: I. Introduction II. The Laffer Curve I. Introduction Consider the relationship between the tax rate, t , and tax revenue, T . If t = 0 is zero, then T = 0. If t = 1 then no one will wish to demand or supply the good, so again T = 0. This would imply that there is an optimal tax rate, t ! , at which T is maximised. This relationships is known as the Laffer Curve. II. The Laffer Curve The Laffer Curve would suggest that further increases in the tax rate beyond t ! would result in a fall in tax revenue – see Figure 1. Figure 1: The Laffer Curve Indeed, the Laffer Curve was featured prominently in the debates of the early 1980s, in both the USA and the UK, regarding ‘Reagonite’ and ‘Thatcherite’ policies to cut income taxes. The question is, so just how high does the tax rate have to be for the Laffer effect to work
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