The idea behind the Laffer Curve is that tax rate cuts can sometimes expand the tax base by more than rates are cut, causing net revenue to rise.
Russia has been a virtual laboratory for the Laffer Curve. When Communism collapsed a decade ago, the country had a rudimentary tax system. Although the old Soviet Union had taxes, they didn't serve the same purpose as in market economies. Since the government owned everything, it could get all the revenue it needed just by raising prices.
And since everyone worked for the state, it could alter the distribution of income simply by changing wage rates. Taxes were used mainly to adjust the money supply, as Federal Reserve open market operations do here.
After Communism fell, Russia adopted a tax system with high tax rates, especially on businesses and entrepreneurs; the tax administration system was inadequate and unworkable; and opportunities for evasion were too easy. The result was a government starved for revenue, forcing it to print money to pay its bills, leading to hyperinflation.
The International Monetary Fund correctly recognised that tax revenue needed to rise to control inflation. But the IMF encouraged it to enact new taxes and crack down on evaders, which only exacerbated the problem.
The result was that Russian tax revenue fell from 11.1 percent of Gross Domestic Product in 1995 to 8.6 percent in 1998.
Finally, against the IMF's advice, taxes were cut, leading to increased revenue as evasion became less profitable.
Two years ago, Russia initiated a 13 percent flat rate tax system that became fully effective last year as a result tax revenue jumped more than 50 percent rising to 16.1 percent of GDP in 2001.
A flat tax could reduce the burden on taxpayers in other countries as well.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, April 15, 2002.
For more on Russia's flat tax http://www.russiaeconomy.org
For more on Russia http://www.ncpa.org/iss/int/
FMF Policy Bulletin\23 April 2002