Draw a Laffer Curve and explain the relationship it purports to portray. Why might this curve be important for macroeconomic policy?

What will be an ideal response?

The following curve suggests that up to point b higher tax rates will result in larger tax revenues, but beyond that any increase in rates will have adverse effects on incentives, result in tax avoidance or tax evasion, and generally reduce overall tax revenues. The curve is important for macroeconomic policy because it correctly suggests that there is an upper limit to tax rates in terms of their potential to increase revenue. Beyond the limit, higher rates will not raise revenues, but will lower them. Laffer was suggesting that the government had already reached the limit and that by lowering rates the government could increase revenue. That is the point of debate. There is little evidence to suggest what the upper limit on tax rates might be in terms of their revenue-raising potential. See graph.