Arthur B. Laffer

Tax Rates, Factor Employment, and Market Production

An increasing amount of attention has recently been devoted to the effects of alternative tax structures on the pattern of economic activity, on the level of taxable economic activity, and on the aggregate amount of revenue generated by the tax system. In this paper, a static, one-sector, two-factor model is developed in order to analyze the effects of taxes imposed purely for the purpose of generating revenues.1 For simplicity, these taxes are assumed to be proportional taxes on the incomes of factors of production. We derive some properties of the tax structure needed to maximize output while raising a given level of government revenue. We then examine empirically a specific instance of tax cuts, the Kennedy cuts of the early 1960s, to determine their effect on revenues.

Tax Rates, Factor Employment, Market Production, and Welfare

An increasing amount of attention has recently been devoted to the effects of alternative tax structures on the pattern of economic activity, on the level of taxable economic activity, and on the aggregate amount of revenue generated by the tax system. This chapter presents a static, one-sector, two-factor model to analyze the effects of taxes imposed purely for the purpose of generating revenues. The analysis presented in the chapter shows that increases in tax rates on factor incomes reduce the after-tax returns to factors, factor employment, and market output. The analysis also indicates that increases in tax rates could also reduce as well as increase government tax revenue. There exists a tax rate structure, which maximizes government tax receipts. This tax structure depends on the supply and output elasticities of the factors of production. The set of tax rates for which increases in the rates are accompanied by increases in government revenue is referred to as the normal range. Tax rates for which increases in the rates are accompanied by decreases in tax revenue are said to be in the prohibitive range. In general, a reduction in tax rates does not reduce total revenue in the same proportion. The more the elastic factor supplies are, the more likely it is that any given tax rates will fall into the prohibitive range. Also, the higher the level of tax rates, the more likely tax rates are to be in the prohibitive range.

Foundations of Supply-Side Economics

Foundations of Supply-Side Economics: Theory and Evidence is composed of a series of papers containing both theoretical and empirical analyses of a set of issues in government fiscal policy. The type of analysis employed in the book is standard neoclassical economics, and this analysis is used to study the macroeconomic incentive effects of taxation. The book contains contributions that cover the analysis of the effects of taxes imposed purely for generating revenues; the process of capital formation; and an attempt to integrate supply-side analysis into a traditional macroeconomic framework. Reports on the empirical evidence on taxation and economic activity and the estimation of a small macroeconomic model of the United States for the postwar period; description of a method of calculating effective marginal tax rates on factor incomes using available U.S. data; and the estimation of the effect of fiscal policy on private investment in plant and equipment are presented as well. Economists will find the book highly insightful.