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WHY WHEN WE ARE ON THE DOWNWARD SLOPING SIDE OF THE LAFFER CURVE WOULD A TAX CUT  GIVE...

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rogerarnold | Student, Undergraduate | (Level 2) Honors

Posted April 3, 2010 at 11:02 AM via web

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WHY WHEN WE ARE ON THE DOWNWARD SLOPING SIDE OF THE LAFFER CURVE WOULD A TAX CUT  GIVE PEOPLE AN INCENTIVE TO WORK MORE AND JOIN THE LABOR FORCE?

I MEAN WHY JUST BECAUSE TAXES ARE LOWERED FROM SUCH A HIGH RATE WOULD THAT ENCOURAGE PEOPLE TO WORK MORE AND JOIN THE LABOR FORCE? I WOULDN'T REALLY SEE A CHANGE IN BEHAVIOR!

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krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted April 3, 2010 at 3:07 PM (Answer #1)

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Laffer curve, named after economist Arthur Laffer is a graph of tax rate expressed as a percentage of income versus the total tax revenue. Please note that the shape of Laffer curve does not determine the behavior of people. Rather Laffer curve depends on behavior of people.

As represented by Laffer curve, total revenue initially rises as the tax rate are increase from a level of 0 % or no tax, reaches a maximum level of total revenue, and then again declines to reach a level of 0 revenue at the tax rate of 100 percent.

The typical shape of Laffer curve is because of two factors that contribute to the total revenue. We know:

Total revenue = Total income x Tax rate

When the tax rate is low the people retain most of the amount they earn and therefor have greater motivation to increase their earnings, and as the tax rate increases they have reduced motivation to earn. leading to reducing total income as the tax rate rises. Thus tax revenue is a product of two variables, total income and tax rate. The total income falls as the tax rate increases reaching to a level of 0 when ax rate is 100%. The tax revenue is thus 0 when either the tax rate or total income is 0. Therefor the tax revenue is 0 when the tax rate is either 0 or 100%. In between these two points the tax revenue reaches a maximum level as the rise in tax is accompanied with less matching fall in total income. The total revenue levels of to a maximum level at point where rise in tax is accompanied by matching  fall in total income. After this point the rise in tax is accompanied with more than matching  fall in total income, resulting in falling tax revenue.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted April 3, 2010 at 11:06 AM (Answer #2)

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The idea here is that when taxes are lower, you take home more of your pay because you have to give less of it to the government.  In effect, that is an increase in your wages.  If wages increase, then (the argument goes) you will want to work more because for each hour you work you are getting more money.  Since it's more worth your while to work, you will work more.

Of course, you can argue that people will just work less for the same amount of pay.  But supply-side economists do not believe that this is how it will happen.  They believe you'll work more to get more money.

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