The concept of Taxable Income Elasticity led to the Laffer Curve phenomenon that plots government tax revenues against tax rate.  The two points the rate of revenue are 0% and 100% income tax. 

The first is obvious, since if there is no tax there is no tax revenue.  The second would appear contradictory, but if the tax rate is 100%, nobody would work and so again there would be no tax revenues. The optimum tax rate for maximum tax revenue is somewhere between the two, and it is that which the Laffer Curve is designed to plot.

The term “Laffer Curve” was invented by Wall Street Journal writer Jude Wanniski, who learned about it during a meeting with Laffer, Dick Cheney and Donald Rumsfeld in 1974, although the concept that tax revenue could be increased by reducing taxes was known well before that.  Arthur Laffer himself stated that he got the idea from John Maynard Keynes. The innovation that Laffer introduced is that existing tax rates are at a higher rate than the level at which tax revenues were maximized, and that the true optimum rate is much lower than was at first thought.

Prior to that it was believed that the maximum tax rate for optimum return was not far off 100%.  In fact at one time the highest rate was 96% in the UK.  Now the average maximum is below 40%.  Since people do not work simply to pay the government all their earnings,  the Laffer Curve phenomenon is intended to predict at what point they start to stop working, so that revenue to the government becomes less overall, even though they are taking more from those that continue to work.

If tax was cut across the board it is generally agreed by economists that the result would be stimulated growth. However, the stimulation might only be in selected areas, such as those not dependent on government income from tax, and citizens dependent on government income might benefit less than those working for private industry, and they might perhaps even suffer. The point at which government income would actually increase would be determined by what tax rate was acceptable for more people to work, and therefore provide a larger number of smaller tax units being paid by the population.

Thus, 1000 people working to pay 90% tax on $100000 would provide the government with $90 million tax revenue, but 1500 people paying 65% on the same amount would provide  $97.5 million revenue. Better for the people and better for government.  However, does it work in practice?

Much depends on the elasticity of supply and demand, and the Laffer Curve is a theory that suits supply side economic theory.  Under this theory, economic growth can be created by providing people with inducements to supply goods and services, inducements such as lower taxes. This is the opposite to demand side economic theory such as propounded by John Maynard Keynes, that growth is obtained by governments controlling the demand for goods, rather than their supply, through such devices as controlled government spending.

The major problem with the Laffer Curve as a model is that it assumes a single tax rate across all incomes, and very few governments operate such as system.  Most have an initial zero rate, then a standard income tax rate followed by a third ‘supertax’ rate applied to income above a certain level. In such systems Laffer effects can still be seen, but not through a single overall tax cut.  The curve would be relevant to a cut (or increase) in the standard rate of tax since any change to the higher rate would affect only the rich, and have a lower effect on overall tax revenues. The rich do not start or give up earning simply because of tax rates, although they can move residence!

The elasticity of the labor market is also a factor. It has been proved by economic theory and actual, data that labor supply is definitely affected by tax rates, and the labor pool is higher when tax rates are lower, and vice versa.  The data supports the theory of the Laffer Curve but does not predict its shape. 

The Curve does not predict whether a tax cut will increase revenue or reduce it, since there are many variables that have an effect such as the elasticity of the labor pool, the tax system in place, the ease of avoiding or even evading tax and also the timing of the cut.  Timing is essential and can critically affect the effect of the cut.  What it should say is whether or not the current rate is above the point that a reduction should result in economic benefits that in turn result in higher revenue.
The Laffer Curve phenomenon shows that tax cuts provide the incentive to an increased output, increased employment and create a stronger economy, which leads to even higher employment and increased taxes and also a reduction in unemployment, welfare  and social security benefits having to be paid.  The result is a net increase in government income allied to a reduction in expenditure.

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