Question

During the recession of 2007–2009, the U.S. federal government’s tax collections fell from about \(2.6 trillion down to about \)2.1 trillion while GDP declined by about 4 percent. Does the U.S. tax system appear to have built-in stabilizers?

1. Yes

2. No

Short answer

Option (a): Yes

Step-by-step solution

Meaning of built-in stabilizers

Built-in stabilizers are the part of fiscal policy which automatically adjusts to stabilize the economy. These are collectively referred to as the non-discretionary fiscal policy. A non-discretionary fiscal policy includes taxes and transfer payments.

Taxes vary according to the fluctuations in GDP, and transfer payments move in the opposite direction to GDP. During economic expansion, an economy receives greater tax revenues and reduces transfer payments. In contrast, the tax revenues shrink, and transfer payments expand during economic contraction.

Explanation for the answer

During the recession of 2007-2009, the GDP of the US declined by about 4%.The US economy has a progressive tax system. As the GDP increases, the tax rate increases with an increasing rate. As a reaction to the decline in GDP, the tax revenues declined from about $2.6 trillion to about $2.1 trillion. Thus, the decline in taxes automatically came into action to stabilize the economy.

The decline in tax revenues stimulates aggregate consumption expenditure as it saves the disposable income of households. Therefore, it can be concluded that the US tax system has built-in stabilizers.