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Suppose Congress enacts a tax reform law and the average federal tax rate drops from 30 percent to 20 percent. Researchers investigate the impact of the tax cut and find that the income subject to the tax increases from $600 billion to $800 billion. The theoretical explanation is that workers have increased their work effort in response to the incentive of lower taxes. Is this a movement along the downward-sloping or the upward-sloping portion of the Laffer curve?

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Economics For Today

10th Edition
Tucker
Publisher: Cengage Learning
ISBN: 9781337613040

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BuyFindarrow_forward

Economics For Today

10th Edition
Tucker
Publisher: Cengage Learning
ISBN: 9781337613040
Chapter 21, Problem 10SQP
Textbook Problem
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Suppose Congress enacts a tax reform law and the average federal tax rate drops from 30 percent to 20 percent. Researchers investigate the impact of the tax cut and find that the income subject to the tax increases from $600 billion to $800 billion. The theoretical explanation is that workers have increased their work effort in response to the incentive of lower taxes. Is this a movement along the downward-sloping or the upward-sloping portion of the Laffer curve?

To determine

Movement of the economy on the Laffer curve.

Explanation of Solution

The Laffer curve explains the relationship between the tax rates and the tax amounts collected by the government in the economy. This idea was introduced by the supply side economist Arthur Laffer and thus, it belongs to the school of supply side economists.

When the tax rate in the economy was 30 percent and 20 percent, respectively, the total tax revenue collected from the economy can be calculated by multiplying the tax rate with the income. This can be done as follows:

Tax revenue at 30 percent=Tax rate×Income=0.3×600=180

Similarly, the tax revenue when the tax rate is 20 percent can be calculated as follows:

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