Automatic StabiliserGovernment spending and taxation that automatically change to reduce variations in economic activity. Forexample, an increase in economic activity will result in individuals and businesses paying more taxes. Theseincreased tax payments will leave consumers and businesses with less money to spend. Declining economicactivity will be accompanied by increased unemployment benefits.In macroeconomics automatic stabilisers work as a tool to reducing the fluctuations in real GDP without any plainpolicy action by the government. It is a government program that changes automatically depending on GDP and aperson’s income, and acts as a negative feedback loop on GDP.The size of the government deficit tends to increase as a country enters recession, which helps keep national incomehigh through the multiplier.Furthermore, imports often tend to decrease in a recession, meaning more of the national income is spent at homerather than abroad. This also helps stabilise the economy.DefinitionPolicies or institutions (built into an economic system) that automatically tend to dampen economic cyclefluctuations in income, employment, etc., without direct government intervention. For example, in boom times,progressive income tax automatically reduces money supply as incomes and spending rise. Similarly, inrecessionary times, payment of unemployment benefits injects more money in the system and stimulates demand.Also called automatic stabilizers or built-in stabilizers.Induced taxesGovernment tax revenue tends to fall as a proportion of national income during recessions.This occurs because of the way tax systems are generally constructed.Income tax is generally at least somewhat progressive. If an individuals income rises, then their average tax rateincreases. This means that as incomes fall, households pay less as a proportion of their income in direct taxation.Corporation tax is generally based on profits, rather than turnover. In a recession profits tend to fall much faster thanturnover. Therefore, a corporation pays much less tax while having only slightly less economic activity.If national income rises, by contrast, then both households and corporations end up paying higher proportions oftheir income in tax.This means that in an economic boom tax revenue is higher and in a recession tax revenue lower; not only inabsolute terms but as a proportion of national income.Other forms of tax do not exhibit these effects, because they are roughly proportionate to income (e.g. taxes onconsumption like sales tax or value added tax, or they bear no relation to income (e.g. poll tax or property tax).Transfer paymentsMost governments also pay unemployment and welfare benefits. Generally speaking, the number of unemployedpeople and those on low incomes who are entitled to other benefits increases in a recession and decreases in a boom.This means that government expenditure increases automatically in recessions and decreases automatically in aboom in absolute terms. Since the trend of output is to increase in booms and decrease in recessions, expenditure isexpected to increase as a share of income in recessions and decrease as a share of income in booms.
When stabilisers dont workThere is broad consensus amongst economists that the automatic stabilisers often exist and function in the shortterm.However, the automatic stabilisers model does not incorporate rational expectations or other microfoundations. Nopart of economics is in the final analysis a mechanistic process and the existence of the stabilisers can easily beovershadowed by other changes to policy, expectations or markets.Automatic stabilisers incorporated into the expenditure multiplierThis section incorporates automatic stabilisation into a broadly Keynesian multiplier model.MPC = Marginal propensity to consumeT = Induced taxesMPI = Marginal Propensity to ImportHolding all other things constant, ceteris paribus, the greater the level of taxes, or the greater the MPI then the valueof this multiplier will drop. For example, let’s assume that:→ MPC = 0.8→T=0→ MPI = 0.2Here we have an economy with zero marginal taxes and zero transfer payments. If these figures were substituted intothe multiplier formula, the resulting figure would be 2.5. This figure would give us the instance where a (forinstance) $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 MPIremain the same:→ MPC = 0.8→ T = 0.2→ MPI = 0.2If these figures were now substituted into the multiplier formula, the resulting figure would be 1.79. This figurewould give us the instance where, again, a $1 billion change in expenditure would now lead to only a $1.79 billionchange in equilibrium real GDP.This example shows us how the multiplier is lessened by the existence of an automatic stabiliser, and thus helping tolessen the fluctuations in real GDP as a result from changes in expenditure. Not only does this example work withchanges in T, it would also work by changing the MPI while holding MPC and T constant as well.
ConclusionHigher taxes on capital will hamper the growth of investment and capital stock. The decrease in capital will reduceeconomic growth, which will lead to higher unemployment and reduced personal income. Tax rates should not be adetermining factor in allocating investment dollars, and lower tax rates mitigate the lock-in effect.Investment is a forward-looking enterprise, and companies are already making decisions about their future. Makingpermanent the lower tax rates on capital gains and dividends will make future investment more attractive tobusinesses and investors. This will ensure more capital stock and economic growth. Congress should therefore makepermanent these reductions on the cost of capital.