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A micro-foundation for the Laffer curve in a real effort experiment

  • Louis Lévy-Garboua

    ()

    (TEAM et CIRANO)

  • David Masclet

    ()

    (CREM - Université de Rennes)

  • Claude Montmarquette

    ()

    (Université de Montréal et CIRANO)

A conjecture of Laffer, which had considerable influence on fiscal doctrine, is that tax revenues of a Leviathan state eventually decrease when the tax rate exceeds a threshold value. We conduct a real effort experiment, in which a "worker" is matched with a non-working partner, to elicit the conditions under which a Laffer curve can be observed. We ran four different treatments by manipulating work opportunities and the power to tax. In the endogenous treatment, the non-working partner chooses a tax rate among the set of possibilities and receives the revenue generated by her choice and the worker's effort response to this tax rate. In the exogenous treatment, the tax rate is randomly selected by the computer and the non-working partner merely receives the revenue from taxes. The Laffer curve phenomenon cannot be observed in the exogenous treatments, but arises in endogenous treatments. Tax revenues are then maximized at a 50% tax rate. We demonstrate that an " efficiency tax " model (with or without inequity aversion) falls short of predicting our experimental Laffer curve but an alternative model of social preferences provides a micro-foundation for the latter. This new model endogenously generates a social norm of fair taxation at a 50% tax rate under asymmetric information about workers' type. Taxpayers manage to enforce this norm by working less whenever it has been violated but do not systematically reward " kind " tax setters. Workers who maximize their expected wealth adjust work to the tax rate equitably so that tax revenues remain at a fair level. Workers who respond affectively to norm violations just refuse to work so that tax revenues are cut down. Workers endowed with higher work opportunities tend to respond more emotionally to unfair taxation in our experiment, which is consistent with the observed Laffer curve and with the history of tax revolts.

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Paper provided by Université Panthéon-Sorbonne (Paris 1) in its series Cahiers de la Maison des Sciences Economiques with number bla05071.

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Length: 34 pages
Date of creation: Oct 2005
Date of revision:
Handle: RePEc:mse:wpsorb:bla05071
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  1. Swenson, Charles W., 1988. "Taxpayer behavior in response to taxation: An experimental analysis," Journal of Accounting and Public Policy, Elsevier, vol. 7(1), pages 1-28.
  2. LEVY-GARBOUA, Louis & MONTMARQUETTE, Claude, 1997. "Reported Job Satisfaction : What Does It Mean?," Cahiers de recherche 9705, Universite de Montreal, Departement de sciences economiques.
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  15. Sillamaa, M. A., 1999. "How work effort responds to wage taxation: An experimental test of a zero top marginal tax rate," Journal of Public Economics, Elsevier, vol. 73(1), pages 125-134, July.
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  17. Austan Goolsbee, 1999. "Evidence on the High-Income Laffer Curve from Six Decades of Tax Reform," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 1-64.
  18. Andereoni, J., 1988. "Why Free Ride? Strategies And Learning In Public Goods Experiments," Working papers 375, Wisconsin Madison - Social Systems.
  19. Sutter, Matthias & Weck-Hannemann, Hannelore, 2003. " Taxation and the Veil of Ignorance--A Real Effort Experiment on the Laffer Curve," Public Choice, Springer, vol. 115(1-2), pages 217-40, April.
  20. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 367-388, December.
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