A behavioral Laffer curve: Emergence of a social norm of fairness in a real effort experiment

This paper demonstrates, through a controlled experiment, that the ‘‘Laffer curve” phenomenondoes not always reflect a conventional income leisure trade-off.Whether out of reason or out of emotion, taxpayers may also bewilling to punish intentionally unfair tax setters by working less than they would under the same exogenous circumstances. We conduct a real effort experiment in which a player A (the ‘‘tax receiver”) is matched with a player B (the ‘‘worker”) to elicit the conditions under which tax revenues will increase under a certain threshold and decrease thereafter. We ran four different treatments by manipulating work opportunities and the power to tax. Consistent with the history of tax revolts, the working partner overreacts to the perceived unfairness of taxation when the tax rate exceeds 50%, most strongly so in thehigh effort treatment.With two types of players, selfish andempathic, ourmodel predicts the emergence of a social normof fairness under asymmetric information, and elicits the optimal and emotional patterns of punishments and rewards consistent with thenorm’s enforcement. The social normallowsplayers to coordinate tacitly on a ‘‘focal equilibrium”, which offers a solution to the indeterminacy raised by the Folk theorem for infinitely-repeated games and a behavioral justification for the tit-for-tat strategy. The social norm of fairness enhances productive efficiency in the long run. 2008 Elsevier B.V. All rights reserved.