Question

(1 Question, 2-parts) Consider automatic stabilizers (aka non-discretionary fiscal policy): 1) How does the United States' structure of taxes and government spending add stability in this specific scenario: The U.S. economy is experiencing high GDP growth rates and has a high (and increasing) inflation rate? 2) What effect do automatic stabilizers have on the U.S. Government Budget if the economy is sliding into a recession? Please be specific in describing the impacts on the budget, and only if the economy is entering a recession.

Answer 1

1. The United States tax structure is progressive in nature i.e. the people in the higher income group pay a higher rate of tax and also pay a larger amount of tax as compared to individuals in the lower income bracket. Similarly, the corporate tax structure is federated and has a varied range. In light of the above fact, if at any time, the U.S. economy is experiencing high GDP growth and an increasing inflation rate, a progressive tax rate will help to curb the inflation and will provide more funds for government spending.
2. In times of recession, automatic stabilizers such as progressive income taxes, taxes on corporate profits, and Unemployment insurance programs by the government increase the budget deficits or decrease the budget surplus. For example: During a recession, individuals may fall into a lower income bracket or may have no tax liability at all, hence, it increases the government budget deficit or decreases the government budget surplus. Also, during a recessionary phase, since unemployment will rise, the government will have to increase its spending on unemployment insurance programs, thereby reducing the budget surplus or increasing the budget deficit.