What is an Automatic Stabilizer?

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This measure instantly stabilizes income, consumption, corporate expenditure levels and promotes aggregate demand. It uses a progressive or flexible taxation structure and transfer payments (unemployment insurance and welfare spending) during economic downturns. When the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more improves, the authorities put in place measures to boost government revenue to prepare for any unanticipated crises.

Automatic Stabilizer In Economics Explained

An automatic stabilizer in the economy is a fiscal measure to offset negative economic growth. It enables the government to deal with the economic crisis without exerting additional efforts or depleting the budget. The automatic resources that policymakers use to address economic instability come from progressive income and corporate taxCorporate TaxCorporate tax is a tax levied by the government on the profits earned by a company at a fixed rate each year and is calculated in accordance with specific tax regulations.read more collections. However, since the measure is a part of the budget, it does not require government permission and is implemented automatically when economic cycles fluctuate.

Key Takeaways

  • An automatic stabilizer definition is a fiscal measure embedded into the government’s budget that demands more public spending and lower taxes to sustain the economy automatically during the recession.It proposes a progressive or flexible taxation framework and transfers payments to rapidly stabilize income, consumption, and corporate expenditure levels and encourage aggregate demand.Even though taxation helps the government generate more revenue, unemployment insurance is a superior choice for economic stabilization.Unlike fiscal policy, which must go through legislative approval before being enacted, automatic stabilization is a swift action that policymakers can take during an economic downturn.

The economy of a nation highly depends on employment rates. It allows citizens to spend money on goods and services while contributing to the taxes that governments anticipate receiving. Furthermore, when people earn money, the authorities are aware that they will receive their fair share in the form of income taxIncome TaxIncome tax accounting recognizes the income tax payable in the books of account and determines the current period’s tax expenses. It has to be paid either before or after the end of the financial year and recognized in the books of account accordingly. read more. The higher the income, the better the tax rates. This revenue generation helps the government build a supplementary depository that supports the nation during economic downturns. It is this fund that acts as an automatic stabilizer when needed.

When the economic crisis occurs, the government increases public spending to boost employment, encourage investments, and provide welfare benefits through transfer paymentsTransfer PaymentsA transfer payment is a mode of payment where a party receives the money, but no goods or services are offered in return. The governments and governmental agencies typically disburse these payments to those who have no other means of income and have a poor quality of life.read more, for example, unemployment insurance and stimulus checks, as needed. In addition, less tax collection supports aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices.read more. And when the economy stabilizes, the employment rate increases. Hence, the procedure is reversed to collect tax revenues from citizens, thus strengthening the government’s budget.

Though the tax collection helps the government generate significant revenue, unemployment insurance is considered a better option for stabilization.

Unlike fiscal policyFiscal PolicyFiscal policy refers to government measures utilizing tax revenue and expenditure as a tool to attain economic objectives. read more, which requires legislative proceedings before implementation, automatic stabilizing is an immediate step that policymakers can take during an economic slowdown.

Example

Let us look at one of the automatic stabilizer examples in relation to COVID-19’s economic doldrums. During the pandemic in 2020, the U.S. government issued a $900 billion stimulus package, accounting for half of the tax revenue produced by state and local governments in 2019. Even though the world is still striving to recover from the crisis, governments continue to do everything to stabilize the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more.

Automatic Stabilizer and Fiscal Policy

Automatic stabilizers and fiscal policy are inextricably linked. The former is a key instrument in Keynesian economicsKeynesian EconomicsKeynesian Economics is a theory that relates the total spending with inflation and output in an economy. It suggests that increasing government expenditure and reducing taxes will result in increased market demand and pull up the economy out of depression.read more for dealing with recessions. It ultimately boils down to the government’s efforts to bring out an economy from the crisis by utilizing existing resources rather than borrowing additional funds.

On the other hand, the fiscal policy intends to keep the economy stable enough to avoid a recession. It focuses on collecting less in the form of taxes and delivering more in transfer payments and tax refunds to citizens. Policymakers aim to enhance consumption and investment spending or ensure that it does not lead to insufficient income through effective fiscal policies. If one’s income is inadequate, one’s tax payments will be reduced, influencing the government’s revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more.

The automatic stabilizer differs from fiscal policy in that the former does not require legislative action, allowing for immediate response to an economic crisis. In contrast, discretionary fiscal policy necessitates congressional action before it can be enacted.

This article has been a guide to Automatic Stabilizer and its definition. Here we explain how it works in the economy, along with an example. You can learn more from the following articles – 

An automatic stabilizer in economics is a budgetary policy to counterbalance negative economic growth. It enables the government to address the economic issues without adding to its workload or depleting the budget. It utilizes a progressive or flexible taxation system and transfers payments to stabilize income, consumption, and corporate spending levels quickly to stimulate aggregate demand.

When a recession strikes, the government boosts public expenditure to promote employment, encourage investment, and offer social benefits through transfer payments. In addition, progressive income and corporation tax revenues provide policymakers with automatic resources to combat economic instability and support aggregate demand.

Fiscal policy and automatic stabilizers are tightly intertwined. The latter is a major tool for dealing with recessions in Keynesian economics and does not require legislative action. Instead, it all comes down to the government’s efforts to pull the economy out of the impasse by repurposing current resources rather than borrowing more funds.Whereas fiscal policy ensures the economy remains stable to avoid a recession. However, it requires congressional approval before implementation. It focuses on collecting fewer taxes and distributing more to citizens through transfer payments and tax refunds.

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