Question

During the recession of \(2007-2009,\) the U.S. federal government's tax collections fell from about 2.6 trillion dollars down to about 2.1 trillion dollars while GDP declined by about 4 percent. Does the U.S. tax system appear to have builtin stabilizers? LO31.2 a. Yes. b. No.

Short answer

Yes, the U.S. tax system appears to have builtin stabilizers as tax collections fell proportionally more than GDP.

Step-by-step solution

Identifying the Components

First, let's identify the key figures: the tax collections fell from $2.6$ trillion to $2.1$ trillion, which is a decrease of $0.5$ trillion. Meanwhile, the GDP declined by 4% during the same timeframe.

Understanding Automatic Stabilizers

Automatic stabilizers are economic policies or programs that automatically adjust with the economic conditions to stabilize income and consumption. Common examples include taxes that decrease as income falls or unemployment benefits that increase when more people are out of work.

Calculating the Rate of Change in Tax Collections

Calculate the percentage decrease in tax collections: \[ \text{percentage decrease} = \left( \frac{2.6 - 2.1}{2.6} \right) \times 100 \approx 19.23\% \]

Comparing Tax Collection Change to GDP Change

Compare the decrease in tax collections (approximately 19.23%) to the decrease in GDP (4%). This comparison indicates how responsive the tax system is to changes in the economy.

Conclusion on Automatic Stabilizers

Since the percentage decrease in tax collections (19.23%) is more than the GDP change (4%), the tax system is responsive to changes in economic conditions, suggesting the presence of automatic stabilizers.

Key concepts

Recession Impact

Recessions can be challenging periods for any economy. They typically involve a decline in economic activity, which leads to negative effects such as increased unemployment and reduced consumer spending. During a recession, the output of goods and services tends to drop, and businesses may close or reduce their operations. This has a cascading effect on various sectors of the economy, impacting income levels and causing financial strain on households.

One of the most significant impacts of a recession is the reduction in overall demand. With consumers spending less, businesses experience lower sales and profits, which can lead to layoffs and further exacerbate the downturn. This cycle of reduced consumer spending and lowering business revenues characterizes the overall influence of a recession on the economy.

• Lower consumer spending
• Increased unemployment
• Business closures or downsizing

Understanding the broader impact of a recession helps us appreciate the role of automatic stabilizers, such as adjustments in the taxation system, which aim to mitigate some of these adverse effects.

Tax Collections

Tax collections are one of the key indicators of the health of an economy. During a recession, as seen in the 2007-2009 period in the U.S., tax revenues can fall significantly due to reduced economic activity. When businesses earn less, and people are laid off, their income drops, leading to lower income tax collections.

Furthermore, corporate taxes decrease as businesses report lower profits, and sales taxes drop as consumer spending declines. For example, during the 2007-2009 recession, U.S. tax collections fell from approximately $2.6 trillion to $2.1 trillion, a reduction of $0.5 trillion or about 19.23%.

• Income taxes decline with reduced earnings
• Corporate taxes fall with lower profits
• Sales taxes decrease as spending declines

The reduction in tax collections during a recession demonstrates how tax systems can act as automatic stabilizers, where these systems adjust in response to the economic conditions, helping to moderate the severity of economic downturns.

GDP Decline

GDP, or Gross Domestic Product, represents the total value of all goods and services produced within a country. During periods of economic recession, GDP often falls as production slows, marking an overall decline in economic performance.

The decline in GDP during the 2007-2009 recession in the U.S. was around 4%. This reduction indicates a significant drop in economic productivity and output. A falling GDP means fewer goods and services are produced, leading to potentially higher unemployment rates and lower standards of living.

• Indicators of economic health and productivity
• Falls signal reduced economic activity
• Impacts employment and living standards

Understanding GDP decline gives insight into economic conditions and helps explain why tax collections and other economic factors react as they do during recessions, emphasizing the importance of stabilizing policies.

Economic Policies

Economic policies play a crucial role in managing and stabilizing economies during times of recession. These policies can be classified into fiscal and monetary policies, both designed to mitigate the adverse effects of economic downturns and facilitate recovery. Automatic stabilizers, which include tax adjustments and unemployment insurance, are integral components of these policies.

Fiscal policies involve government spending and tax policies, which can be adjusted to influence economic activity. During a recession, governments may implement tax cuts or increase public spending to stimulate demand. Monetary policies, on the other hand, focus on controlling the supply of money in an economy. Central banks may lower interest rates to encourage borrowing and investment.

• Fiscal policies: government spending and tax adjustments
• Monetary policies: control of money supply and interest rates
• Automatic stabilizers such as unemployment benefits

These strategies effectively support automatic stabilizers by adjusting with economic conditions, working to maintain economic stability and confidence during volatile periods.