Question

Problem 5 "Laffer Curve" (20 points) 1. (6 pts) What is Laffer Curve? 2. (8 pts) As Canada recovers from the economic challenges brought on by the COVID pandemic, the federal government will make choices that will cause tax rates to rise or fall. This will cause a change in Canada's position on the Laffer Curve. Explain what will happen to Canada's position on the Laffer Curve for both the cases where the tax rates rise and when they fall. 3. (6 pts) What will happen if Canada's Tax Rate grows higher than T*? Catesi

Answer 1

a) Laffer Curve says that tax revenue rises when tax rate rises upto a certain limit while it start declining if tax rate keep on rising because high tax rate will reduce economic activity such as people would be reluctant to earn less money because huge portion of their income is going to tax.

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b) As Canada is recovering from recession caused by COVID, they should lower the tax rate such that people have more disposable income to spend on goods which they will spend on consumption and investment. It will help economy in recovering soon.

Fall in tax rate will decline tax revenue assuming Canada is charging tax rate less than when Laffer curve reaches its peak.

c) If tax rate grows more than T*, tax revenue will start declining. Producers will not invest, people will not run for higher packages because they will be taxed more. It will result in decline in economic activity and economy will enter into a recession.