An alternative to the Laffer curve: Theory and consequences

The Laffer curve is often used to analyze revenue-maximizing tax pressure and to provide normative suggestions to policymakers. We suggest that although the Laffer curve provides valuable insights, revenue maximization is not the only factor guiding policymakers’ decisions in regard to the suitable tax pressure. Thus, we try to broaden the spectrum by replacing the Laffer curve with a different graphical instrument, which takes into account three key variables: the quality of public expenditure, ideology (the role of populism) and rent-seeking. By means of this new graphical instrument, we derive results that shed light on the nature of the equilibria various countries can hope to obtain, as well as on the features of the imbalances. We then extend our insights to an open-economy contest featuring tax competition. In particular, we assess when tax competition is relevant, and we investigate whether the proposed remedy–tax harmonization–is credible. It is argued that tax harmonization is inferior to cooperation and that it is in fact an intermediate step on the way towards tax centralization.