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The increase in a tax rate decreases the tax base and, beyond a certain tax rate, this effect is sufficiently important for the increase in the tax rate to induce a decrease in tax revenues instead of an increase. It is now usual to label this process as the “Laffer-effect.” But it had been developed before Arthur Laffer gave it its popular expression. One can find it, for instance, in a refined form, in Geoffrey Brennan and James Buchanan,The Power to Tax (Cambridge University Press, 1980).
Hans-Hermann Hoppe raised an interesting question on a previous version of this paper: If the income effect does not exist, does it imply that a supply curve cannot be backward sloping? We explain in the appendix why, in our opinion, it is impossible.
Figure 1 is extracted from the classic textbook by James M. Henderson and Richard E. Quandt,Microeconomic Theory. But a similar graph can be found in most microeconomics textbooks.
If B was not preferred to A, it would just mean that the supply curve cannot go through B.
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Salin, P. The myth of the income effect. Rev Austrian Econ 9, 95–106 (1996). https://doi.org/10.1007/BF01101883
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DOI: https://doi.org/10.1007/BF01101883