Answer to Question #113207 in Macroeconomics for John Picchiotti

Question

Graph 1. Draw graphs of 1) a tax on a good designed to raise revenue and 2) a tax on a good designed to abate an externality. Discuss the similarities and differences.

Answer 1

The Laffer Curve is a theory developed by supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate Laffer’s argument that sometimes cutting tax rates can increase total tax revenue.

If taxes are too high along the Laffer Curve, then they will discourage the taxed activities, such as work and investment, enough to actually reduce total tax revenue. In this case, cutting tax rates will both stimulate economic incentives and increase tax revenue.