Figure 18-4 A Laffer Curve
labour is relatively inelastic with respect to the real wage. Figure 18-3
shows that an income tax does generate an excess burden. But if the
labour supply curve is very steep—as most empirical evidence suggests—
the excess burden is small, and the income tax is therefore relatively
efficient. The greater equity of the income tax comes from the fact that it
can be designed to be either proportional or progressive, thus permitting
some redistribution from high-income households to low-income
households.
Disincentive Effects of Income Taxes
Our discussion of income taxes, and the illustration in Figure 18-3 ,
shows how an income tax affects workers’ incentives. If an increase in the
income-tax rate leads to a reduction in the amount of work effort, it is
possible that total tax revenue might actually fall as a result. This
possibility is illustrated in Figure 18-4 , which shows what economists
call a Laffer curve, named after well-known U.S. economist Arthur Laffer.