Laffer Curve

Discipline: Economics

Named after American economist Arthur B. Laffer, who maintained that economic expansion could be achieved without government budget deficits.

Laffer curve shows the tax-rate at which government tax revenue is maximized, after which it declines. It illustrates the relationship between average tax-rates and total tax revenue, and shows that above a certain average rate of tax, total tax revenue will fall.

Laffer curve implies that there is a maximum amount of tax that a government can raise, therefore there is a ceiling to the level of public goods which can be provided.

Laffer curve was also stated by French economist Jules Dupuit (1804-1866) in 1844.

In his article 'The Laffer Curve: Past, Present and Future' published on the web site of Heritage Foundation on June 01, 2004, Arthur B. Laffer stated the following:

"The Laffer Curve, by the way, was not invented by me. For example, Ibn Khaldun, a 14th century Muslim philosopher, wrote in his work The Muqaddimah: "It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.

"A more recent version (of incredible clarity) was written by John Maynard Keynes:

"'When, on the contrary, I show, a little elaborately, as in the ensuing chapter, that to create wealth will increase the national income and that a large proportion of any increase in the national income will accrue to an Exchequer, amongst whose largest outgoings is the payment of incomes to those who are unemployed and whose receipts are a proportion of the incomes of those who are occupied...

Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more--and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.'" (John Maynard Keynes, The Collected Writings of John Maynard Keynes; London: Macmillan, Cambridge University Press, 1972)

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