The Laffer Curve is the contention that there is a tax rate which maximises revenue collection. That’s all it is too. It does not claim – although Art Laffer often does – that this rate is lower than the current one. It just claims that there is a revenue maximising rate.
Underneath the hood there is the joint influence of two processes. Some folks live and work on the basis that there’s a certain income they must have and so they’ll work long enough to get it. Raise their tax rate and they might well work longer. This is the income effect and it’s known that taxi drivers – and thus we assume many other pieceworkers – often do work to this stricture.
There are also people who look at the marginal income from the extra piece of effort and think, well, if I’m only going to get that tiddler portion then I’m off fishing instead. This is the substitution effect.
We’re all subject to both effects. What happens to tax revenues overall depends upon how many of us, how much, react according to either idea when taxes change.
A useful guide is that the lower paid are more driven by the income effect, the higher by the substitution. This isn’t absolutely true but it’s a useful guide.
There are those who absolutely deny that this happens at all. They are wrong:
Official NHS data show that 1,358 GPs and hospital doctors retired early in 2020-21 – up from 401 in 2007-8.
The British Medical Association (BMA) said changes in tax regulation were one of the main reasons doctors were choosing to retire early.
The data show the average age of retirement fell during this period, from 61 to 59. And the number retiring because they had reached retirement age fell from 2,030 in 2007-08 to 1,594 in 2020-21.
Even The Guardian is nothing it:
The number of doctors retiring early has more than trebled since 2008, prompting fears that burnout and high pension tax bills are prompting medics to leave the NHS.
Doctors gain both good salaries and also very decent indeed pensions. Combine this with a limit on lifetime pension pots and we get, in those final years of a doctoral career, bowelquakingly high marginal tax rates. So, doctors withdraw their labour – the substitution effect.
The Laffer Curve is true. That a tax rate can be too low to maximise revenue is obvious and trivial. But we now have proof that it can also be too high. Therefore there must be that peak.
What the peak is is still up for grabs of course. But the existence is proven.