On the Possibility of an Inverse Relationship between Tax Rates and Government Revenues

30 Pages Posted: 19 Jun 2004

See all articles by Don Fullerton

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: April 1980

Abstract

When Arthur Laffer or other "supply side advocates" plot total tax revenue as a function of a particular tax rate, he draws an upward sloping segment called the normal range, followed by a downward sloping segment called the prohibitive range. Since a given revenue can be obtained with either of two tax rates, government would minimize total burden by choosing the lower rate of the normal range. A brief literature review indicates that tax rates on the prohibitive range in theoretical and empirical models have been the result of particularly high tax rates, high elasticity parameters, or both. Looking at labor tax rates and total revenue, for example, the tax rate which maximizes revenue will depend on the assumed labor supply elasticity. This paper introduces a new curve which summarizes the tax rate and elasticity combinations that result in maximum revenues, separating the "normal area" from the "prohibitive area." A general-purpose empirical U.S. general equilibrium model is used to plot the Laffer curve for several elasticities, and to plot the newly introduced curve using the labor tax example. Results indicate that the U.S. could conceivably be operating in the prohibitive area, but that the tax wedge and/or labor supply elasticity would have to be much higher than most estimates would suggest.

Suggested Citation

Fullerton, Don, On the Possibility of an Inverse Relationship between Tax Rates and Government Revenues (April 1980). NBER Working Paper No. w0467. Available at SSRN: https://ssrn.com/abstract=262690

Don Fullerton (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-3621 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Register to save articles to
your library

Register

Paper statistics

Downloads
18
Abstract Views
745
PlumX Metrics