Iceland’s Laffer Curve

The Wall Street Journal notes that corporate tax revenue has jumped dramatically in Iceland, even though the corporate tax rate has been slashed to 18 percent. That sentence actually should say that revenues jumped because of the lower tax rate. Iceland is a clear example of the Laffer Curve. As the rate fell, companies had less reason to avoid taxes. The low rate also encouraged additional economic activity. Iceland’s workers are the biggest winners, of course, since they now enjoy higher incomes and more prosperity:

The benefits of low taxes are on full display in Iceland, which provides an almost perfect demonstration of the Laffer Curve. From 1991 to 2001, as the corporate-tax rate fell gradually to 18% from 45%, tax revenues tripled to 9.1 billion kronas ($134 million in today’s exchange rate) from just above 3 billion kronas. Since 2001, revenues more than tripled again to an estimated 33 billion kronas last year. Personal income-tax rates were cut gradually as well, to a flat rate of 22.75% this year from 33% in 1995. Meanwhile, the economy averaged annual growth rates of about 4% over the past decade.

The editorial also notes that tax competition is encouraging good policy in other European jurisdictions. It is not surprising that Swiss cantons are lowering tax rates, but it is noteworthy that even the tax-loving German politicians are being forced to reduce the tax burden:

In addition to Eastern Europe’s flat-tax movement, there is healthy rivalry from Switzerland, where the individual cantons can set their rates independently. Obwalden just lowered its corporate-tax rate to 6.6%, drawing criticism from the European Union, which called it an illegal subsidy. One of the biggest critics, Germany, recently announced that it will cut its corporate-tax rate to just below 30% next year from the current rate of about 38%.