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What is the Laffer curve?

The Laffer curve shows the theoretical relationship between tax rates and tax revenues.

Imagine a government charges a 0% income tax; they definitely won’t receive any money from that tax. Meanwhile, at 100%, no one has incentive to work in paid employment, so they don't earn any money and the government receive no tax revenue. In between, we have tax revenue rising at first, but then falling with the average tax rate.

As the tax rate increases, the government receive more money from the tax. However, as the tax rate continues to increase, people get less and less of the money they earn as the government is taking ever more of it.

At some tax rate t*, the government can maximise the amount of tax revenue it receives at R*. At this point, neither increasing nor decreasing the tax rate can lead to an increase in tax revenue. 

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