Curve of Laffer
The curve of Laffer is a economic modeling developed by economists of the offer, in particular Arthur Laffer, based on the idea that the positive relation between growth of the tax rate and growth of the public revenue (the State being defined in the broad sense, i.e. the term represents all here the Public administrations) is reversed when the tax rate becomes too high.
When the Taxes and social security deduction are already raised, an increase of taxation would lead then to a lowers public revenue, because the Economic agents surtaxed would be encouraged with less working (that is not worth any more the sorrow to work if the returned resulting from work are too weak).
History of the idea
The idea that “ too much tax kills the tax ” is old: liberal economists old had in their time already carried out a reflection on this phenomenon, as Adam Smith which suggested the phenomenon while writing: “ the tax can block the industry of the people and divert it to be devoted to certain branches of trade or work ”; and especially Jean-Baptiste Say which concluded “ that an exaggerated tax destroyed the base on which it carries ” (principle at the base of policies anti-alcohol or anti-nicotinic: one imposes strong taxes with an aim asserted to reduce consumption).
But it is allocated to the American economist Arthur Laffer, at the end of the Années 1970, to have tried to theorize what it named the tax allergy “ ”, and to have popularized it (at the point to be evoked in the debate and the policy options), with assistance of the curve which bears its name.
Presentation
Assumptions
To simplify, the curve is built on the assumption of a closed economy (where the exchanges with outside are ignored); to take into account the opening of the borders does not change anything with the result Laffer, since that does nothing but add the possibility of tax avoidance for the surtaxed individuals, which is likely to accentuate the reduction in the public revenue in the event of too strong imposition.
An assumption is made on the rationality economic agents: when the tax rate is too strong, the agents decrease their work. Pushed to the extreme, this reasoning implies that the agents would cease working if the tax rate were of 100% (i.e. if they do not touch any wages for provided work). The level of the threshold of imposition beyond whose the agents decrease to them Offre of work is difficult to establish, and depends on the Living conditions (for example, an individual whom the State deprives of the incomes necessary to satisfy its primary education Besoins will tend to work more).
Result
There then exists mathematically a maximum level of the tax proceeds, at the income tax rate (see graphic) beyond whose the tax proceeds decrease when the income tax rate increases, since this rise of tax generates a fall of the Taxability to which the imposition applies.
One can illustrate this relation between level of tax and product of tax by a parabolic Courbe, like that opposite, even if in reality:
- it can have several there maximum buildings (there is at least one, but there can be several without that changing the result of Laffer basically);
- one knows only little thing about the curve. In fact, one knows only that it crosses the horizontal line (returned tax null) at two the 0 and 100% rates, but for the remainder it can present jumps very well (not to be continuous), to present great beaches where the variations of rate have only little effect on the receipts, to go up and go down, to thus make loops (, the same rate could, according to the conditions, to correspond to several levels of receipts! - this being related to the effects of Hysteresis);
- the rate giving the maximum of tax incomes can vary with the wire of time, since economic operation can change.
Prolongations
The curve of Laffer is simple to include/understand, and it shows that it is not fiscally profitable to exceed a certain rate of taking away (located according to the studies between 50 and 80% of the GDP).
It illustrates the idea according to which starting from the désincitatif effect on the offer of work overrides the awaited receipts. Two contradictory effects return concerned: a Substitution effect which encourages an agent to decrease its working time (to occupy its time with another thing, to even emigrate), and a Income effect which encourages the agents to work more in order to find the level of wages of which it had before the increase the taxes. For “high” tax rates the substitution effect overrides the income effect.
All the difficulty is to determine if a given rate is “high” in this direction, and the empirical studies, which try to check this relation, lead to discussed results. It is difficult at the time of an empirical study to separate the many factors which come into play, like:
- the needs for the State which can be different or not constant;
- the structure of the Taxes and social security deduction and the way in which they are perceived near the population;
- tax history of the country, and the usual level of the taking away for this country;
- beliefs of the agents in the future economic situation, and the general economic context;
- the level of Aversion to the risk of the investors and the contractors.
The first part of the curve (low rates) can be comparison with the Théorème of Haavelmo.
Si the curve is continuous and derivable, then it presents necessarily a plate (Théorème of Poker), i.e. a zone where the variations of tax rate have little impact on the tax incomes. If there exists such a zone of about stable income for the State, then, while the public revenue stagnates, those of the taxpayers progressively lower in an important way of the rise of the rates: for example (simplified), if a rate of 50% brings back the same thing that a rate of 40%, that wants to say that the taxpayers reduced their production by 100 to 80, but also that the quantity which remains to them after tax (and before redistribution, possibly) passed from 60 to 40! The rate low which gives the same tax incomes corresponds to more collective richness (100 against 80) and more private richnesses (60 against 40).
Economic visions
According to nonliberal theorists like Peter Lindert, examples of the Scandinavian countries, whose imposition could exceed the 70% of the GDP at a certain time, without involving the consequences that Laffer provided, would show that if the curve of Laffer applied to it, the level of imposition to reach it would be very high and never would thus have been reached to date by any country. Being given the current levels of imposition (between 30 and 50% of the GDP according to the countries), the majority of the countries would be then in the first part of the curve or the punt part (an increase in the taxes then not increasing the total revenues of the State, but decrease the wellbeing of the taxed agents).
According to the liberal theorists of the offers, the essential means of action of a State passes by the reduction of the taxes. This economic policy, by decreasing the weight of the imposition and the national insurance contributions on the companies and the population, would reduce a penalization, considered by these authors, of work and the saving. It would be appropriate in parallel, to decrease competences of the État-providence, which are generally at the origin of the rise of the taxes, and to decrease the debt of the public sphere. It was the policy of the president Ronald Reagan (the United States) or of Margaret Thatcher (the United Kingdom), in the Années 1980.
The aforementioned curve is criticized, including by some economists. If nobody denies that a tax rate of 100% would reduce the public revenue to shagreen, the evolution of the relation in the neighborhoods of the optimal tax rate is called in question. The tax allocation according to the social categories make this relation complex. Economists critical, as new-keynésien Joseph E. Stiglitz ( When capitalism loses the head ), reproaches Laffer for having presented a curve whose form is in fact unknown factor, without empirical studies specific to determine the notable points of them.
Positive applications
Arthur Laffer recalled that the Baltic States and Russia which set up a flat tax lower than 35% saw their economy taking off shortly after. It also defended its theory by evoking economic successes which followed Kemp-Roth tax act, the falls of taxes of Kennedy, or the tax reforms of 1997 in the United States to illustrate how the fall of the tax can involve the economic growth and of the revenues from taxes.
In April 2006, the American Treasury announced that the revenues from taxes had reached their second point highest of the history following the falls of taxes of 2003. For the defenders of Laffer it is a new illustration of its effectiveness.