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Concept
Automatic stabilizer
Summary
In macroeconomics, automatic stabilizers are features of the structure of modern government budgets, particularly income taxes and welfare spending, that act to damp out fluctuations in real GDP.
The size of the government budget deficit tends to increase when a country enters a recession, which tends to keep national income higher by maintaining aggregate demand. There may also be a multiplier effect. This effect happens automatically depending on GDP and household income, without any explicit policy action by the government, and acts to reduce the severity of recessions. Similarly, the budget deficit tends to decrease during booms, which pulls back on aggregate demand. Therefore, automatic stabilizers tend to reduce the size of the fluctuations in a country's GDP.
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.
Income taxes are generally at least somewhat 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. poll taxes, export tariffs or property taxes).
Most governments also pay unemployment and welfare benefits.
Official source
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