- Let's consider an issue of public policy.
What is the optimal tax rate for a government?
Now, we'll define optimal in this way.
What is the income tax rate that will yield
the highest tax revenue for the government?
Is that optimal rate 100%?
Is it 0%?
Or is the optimal rate somewhere in between?
Well, this simple but interesting question
was considered in the 1970s
by an economist named Arthur Laffer.
This simple picture summarizes Dr. Laffer's analysis.
The story goes that
in one of his first explanations of the idea,
first explanations of the idea,
he drew this diagram on the napkin in a restaurant.
Now, look down at the bottom of the diagram.
If the tax rate is zero,
then the government will collect zero in revenue.
will collect zero in revenue,
So that certainly can't be the optimal tax rate
for a government interested in collecting
the highest possible revenue.
But what if the tax rate is 100%?
Now, you might initially say, oh yeah, yeah.
That 100% rate will give the government
the maximum amount of revenue.
But the insight underlying the Laffer Curve
is that when tax rates get so high, say, close to 100%,
say close to 100%, thenpeople stop working.
then people stop working.
With 100% tax rate, people say, well, why should I work?
All the income will be taken away from me.
I'll just stay home and rest.
This Laffer Curve reflects the simplified assumption
that no one will work if the tax rate is 100%.
Of course, some people would keep working
just for the joy of working and to contribute to society.
But overall, the level of productive labor would go way down
would go way down ifthe tax rate were 100%.
if the tax rate were 100%.
Therefore, the optimal tax rate is certainly not zero,
because the government would collect no revenue.
And the optimal tax rate is also not 100%,
because such a high rate gives people
a huge disincentive to work.
So the inevitable conclusion
is that there is some optimal tax rate,
that there is some optimal tax rate,
more than 0% but less than 100%,
that gives the government the highest possible tax revenue.
Now, here in this simple picture,
the optimal rate is drawn to be 50%.
But we don't know exactly what it is.
Is it 70%, is it 30%?
No one knows the exact value of this optimal rate.
But discussion about this general topic
is an interesting and important public policy question.
What is the tax rate
that will properly balance the collecting of revenue
the collecting of revenuefor operating the government,
for operating the government
but also not provide too much disincentive
so that people stop working?