Question

Which of the following scenarios is consistent with the Laffer curve?

a. An increase in the tax rate always increases tax revenue .
b. The tax rate is 1 percent, and tax revenue is very high.
c. The tax rate is 99 percent, and tax revenue is very high.
d. A decrease in the tax rate always increases tax revenue .

Answer 1

No option is correct.

• a. An increase in the tax rate always increases tax revenue. ⇒ FALSE, if tax rates increase beyond the optimal level, instead of increasing total revenue they will decrease it.
• b. The tax rate is 1 percent, and tax revenue is very high. ⇒ FALSE, very low tax rates will result in very low government revenue.
• c. The tax rate is 99 percent, and tax revenue is very high. ⇒ FALSE, very high tax rates will result in very low government revenue.
• d. A decrease in the tax rate always increases tax revenue. ⇒ FALSE, if tax rates decrease beyond the optimal level, instead of increasing total revenue they will decrease it.

Step-by-step explanation:

According to Arthur Laffer, a direct and sometimes inverse relationship exists between tax rates and government revenue. Sometimes a lower tax rate can result in higher government revenue. But that is not always the case. Sometimes an increase in the tax rate can increase government revenue. The optimal tax rate (T*) is equal to the tax rate that will allow the government to collect the highest amount of revenue. Any lower or higher tax rate will decrease government revenue.