The economist Arthur Laffer has long argued that lower tax rates, by stimulating employment and investment, can lead to increased tax revenue to the government. If this prediction is correct, a tax rate reduction would be a win-win policy, good for both taxpayers and the government. Laffer went on to sketch a tax revenue curve in the shape of an upside-down U.
In general, the government's tax revenue can be expressed as R = t · B (t), where t denotes the tax rate ranging between 0 and 1 (i.e., between 0 and 100 percent) and B denotes the tax base. Explain why the tax base is likely to shrink as tax rates become very high. How might this lead to a U-shaped tax revenue curve?