Principles of Economics/Laffer

As the government increases taxes, the economy's available money decreases, resulting in less and less economic activity. Additionally, the taxes reduce the returns on entrepreneurial activity. At first, increasing taxes increases revenues, but provides decreasing marginal returns. At a certain point, the economy has been so taxed (pun intended) that additional taxation would cause the economy to shrink so markedly that it would not increase revenue. This is a point that economists and politicians have much internal and external conflict, because it is particularly difficult to find and may perhaps change over time. At even higher tax rates the government drives the economy into the ground and ends up with less revenue. This is the Laffer Curve.

Fig - 1. Laffer curve with maximum revenue point marked out.

Some economists believe that the Laffer curve is actually jumbled and fuzzy in the middle - in other words, there is no clear point associated with any particular tax rate.