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Two Sources Of Bias In Estimating The Peak Of The Laffer Curve

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  • Dan Usher

    (Department of Economics, Queen's University)

Abstract

Important as it is for public policy, there is still no consensus about the size of the revenue-maximizing tax rate at the top of the Laffer curve. The purpose of this essay is not to supply a correct rate, but to identify difficulties in doing so. 1) Estimates of the revenue-maximizing tax rate are distorted by the discrepancy between the “elasticity of taxable income” at observed tax rates and as it would become at the revenue-maximizing tax rate, a discrepancy illustrated with reference to tax evasion as the source of the contraction in the tax base in response to increases in the tax rate. 2) When the response of tax revenue to tax rate is through the supply of labour, the Laffer curve may not be humped at all because the supply of labour may expand, rather than contract, in respond to an increase in the tax rate, causing tax revenue to rise more than proportionally to the tax rate all the way up to 100%.

Suggested Citation

  • Dan Usher, 2013. "Two Sources Of Bias In Estimating The Peak Of The Laffer Curve," Working Paper 1320, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:1320
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    File URL: https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1320.pdf
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    References listed on IDEAS

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    1. Peter Diamond & Emmanuel Saez, 2011. "The Case for a Progressive Tax: From Basic Research to Policy Recommendations," Journal of Economic Perspectives, American Economic Association, vol. 25(4), pages 165-190, Fall.
    2. Lindsey, Lawrence B., 1987. "Individual taxpayer response to tax cuts: 1982-1984 : With implications for the revenue maximizing tax rate," Journal of Public Economics, Elsevier, vol. 33(2), pages 173-206, July.
    3. Chung-cheng Lin, 2003. "A backward-bending labor supply curve without an income effect," Oxford Economic Papers, Oxford University Press, vol. 55(2), pages 336-343, April.
    4. Emmanuel Saez & Joel Slemrod & Seth H. Giertz, 2012. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 3-50, March.
    5. Feldstein, Martin, 1995. "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 551-572, June.
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    Cited by:

    1. Soldatos, Gerasimos T., 2015. "Tax Aversion, Laffer Curve, and the Self-financing of Tax Cuts," MPRA Paper 62470, University Library of Munich, Germany.

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    Keywords

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    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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