Automatic stabilizer

In

Tax revenues generally depend on household income and the pace of economic activity. Household incomes fall and the economy slows down during a recession, and government tax revenues fall as well. This change in tax revenue occurs because of the way modern tax systems are generally constructed.

• progressive
  . This means that as household incomes fall during a recession, households pay lower rates on their incomes as income tax. Therefore, income tax revenue tends to fall faster than the fall in household income.
• Corporate tax is generally based on profits, rather than revenue. In a recession profits tend to fall much faster than revenue. Therefore, a company pays much less tax while having slightly less economic activity.
• Sales tax depends on the dollar volume of sales, which tends to fall during recessions.

If national income rises, by contrast, then tax revenues will rise. During an economic boom, tax revenue is higher and in a recession tax revenue is lower, not only in absolute terms but as a proportion of national income.

Some other forms of taxation do not exhibit these effects, if they bear no relation to income (e.g.

• MPC = Marginal propensity to consume (fraction of incremental income spent on domestic consumption)
• T = Marginal (induced) tax rate (fraction of incremental income that is paid in taxes)
• MPI = Marginal Propensity to Import (fraction of incremental income spent on imports)

Holding all other things constant, ceteris paribus, the greater the level of taxes, or the greater the MPI then the value of this multiplier will drop. For example, lets assume that:

→ MPC = 0.8

→ T = 0

→ MPI = 0.2

Here we have an economy with zero marginal taxes and zero transfer payments. If these figures were substituted into the multiplier formula, the resulting figure would be 2.5. This figure would give us the instance where a (for instance) $1 billion change in expenditure would lead to a $2.5 billion change in equilibrium real GDP.

Lets now take an economy where there are positive taxes (an increase from 0 to 0.2), while the MPC and MPI remain the same:

→ MPC = 0.8

→ T = 0.2

→ MPI = 0.2

If these figures were now substituted into the multiplier formula, the resulting figure would be 1.79. This figure would give us the instance where, again, a $1 billion change in expenditure would now lead to only a $1.79 billion change in equilibrium real GDP.

This example shows us how the multiplier is lessened by the existence of an automatic stabilizer and thus helping to lessen the fluctuations in real GDP as a result of changes in expenditure. Not only does this example work with changes in T, it would also work by changing the MPI while holding MPC and T constant as well.

There is broad consensus among economists that automatic stabilizers often exist and function in the short term.

Additionally,

Estimated effects

Analysis conducted by the Congressional Budget Office in 2013 estimated the effects of automatic stabilizers on budget deficits and surpluses in each fiscal year since 1960. The analysis found, for example, that stabilizers increased the deficit by 32.9% in fiscal 2009, as the deficit soared to $1.4 trillion as a result of the Great Recession, and by 47.6% in fiscal 2010. Stabilizers increased deficits in 30 of the 52 years from 1960 through 2012. In each of the five surplus years during the period, stabilizers contributed to the surplus; the $3 billion surplus in 1969 would have been a $13 billion deficit if not for stabilizers, and 60% of the 1999 $126 billion surplus was attributed to stabilizers.^[4]

See also

• Negative feedback

References