Question

4. President Flatonio is once again having problems in Flatland. He’s now convinced that Flatland is on the “wrong” side of the Laffer curve. What would his optimal tax policy be here? Look online, can you find a time in real life (ie, not Flatland) that a country was on the wrong side of the Laffer curve?

Answer 1

4. The Laffer curve is the curve that shows the relationship between tax rate and tax revenue, it states that initially when policy makers increases the tax rate the tax revenue increases but after some optimal tax rate, any further increase in tax rate decrease the tax revenue. So there is tax rate t* after which if we increase the tax rate total tax revenue starts to fall because people losses incentive to work because of the large tax rates. Below I have drawn a typical laffers curve

Here you can see that the shape of Laffer curve is concave which means that after attaining some maximum value of tax revenue it starts to fall. The optimal tax rate is t*.

President of flatonio thinks that they are on wrong side of the laffers curve which means they are on the right side of t* which suggest the tax rate in flatonio is beyond optimal tax rate. So the optimal tax policy here should be to decrease the tax rate and maximize the tax revenue. So, the optimal tax policy here should be to reduce tax rate in order to maximize the tax revenue.

A study was published in 2017 by jacob lundberg, he studied the optimal tax rates in OECD countries in and he found that only Austria, Denmark, Belgium and Sweden have top income - tax rates that exceeds their revenue maximizing levels. However only Sweden could meaningfully boost revenue by cutting tax rate. So we can say that Sweden was on the wrong side of the laffers curve.