Laffer Curve

The Laffer Curve proposes an inverted-U relationship between the tax rate and total tax revenue. Revenue initially rises with the tax rate, but beyond a revenue-maximising rate, further increases may shrink the taxable base enough to reduce total collections.

Shape of the relationship

Tax revenue equals the tax rate multiplied by the taxable base. At a zero rate, revenue is zero; in the curve's stylised form, an extremely high rate can also yield little or no revenue because taxable activity and compliance are severely discouraged.

• On the upward-sloping portion, the direct gain from a higher rate exceeds the contraction of the tax base.
• Beyond the revenue-maximising rate, the shrinking tax base outweighs the gain from the higher rate, so revenue falls.

Why the taxable base changes

Taxpayers may respond to higher rates by reducing work, investment, production or reported income, or by shifting activity towards exemptions, avoidance or evasion. The strength of these behavioural responses determines the curve's shape and the location of its peak.

• A tax cut raises revenue only when the existing rate lies on the curve's downward-sloping portion.
• The curve does not reveal the revenue-maximising rate by itself; that rate must be estimated empirically and can differ across taxes and economies.

Relevance to mining revenue

For mining, an excessively high combined burden of taxes, royalties and other levies may discourage exploration, investment and extraction, thereby narrowing the revenue base. A simpler and predictable regime can improve compliance and activity, but the outcome also depends on mineral prices, resource quality, costs and the design of the levy.

• The revenue-maximising rate is not necessarily the socially optimal rate because policy must also consider resource conservation, environmental costs and distribution.