Question

The observation that both labor force participation rates and hours worked have fallen over the past 80 years at the same time that real wages have increased nearly 400% over that same time period is not consistent with the hypothesis that we are on the downward-sloping side of the Laffer Curve

Answer 1

Answer:

Laffer curve shows the relation between tax rate and tax revenue collected. It is inverted U shaped. This means initially increase in tax rate increases the tax revenue but after a threshold level, an increase in tax rate actually decreases the tax revenue. This is because workers are discouraged from working by high tax rate.

In past 80 years, labor force participation rates and hours worked have fallen and real wages have increased many fold. This is in contradiction to Laffer curve as tax rate in USA is well below the optimal tax rate. The contradiction is because of working of labor market mechanism in which supply curve of labor is backward bending. This means that with increase in wage rate upto a certain level, the supply of labor increases but after a threshold level is achieved, the supply of labor starts decreasing. This is because opportunity cost of leisure is very high. This explains the contradiction in the Laffer curve.