economics : theme 4 - laffer curve

what did liz truss attempt to cut

income tax 20% to 19%

corporation tax

what is income tax

• part of fiscal policy

• can also be a supply side policy when used to encourage entrepreneurs to create and expand businesses effectively allowing entrepreneurs higher abnormal profits for successful innovations

• impact on tax revenue would be positive (higher taxable incomes)

laffer curve

• tax revenue on y axis

• tax rate % on x axis

what does the laffer curve assume

nobody would work at a tax rate of 100% and more obviously when the rate is 0% then no tax revenue is generated

laffer curve explained

• optimal tax rate is when the curve peaks (followed down)

• any rate above a disincentive to increase individual earnings begins

• advocates assume that the current rate is higher than the optimum

• income or corporation tax rates can be reduced and the government will actually receive higher tax receipts because it is argued that lower rates of tax create a greater incentive to work, thus higher employment outweighs the lower tax yield per person

what is the laffer curve often used as an argument for

tax cuts

3 problems with the laffer curve

• evidence

• complementary taxes / costs

• social benefits

evidence explanation

• based off of the american system , not the uk

• corporation tax went from 26% down to 20% in the uk from 2011 to 2015 but there was still no overall change in investment

complementary taxes / costs explanation

• still other taxes you have to pay e.g. NI so full effect of tax change might not be felt

• changing one tax still might not give incentive to invest

social benefits explanation

• income / wealth inequality

• if you lower the tax for the rich, then the gap between the rich and poor will widen