If there is a concept quite unknown to users, that is undoubtedly the one that is linked to the laffer curve. To the point that it is very complex to understand since its application is not overcrowded and this means that it is not the mouth of economic experts. Well, the laffer curve basically refers to the relationship between tax revenues and tax rates. So what is this economic parameter used for? Well, for something as important as tax collection evolves by modifying tax rates. So that in this way, economists can develop a correct fiscal policy and in a sense balanced.
You have to know that this curve was disseminated by the economist Arthur Laffer, hence it has this name that may surprise many people. Although already in the time of the cultural predominance of the Arabs, the foundations of this model were laid to quantify the fiscal effort. Therefore, it is not a modern concept, as some opinion organs believe that have taxation as their first discipline. Another very different thing is that it is not very widespread at the moment. Because in effect, it is not this way.
The laffer curve has been reflected in the policies that have been developed in the world during the last decades. In this sense, in the 80s, President Ronald Reagan was one of the most relevant who put into practice to develop a fiscal policy in his government program. On the other hand, the evidence also indicates that the current president of the United States, Donald Trump, has opted for this strategy to execute its tax strategy. As you can see, the laffer curve has a certain relevance in the international economy.
The laffer curve linked to income
If something that the mentioned Laffer curve shows is, taxes can be increased to reduce income instead of increasing it. What Art Laffer brought to the table with those curves was that if you wanted more income it was better lower taxes to stimulate economic growth and economic activity. It is a debate that a good part of the world's rulers raises. From Mariano Rajoy to Donald Trump and with practically no exceptions. Not only at this time, but through the last decades as has been seen through a review of history.
On the other hand, since the coming to power in the United States, the economic team of President Ronald Reagan came to the conclusion that the proposal to lower taxes for boost economic growth it became firmly embedded as part of the economic creed of the Republican Party. To the point that it is a value that is currently assumed by certain politicians and political parties. In this regard, it must be remembered that Reagan's tax cuts increased the deficit, helping to raise interest rates to 20%, which in turn contributed to the recession that followed.
How does the curve develop?
After a somewhat philosophical disquisition on what the Laffer curve is, it is time to point out how it develops. And this is a bit more complicated to visualize since it requires more learning on the part of the users. In this sense, the Laffer curve has an inverted U shape, where when the rate is 0 the collection will be zero, and on the other hand when the rate is 100%, the collection is also zero as it is extremely high.
Another explanation to understand these complex graphs should be borne in mind that these extremes of the curve that we have pointed out are quite logical to understand from now on. Since if the tax rate is 0% the collection will be null. In other words, the State will not receive anything for the money earned by workers and companies. While on the contrary, if the tax rate is 100%, or what is the same, the maximum, it will be interpreted that the State will take all the wages of the people and all the profits of the companies. What does this really mean? Well, something as simple to understand as that there are no incentives to work, and consequently can be very detrimental to the economy in general.
Exposure of these curves
Of course, the curves that started from the mind of this great international economist can extract many ideas that can even reach the field of macroeconomics. Because indeed, if the interpretation that can be obtained from the analysis of these unique curves is characterized by something, it is because when tax rates are very high, it can be a very strong signal on a lack of motivation for the population to look for work. The reason is because part of his salary goes to the unpopular taxes. With which it is preferable to exhaust other resources, such as opting for the collection of aid or subsidies for unemployment.
From this general scenario, it cannot be forgotten from now on that the curves highlight the trend of the fiscal policy of a country. To the point of deciding whether it is expansive or on the contrary, it opts for a more restrictive model. Where there are followers of these two models, bring taxation by citizens, as is happening at the moment in a large part of the countries of the world. Those who defend, as in the case of liberal positions, the reduction of taxes to boost the economy. Or the defenders of more stable positions that allude to an increase in them as a formula to have more money for public spending and social assistance.
Fiscal policies as a political weapon
There is no doubt that taxation has progressively become a political instrument on the part of the parties in search of the popular vote. In this sense, the so-called Laffer curve is a powerful parameter to determine which is the tax capacity of the rates. Not surprisingly, in its graphs the degree of taxes that a country or economic area has can be detected with the odd problem. Of course, with greater objectivity than through other strategies or other interpretation models. It is of course one of the benefits that this analysis model can provide you.
In another vein, there are many theories about this curve that explain why companies pay less taxes than the middle classes. It is above all an interpretation that can be drawn from this comparative model from political perspectives. As well as to understand other scenarios that can be developed in the tax treatment. And that in any case affect all citizens, in one way or another as explained above. Because it cannot be forgotten that many interpretations can be given to what this very special curve that we are talking about in this article says.
Essence of its development
In either case, there is one thing that is very clear to all analysts and economists. And it has to do with the fact that its creator estimated that there should be an optimal point where the State collected the maximum while charging the minimum possible: the collection of taxes increases the State's collection. But what is the real problem that this situation poses? Well because it tends to discourage economic activity. To the point that it can be thought that the fact of lowering taxes will increase the collection because there will be more people who want to work and invest. In this sense, it can be beneficial to boost economic activity from the beginning.
On the other hand, it cannot be forgotten at any time that the Laffer curve is a graphic representation of how the variation of the tax rate (10%, 40%, 50%, ...) can affect the total amount of tax collection of a tax. It is very useful for any kind of measurements by economists that can arrive at the real problem or solution of the fiscal policies applied by governments. As for example, the fact that a tax increase will incentivize the black economy and fraud. While on the contrary, it is also worth mentioning the effect of variations in taxes on capital income (capital gains via investments in the stock market, deposits or even real estate) of high equity.
In any case, and by way of conclusion, it can be said that through these graphs in which the curves are included, a lower tax rate does not have to increase collection either, since it does not necessarily have to increase activity or encourage consumption. In this sense, everything will depend on the accompaniment of other additional economic measures.