What is an Automatic Stabilizer?

Automatic stabilizers are a type of fiscal policy designed to offset fluctuations in a nation's economic activity through their normal operation without additional, timely authorization by the government or policymakers. The best-known automatic stabilizers are progressively graduated corporate and personal income taxes, and transfer systems such as unemployment insurance and welfare. Automatic stabilizers are so called because they act to stabilize economic cycles and are automatically triggered without additional government action.

Key Takeaways

  • Automatic stabilizers are ongoing government policies that automatically adjust tax rates and transfer payments in a manner that is intended to stabilize incomes, consumption, and business spending over the business cycle.
  • Automatic stabilizers are a type of fiscal policy, which is favored by Keynesian economics as a tool to combat economic slumps and recessions.
  • In the event of acute or lasting economic downturns, governments often back up automatic stabilizers with one-time or temporary stimulus policies to try to jump start the economy.
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What are Automatic Stabilizers?

Understanding Automatic Stabilizers

Automatic stabilizers are primarily designed to counter negative economic shocks or recessions, though they can also be intended to “cool off” and expanding economic or to combat inflation. By their normal operation these policies take more money out of the economy as taxes during periods of rapid growth and higher incomes, and/or put more money back into the economy in the form of government spending or tax refunds when economic activity slows or incomes fall. This has the intended purpose of cushioning the economy from changes in the business cycle

Automatic stabilizers can include the use of a progressive taxation structure under which the share of income that is taken in taxes is higher when incomes are high and falls when income fall due to recession, jobs losses, or failing investments. For example, as an individual taxpayer earns higher wages, his additional income may be subjected to higher tax rates based on the current tiered structure. If wages fall, the individual will remain in the lower tax tiers as dictated by his earned income.

Similarly, unemployment insurance transfer payments, decline when the economy is in an expansionary phase since there are fewer unemployed people filing claims and rise when the economy is mired in recession and unemployment is high. When a person becomes unemployed in a manner that makes him eligible for unemployment insurance, he need only file to claim the benefit. The amount of benefit offered is governed by various state and national regulations and standards, requiring no intervention by larger government entities beyond application processing.

Automatic Stabilizers and Fiscal Policy

When an economy is in a recession, automatic stabilizers may by design result in higher budget deficits. This is an aspect of fiscal policy, a tool of Keynesian economics use government spending and taxes to support aggregate demand in the economy through economic downturns. By taking less money out of private businesses and households in taxes and giving them more in the form of payments and tax refunds, fiscal policy is supposed to encourage them to increase, or at least not decrease, their consumption and investment spending in order to help prevent an economic set back from deepening.

Automatic stabilizers can also be used in conjunction with other forms of fiscal policy that may require specific legislative authorization such as one time tax cuts or refunds, government investment spending, or direct government subsidy payments to businesses or households. Some recent examples of these in the US are the 2008 one-time tax rebates under the Economic Stimulus Act and the $831 billion in federal direct subsidies, tax breaks, and infrastructure spending under 2009 American Reinvestment and Recovery Act. Automatic stabilizers are intended to be a first line of defense, since they almost immediately respond to changes in income and unemployment, to turn mild negative economic trends around. However, governments often turn to these other types of larger fiscal policy programs to address more severe or lasting recessions, or to target specific regions, industries, or politically favored groups in society for extra economic relief.