The Laffer Curve

wreaks havoc in the UK.

Take a look at the graphic in the article. Right there at the peak of maximum revenue, what’s happening in the economy?

It’s stopped growing. Essentially, a tax policy that sits at the peak of the Laffer curve produces a stagnant economy. Wealth is no longer created faster than it is destroyed. You’re not quite at the devastating consequences of the right-hand side of the curve, in which your economy actively contracts and destroys wealth as a response to tax policy, but you’re awfully close, and any non-tax-policy changes in the marketplace might easily push you over into the “destruction of the economy” side of things.

What happens if you’re on the left side of the curve? Well, the government’s not taking in the theoretical maximum amount of revenue it could every year, but the economy is growing and wealth is actively being produced. Society is becoming richer. When that happens, the amount of tax revenue goes up every year in tandem with the growing economy; not by as much as the politicians could theoretically realize by hiking tax rates up to the Laffer curve peak, but once you hit the peak you will never see revenues go any higher, because economic growth has stopped. So as far as long-term sustainability goes, a society with tax rates set on the left side of maximum is going to enjoy economic growth, while a society with tax rates set at peak or right of maximum is going to suffer economic stagnation or contraction.

This is why economists’ projections of funds that will be raised by tax rate increases (or lost by tax rate decreases) are often wrong. The economy shifts in response to tax rates (among other things), and lacking crystal balls, it’s hard to tell exactly how much money is going to be gained or “lost” in revenue when a tax rate is changed.

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