Final answer:
Tax revenues typically increase as GDP rises due to higher income and sales in a growing economy. The Laffer Curve suggests that reductions in tax rates can sometimes boost tax revenue by stimulating economic activity. A growing GDP relative to population also increases per capita income and tax collection.
Step-by-step explanation:
As GDP rises during a period of prosperity, tax revenues generally increase. This is because tax collection, which includes income taxes and sales taxes, typically changes in line with the economic activity. Income and sales usually see upward trends when the economy is growing, which leads to a higher tax collection.
Economist Arthur Laffer explained that sometimes when tax rates go down, income tax revenue can actually go up. This phenomenon, represented by the Laffer Curve, suggests that lower tax rates may encourage more economic activity, leading to an expansion of the overall tax base. With more transactions and higher income, even at a lower rate, tax revenues can rise due to the increase in taxable activities.
Moreover, when GDP grows faster than the population, not only does GDP increase, but so does GDP per capita, which tends to raise the total taxable income, adding to the increase in tax revenues.