From the course: Finance Foundations: Income Taxes

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What is the optimal income tax rate?

What is the optimal income tax rate?

From the course: Finance Foundations: Income Taxes

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What is the optimal income tax rate?

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- Let's consider an issue of public policy. What is the optimal tax rate for a government? Now, we'll define optimal in this way. What is the income tax rate that will yield the highest tax revenue for the government? Is that optimal rate 100%? Is it 0%? Or is the optimal rate somewhere in between? Well, this simple but interesting question was considered in the 1970s by an economist named Arthur Laffer. This simple picture summarizes Dr. Laffer's analysis. The story goes that in one of his first explanations of the idea, first explanations of the idea, he drew this diagram on the napkin in a restaurant. Now, look down at the bottom of the diagram. If the tax rate is zero, then the government will collect zero in revenue. will collect zero in revenue, So that certainly can't be the optimal tax rate for a government interested in collecting the highest possible revenue. But what if the tax rate is 100%? Now, you might initially say, oh yeah, yeah. That 100% rate will give the…

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