Exploring the Laffer Curve: Behavioral Responses to Taxation

This project assesses behavioral responses to tax rate changes in an effort to add substance to the policy debate about appropriate levels of federal income tax rates. It is necessary to know how individuals will react to tax rate changes to judge the potential effects of a tax reform. The Laffer curve, which is a theoretical concept coined by Arthur Laffer in the 1970’s that shows a graphical representation of the relationship between tax rates and tax revenues, will be estimated since it is a well-known model that applies to this debate. Other methods will also be used to estimate this relationship to test which one is the most accurate. Along with showing the validity of a particular model, the other goals of this project are to show the magnitude of an individual’s reaction to tax rate changes and also to show if income switching between different forms of income (capital gains and wage income for example) occurs. Multiple regressions have been built to test the validity of various theories about the relationship between tax rates and tax revenues. The results of this research have shown that the Laffer curve theory is not the most accurate method of modeling this relationship. Although the magnitude generated of individual responses to tax rate changes was not in keeping with modern scholarly articles, this research showed that individuals switch income forms when tax rates change.