Working paper

The Laffer Curve in an Incomplete-Market Economy

Patrick Fève, Julien Matheron, and Jean-Guillaume Sahuc


This paper is a quantitative investigation into the characteristics of the Laffer curve in a neoclassical growth model with incomplete markets and heterogeneous, liquidity-constrained agents. We show that the shape of the Laffer curves related to taxes on labor, capital and consumption dramatically changes depending on which of transfers or government debt are adjusted to make the government budget constraint hold. When transfers are adjusted, the Laffer curve has the traditional shape. However, when debt is adjusted, the Laffer curve looks like a horizontal S, in which case fiscal revenues can be associated with up to three diferent levels of taxation. This finding occurs because the tax rates change non monotonically with public debt when markets are incomplete.

JEL codes

  • E6: Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
  • H6: National Budget, Deficit, and Debt

See also

Published in

TSE Working Paper, n. 12-288, April 2012, revised July 2013