Suppose Congress enacts a tax reform law and the average federal tax rate drops from 30% to 20%?

Question

Researchers investigate the impact of the tax cut and find that the income subject to the tax increases from $800 billion. The theoretical explanation is that workers have increased their work effort in response to the incentive of lower taxes. Is this a movement along the downward-sloping or the upward -sloping portion of the Laffer curve?

Answer 1

It is along the downward sloping portion of the Laffer curve. The Laffer curve is 0 at both ends of the tax rate spectrum. This is fairly intuitive. If the tax rate is 0, revenue will be 0. If it is 100%, no one will work, and tax revenue will again be 0. So, it rises and then begins to decline in there. In this example, the tax rate moves from 30%, where revenue is $800 billion, to 20%, which is higher than $800 billion. Thus, the 30% rate is lower revenue than the 20% rate, which means that between 20% and 30%, revenue is declining, meaning it is on the downward sloping portion of the Laffer curve.