Chapter 15: Problem 18

According to the Laffer curve, when very high marginal tax rates are lowered, tax revenue will \- (LO6) a) decline considerably c) stay the same b) decline slightly d) increase

Short Answer

Expert verified

d) increase

Step by step solution

Understand the Concept of the Laffer Curve

The Laffer curve is a representation in economics that illustrates the relationship between rates of taxation and the resulting levels of government revenue. It demonstrates the concept of taxable income elasticity—taxable income will change in response to changes in the rate of taxation.

Analyze the Tax Rates Scenarios

The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100%, shown as the far right on the Laffer curve, all people would choose not to work because everything they earned would go to the government. This would lead to zero tax revenue.

Apply the Laffer Curve Concept to the Given Scenario

Since we know that the relationship stated by the Laffer curve is parabolic, it infers that if we're at tax rates higher than T*, lowering tax rates would actually lead to an increase in tax revenue.

Choose the Correct Option

Based on the Laffer curve theory, if very high marginal tax rates are lowered - i.e., if the current tax rate is higher than T* - the tax revenue will increase. So, the correct answer is (d) increase.

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