What enables federal tax revenues to increase following a reduction in tax rates?

The reason the position on the Laffer curve is the correct answer lies in the concept of how taxation rates and tax revenues interact within an economy. The Laffer curve illustrates the relationship between tax rates and tax revenue collected by governments. According to this theory, there is an optimal tax rate that maximizes revenue; if tax rates are too high, decreasing them can actually lead to an increase in revenues. This is because lower tax rates can incentivize more work, investment, and consumption, ultimately expanding the tax base as more economic activity occurs.

When rates are lowered, they can stimulate economic activity by encouraging businesses and individuals to engage more in the economy, which can lead to increased income. As incomes rise, even at a lower tax rate, the total tax revenue collected by the government may rise due to the larger tax base, thus leading to increased federal tax revenues.