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A Tax Reform Analysis of the Laffer Argument

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  • Alan Krause
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    Abstract

    This paper shows that tax reform techniques are well-suited to an examination of the Laffer argument, i.e., the possibility that an increase in a tax rate may reduce tax revenues (and vice versa). Our methodology allows us to examine the Laffer argument directly, without deriving the Laffer curve, which in turn allows us to conduct the analysis in a very general setting. Despite the high level of generality, we are able to reach some clear conclusions that provide formal support for the established intuitions that the Laffer effect requires: (i) a 'high' labour-income tax rate, and (ii) a 'large' labour supply response to wage changes. The notions of 'high' and 'large' are made precise in our framework. The analysis also provides indirect support for the intuition that it is never optimal for a government to operate on the downward-sloping segment of the Laffer curve. Finally, we show that our methods provide a theoretical framework for an empirical investigation.

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    Bibliographic Info

    Paper provided by Department of Economics, University of York in its series Discussion Papers with number 07/10.

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    Date of creation: May 2007
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    Handle: RePEc:yor:yorken:07/10

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    Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
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    Keywords: Laffer argument; tax reform;

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    References

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    1. Guesnerie, Roger, 1977. "On the direction of tax reform," Journal of Public Economics, Elsevier, vol. 7(2), pages 179-202, April.
    2. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
    3. Hindriks, J., 1999. "Mobility and Redistributive Politics," Discussion Papers 9915, Exeter University, Department of Economics.
    4. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December.
    5. Agell, J. & Persson, M., 2000. "On the Analytics of the Dunamic Laffer Curve," Papers 2000:5, Uppsala - Working Paper Series.
    6. Marc Fleurbaey, 2005. "Is Commodity Taxation Unfair?," IDEP Working Papers 0502, Institut d'economie publique (IDEP), Marseille, France, revised Jan 2005.
    7. Guesnerie,Roger, 1998. "A Contribution to the Pure Theory of Taxation," Cambridge Books, Cambridge University Press, number 9780521629560, April.
    8. Hansson, Asa & Stuart, Charles, 2003. "Peaking of fiscal sizes of government," European Journal of Political Economy, Elsevier, vol. 19(4), pages 669-684, November.
    9. Sushama Murty & R. Robert Russell, 2005. "Externality Policy Reform: A General Equilibrium Analysis," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(1), pages 117-150, 02.
    10. Fullerton, Don, 1982. "On the possibility of an inverse relationship between tax rates and government revenues," Journal of Public Economics, Elsevier, vol. 19(1), pages 3-22, October.
    11. Alan Krause, 2007. "Generational incidence of savings taxation versus capital-income taxation," International Journal of Economic Theory, The International Society for Economic Theory, vol. 3(2), pages 113-129.
    12. Robert Carroll & Warren Hrung, 2005. "What Does the Taxable Income Elasticity Say About Dynamic Responses to Tax Changes?," American Economic Review, American Economic Association, vol. 95(2), pages 426-431, May.
    13. Guesnerie, R. & Jerison, M., 1990. "Taxation as a Social Choice Problem, the Scope of the Laffer Argument," DELTA Working Papers 90-06, DELTA (Ecole normale supérieure).
    14. Blackorby, Charles & Murty, Sushama, 2007. "Unit versus ad valorem taxes: Monopoly in general equilibrium," Journal of Public Economics, Elsevier, vol. 91(3-4), pages 817-822, April.
    15. Weymark, John A., 1979. "A reconciliation of recent results in optimal taxation theory," Journal of Public Economics, Elsevier, vol. 12(2), pages 171-189, October.
    16. Michael Keen & Christos Kotsogiannis, 2003. "Leviathan and Capital Tax Competition in Federations," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 177-199, 04.
    17. Diewert, W. E., 1978. "Optimal tax perturbations," Journal of Public Economics, Elsevier, vol. 10(2), pages 139-177, October.
    18. Gahvari, Firouz, 1989. "The nature of government expenditures and the shape of the laffer curve," Journal of Public Economics, Elsevier, vol. 40(2), pages 251-260, November.
    19. Malcomson, James M., 1986. "Some analytics of the laffer curve," Journal of Public Economics, Elsevier, vol. 29(3), pages 263-279, April.
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