The Laffer Curve, developed by economist Arthur Laffer to justify tax cuts, argues that government can maximize revenue (taxes) by setting an optimal tax rate. At both extremes--zero percent and one-hundred percent--the government collects no revenue: a 0% tax rate means the government's revenue is, of course, zero; moreover, by imposing a 100% tax rate, the government collects zero revenue because taxpayers have no incentive to work or earn. Somewhere between 0% and 100%, therefore, lies a tax percentage rate that will maximumize revenue, an idea central to the supply side economics and tax cuts of the 1980s.
The Laffer Curve and supply side economics inspired the Kemp-Roth Tax Cut of 1981.
Figure 1: t* represents the optimal rate of taxation
Supply-side advocates of the 1980s claimed that lower taxes would generate more revenue because government was operating on the right side of the curve. Conventional economic paradigms acknowledge this basic notion, but argue that government was operating on the left side of the curve, so a tax cut would thus lower revenue. The central question is the elasticity of work with respect to tax rates.
In the United States, some claimed that both tax cuts and government spending policies of the 1980s caused large budget deficits, but actual data show United States government revenue increased during that period, revealing that deficits were unrelated to tax cuts, but were attributed to increased spending.
The central idea of the Laffer curve had been written about in antiquity by many scholars including the Islamic Scholar Ibn Khaldun.
Rumor suggests the Laffer Curve was originally sketched on a restaurant napkin in the late 1970s as Art Laffer and Robert Mundell described the concept to Jude Wanniski.
