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Why is the shape of the Laffer curve for consumption tax different from that for labor income tax?

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  • Kazuki Hiraga
  • Kengo Nutahara

Abstract

Recent studies on Laffer curves (tax revenue curves) find that the Laffer curve for consumption tax might not be hump-shaped, but monotonically increasing, whereas the Laffer curve for labor income tax is hump-shaped. This study investigates the cause of this difference in the shapes of two Laffer curves, by decomposing the effects of an increase in a tax rate on the tax base as a product of two parts: (i) the effects on the relative price of leisure (RPL), and (ii) the substitution and income effects. It is shown that the first effect with respect to the consumption tax rate is completely different from that with respect to the labor income tax rate, while the second effect is common among the taxes and depends on the functional form of the utility. The elasticity of the RPL from an increasing consumption tax rate is at most 1, whereas it can be infinity as the tax rate increases in the case of labor income tax.

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  • Kazuki Hiraga & Kengo Nutahara, 2018. "Why is the shape of the Laffer curve for consumption tax different from that for labor income tax?," CIGS Working Paper Series 18-004E, The Canon Institute for Global Studies.
    • Handle: RePEc:cnn:wpaper:18-004e
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    Cited by:

    1. Blum, Bianca & Franke, Marcel & Malmberg, Elina & Neumärker, Bernhard & Weinel, Jette, 2023. "The New Ordoliberalism: A case for UBI?," The Constitutional Economics Network Working Papers 01-2023, University of Freiburg, Department of Economic Policy and Constitutional Economic Theory.
    2. Kazuki Hiraga & Kengo Nutahara, 2019. "Fragility in modeling consumption tax revenue," CIGS Working Paper Series 19-003E, The Canon Institute for Global Studies.

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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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