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Principles of Economics- Mankiw (5th) 166

Principles of Economics- Mankiw (5th) 166 - 172 PA R T T H...

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172 PART THREE SUPPLY AND DEMAND II: MARKETS AND WELFARE CASE STUDY THE LAFFER CURVE AND SUPPLY-SIDE ECONOMICS One day in 1974, economist Arthur Laffer sat in a Washington restaurant with some prominent journalists and politicians. He took out a napkin and drew a figure on it to show how tax rates affect tax revenue. It looked much like panel (b) of our Figure 8-7. Laffer then suggested that the United States was on the downward-sloping side of this curve. Tax rates were so high, he argued, that re- ducing them would actually raise tax revenue. Most economists were skeptical of Laffer’s suggestion. The idea that a cut in tax rates could raise tax revenue was correct as a matter of economic theory, but there was more doubt about whether it would do so in practice. There was little evidence for Laffer’s view that U.S. tax rates had in fact reached such ex- treme levels. Nonetheless, the Laffer curve (as it became known) captured the imagination of Ronald Reagan. David Stockman, budget director in the first Reagan admin-
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