During an economic expansion, what would be the effect of an automatic stabilizer?
It forces consumption to rise.
It increases government spending.
It increases tax revenues.
It decreases tax revenues.
The correct answer and explanation is:
The correct answer is It increases tax revenues.
During an economic expansion, automatic stabilizers work to moderate the pace of growth by naturally adjusting government policies without the need for deliberate action. One of the key automatic stabilizers in an economy is the tax system. As the economy grows and income levels rise, individuals and businesses earn more. This leads to an increase in income tax revenues for the government, as higher incomes are taxed at higher rates.
In an expansion, people typically experience higher wages and increased profits, which naturally push them into higher tax brackets, leading to greater tax collections. This serves as an automatic check on the economy’s growth. By increasing tax revenues, the government helps prevent the economy from overheating or experiencing excessive inflation. The increased taxes reduce the disposable income available to consumers and businesses, thereby slowing down the rate of consumption and investment, helping to balance the growth.
At the same time, automatic stabilizers like unemployment benefits and welfare payments tend to decrease when the economy improves. With fewer people requiring assistance, government expenditure on these programs decreases, which further contributes to a moderation of economic growth.
In summary, during an economic expansion, automatic stabilizers such as the progressive tax system function to cool down the economy by increasing tax revenues as income rises. This helps smooth the economic cycle by preventing overly rapid expansion that could lead to inflationary pressures.