Final answer:
The correct answer is B. Initially increase but eventually decrease.
Step-by-step explanation:
According to the Laffer Curve, as tax rates rise from 0% to 100%, tax revenues will initially increase but eventually decrease. The curve illustrates the concept that at a tax rate of 0%, the government would collect no revenue, and similarly at a tax rate of 100%, there would also be no revenue because there would be no incentive to work. At some point between these two extremes, there is an optimal tax rate that maximizes government revenue. Beyond this optimal point, increasing tax rates will lead to a decrease in revenue as individuals and businesses alter their behavior to avoid paying high taxes, which may include working less, making less income, or finding ways to evade taxes.
Economist Arthur Laffer highlighted that, in some situations, reducing income tax rates could actually lead to an increase in tax revenue. This could happen because lower tax rates can incentivize economic activity, leading to greater overall income that even at lower rates, results in increased tax revenue. However, it is crucial to understand that a tax cut does not always increase tax revenues; this phenomenon largely depends on the current position on the Laffer Curve.
The labor supply decisions are primarily based on the marginal tax rate rather than the average tax rate. Since the marginal tax rate dictates the amount of tax paid on the next dollar earned, it directly affects an individual's incentive to work more hours.