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Automatic Stabilizers

The use of taxes and spending by the government to eliminate recessionary and inflationary gaps is known as discretionary fiscal stabilization. In other words, discretionary fiscal stabilities policy refers to the deliberate changes in tax rates and governments spending that are targeted at stabilizing the economy.

Sometimes it is possible to achieve stabilization in the economy without the discretionary fiscal stabilization policy. We know that as GDP increase, private individual’s capacity to pay taxes also increases.

When people are better off, government spending on transfer (payments e.g., unemployment allowance) also decrease. Thus, net taxes (i.e., total tax receipts net of transfer payments) move in the same direction as GDP. Tax is a leakage from the GDP. Therefore, the leakages increase as the economy expands and the leakages decrease as the economy contracts.

“Even when the government does not undertake to stabilize the economy via discretionary fiscal policy, the fact that net tax revenues rise with GDP means that there are fiscal effects that cause the budget to act an automatic stabilizer for the economy”.