Give an example of a government policy that acts as an automatic stabilizer. Explain why the policy has this effect.

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One example of a government policy that acts as an automatic stabilizer is progressive income tax. Progressive income tax refers to a tax system where higher income individuals are taxed at a higher rate than lower income individuals.

This policy acts as an automatic stabilizer because it helps counteract the economic fluctuations by adjusting tax revenues according to the level of income. During periods of economic expansion, when individuals earn higher incomes, the progressive income tax results in higher tax revenues for the government. This helps prevent the economy from overheating by reducing the excess income available for consumption and investment.

Conversely, during periods of economic downturn, when individuals experience lower incomes, the progressive income tax automatically reduces the tax burden on lower-income individuals. This allows them to have more disposable income available for spending, which can help stimulate consumer demand and provide a boost to the overall economy.

The effect of progressive income tax as an automatic stabilizer is due to the progressive nature of the tax rates. As income levels rise, individuals move into higher tax brackets and are taxed at higher rates. This progressive tax structure helps distribute the tax burden more equitably across income levels and allows the government to collect a larger share of tax revenue during periods of economic expansion while providing relief to lower-income individuals during economic downturns.

Overall, progressive income tax acts as an automatic stabilizer by adjusting tax revenues in response to changes in the economy, helping to moderate economic fluctuations and promote stability.