What is an automatic stabilizer?
Automatic stabilizers are a type of fiscal policy designed to compensate for fluctuations in a country’s economic activity through their normal operation without additional, timely authorization from government or policy makers. The best known automatic stabilizers are progressive corporate and personal income taxes and transfer systems such as unemployment insurance and social assistance. Automatic stabilizers are so called because they act to stabilize economic cycles and are triggered automatically without additional government action.
Key points to remember
- Automatic stabilizers are ongoing government policies that automatically adjust tax rates and transfer payments to stabilize business income, consumption and spending over the business cycle.
- Automatic stabilizers are a type of fiscal policy that is favored by the Keynesian economy as a tool to fight economic slowdowns and recessions.
- In the event of an acute or lasting economic slowdown, governments often support automatic stabilizers with ad hoc or temporary stimulus policies to try to revive the economy.
What are automatic stabilizers?
Understanding automatic stabilizers
Automatic stabilizers are primarily designed to counter negative economic shocks or recessions, but they can also be used to “cool down” and develop the economy or fight inflation. Through their normal functioning, these policies withdraw more money from the economy in the form of taxes during periods of rapid growth and higher incomes, and / or re-inject more money into the economy in the form of public spending. or tax refunds when economic activity slows down or incomes fall. This is to cushion the economy from changes in the economic cycle.
Automatic stabilizers may include the use of a progressive tax structure whereby the share of income taken from taxes is higher when incomes are high and decreases when incomes fall due to recession, job losses or investment failures. For example, as an individual taxpayer earns higher wages, their additional income may be subject to higher tax rates depending on the current tiered structure. If the wages drop, the individual will stay in the lower tax levels based on their earned income.
Similarly, unemployment insurance transfer payments decrease when the economy is expanding, as fewer unemployed people apply and increase when the economy is stuck in recession and the unemployment is high. When a person becomes unemployed in a way that makes them eligible for unemployment insurance, they just have to file to claim the benefit. The amount of the benefit offered is governed by various state and national regulations and standards, requiring no intervention from larger government entities beyond processing requests.
Automatic stabilizers and fiscal policy
When an economy is in recession, automatic stabilizers can inherently lead to higher budget deficits. It is an aspect of fiscal policy, a tool of the Keynesian economy that uses government spending and taxes to support aggregate demand in the economy in the event of an economic downturn. By removing less money from private businesses and households in the form of taxes and giving them more in the form of tax payments and refunds, tax policy is supposed to encourage them to increase, or at least not to decrease , their consumer and investment spending to help prevent an economic downturn from getting worse.
Automatic stabilizers can also be used in conjunction with other forms of fiscal policy that may require specific legislative authority, such as one-time tax reductions or refunds, government investment spending, or direct payments of government grants to businesses or households. In the United States, some recent examples are the 2008 one-time tax rebates under the Economic Stimulus Act and the $ 831 billion in direct federal grants, tax breaks and infrastructure spending under the American Reinvestment and Recovery Act of 2009. Automatic stabilizers are intended to be a first line of defense, as they react almost immediately to changes in income and unemployment, to reverse negative economic trends. However, governments often turn to these other types of broader fiscal policy programs to cope with more severe or more lasting recessions, or to target favored regions, industries or political groups in society for relief. additional economic.