Question

Discuss the "Pros and Cons" of the Laffer Curve? Was Arthur Laffer's concept valued

Answer 1

SOLUTION

THE LAFFER CURVE

The Laffer curve states that if tax rates are increased above a certain level, then tax rates can actually fall because higher tax rates . Equally the Laffer curve states that cutting taxes would in theory can reduce the tax rates. It starts from the premise that if tax rates are 0 % then the government gets zero revenue. Equally if the tax rates are 100 % the government would also get 0 % since there is no point in working.

PROS OF LAFFER CURVE

• If tax rates are very high, and then they cut, it create an incentive for business people to expand and work longer.
• The importance of this theory is that it provides an economic justification for the pollitically popular policy of cutting tax rates.
• The Laffer curve became important in the 1980s because it appeared to give an economic justification to cutting income tax rates. For politicians, the Laffer curve is attractive- it appears to give best for both worlds.
• Lower tax rates which are politically popular.
• Lower budget deficits.

CONS OF LAFFER CURVE

• Economists strongly disagree on the level at which higher tax rates actually cause disincentives to work.
• In reality, it is more complicated. Higher tax rates do not necessarily cause people to work fewer hours.
• It can be difficult to measure the impact on tax cuts because these factors will influence the tax revenue.
• To measure whether the Laffer curve is having an effect, we need to measure whether the tax rates have an impact on labour supply and the levels of entrepreneurship.
• In the era of globilisation there is greater tax competition because it is easy for the multi nationals to move operations to other countries.

IS LAFFER CURVE VALID

The Laffer curve assumes that no tax revenue is raised at the extreme tax rates of 0% and 100% and that there is a tax rate between 0 % and 100 % that maximises the government tax revenue. So, it is valid. However the hypothetical maximum revenue of the Laffer curve for any given economy cannot be observed directly. And the shape of the curve is uncertain and disputed among economists