The Laffer Curve in Taxes..!

The Laffer Curve in Taxes..!

The Laffer Curve in Taxes With the Budget, there are hopes built on tax incentives to consumers and investors to revive the economy.

Laffer Curve theory is an approach to assess appropriate level of taxes in the economy

(1). What is Laffer Curve?

In economics, the Laffer Curve is a graphic rep resentation of the rela tionship between rates of taxation and the resulting levels of government revenue.

The theory tries to arrive at an optimal tax rate beyond which tax revenues for an economy tend to fall.

(2). What does it say?

The Laffer curve was developed in 1979 by economist Arthur Laffer. 

According to Laffer's theory , tax revenues are almost zero at extreme rates.

At zero tax rate, particularly the income-tax, it is natural that tax revenues are zero.

But at an extreme of a 100% tax rate, the government theoretically collects zero revenue because the assumption is that taxpayers have no incentive to work as they would be left with nothing to spend at such high or they find a way to avoid paying taxes.

3. What is its significance for consumers and investors?

The Laffer curve formed the basis of supply side economics and the policy of tax cuts that US president Ronald Regan pursued in the eighties.

He cut taxes so that the tax payers have more money at their disposal to spend and the multiplier effect from such spends would result in more demand for goods and services and employment and income.

This policy was very successful in the US in the eighties and helped the US economy come out of a recession by the end of the decade.

4. Why is it relevant in the Indian context?

Income-tax rates in India have been gradually coming down with the economic reforms over the last 25 years.

But, with the budget coming in there is an expectation from the consumers who fall in the lowest slab of Income Tax could benefit if the government lowers taxes as it would help them spend more and an increase in consumption demand could revive the economy over a period of time.

5. What are the limitations?

Whether a decrease in tax rates would increase tax revenues de pends to a large extent on the elasticity of labour supply , that is, on how much workers respond to increased incentives.

Also, a decrease in tax rates would also increase saving and capital formation and would reduce the incentive to acquire tax shelters.

Src: ET, Gayatri Nayak

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