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The Laffer Curve is a hypothetical representation of the relationship between government revenue raised by taxation and all possible rates of taxation. The Laffer curve theorizes that no tax revenue will be raised at the extreme tax rates of 0% and 100%. If both a 0% and 100% rate of taxation generate no revenue, there must be some intermediate tax rate which generates the maximum tax revenue. Reagan believed that the United States had reached the point on that curve in which further tax increases would actually result in a decrease in government revenue, and that tax cuts were needed to increase revenues and stimulate the economy.
Reagan's theory was implemented through the "Kemp-Roth Tax Cut," a federal law passed early on in Reagan's term. It was an act to amend the Internal Revenue Code. It provided for an across-the-board decrease in the marginal income tax rates by 23% over three years, with the top rate falling from 70% to 50% and the bottom rate dropping from 14% to 11%. This act slashed estate taxes and trimmed taxes paid by business corporations by $150 billion over a five year period.
The Act's sponsors were Representative Jack Kemp of New York (who later ran for Vice-President in 1996) and Senator William V. Roth, Jr. of Delaware. They had hoped for more significant tax cuts, but settled on this bill after a great debate in Congress. It passed Congress on August 4, 1981 and was signed into law on August 13, 1981 by President Ronald Reagan at Rancho del Cielo, his California ranch.
Years later, in his autobiography An American Life, Reagan wrote (at page 231):
"Simply put, I believed that if we cut tax rates and reduced the proportion of our national wealth that was taken by Washington, the economy would receive a stimulus that would bring down inflation, unemployment and interest rates, and there would be such an expansion of economic activity that in the end there would be an increase in the amount of revenue to finance the important functions of government.
"Excessive tax rates were at the heart of the problem. Back in the fourteenth century, a Muslim philosopher named Ibn Khaldoon wrote something about taxes in ancient Egypt: 'At the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.' In other words, when rates were low, the revenue was great; when rates were high, the revenue was low."
Reagan had his critics. For example economist John Kenneth Galbraith believed that the Reagan administration actively used the Laffer curve "to lower taxes on the affluent." Perhaps the shrewdest analysis of the opinion of economists came from Reform Party Candidate and billionaire H. Ross Perot, who when asked for a comment about economists trashing his economic plan, sneered "economists, have you ever met a rich economist?"