[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

already seen in Chapter 30 how income-related taxes serve as automatic stabilizers
by reducing the multiplier. As incomes rise, individuals and business will have to
pay more in taxes to local and state governments and to the federal government, an
increase that automatically acts to limit spending increases and to keep overall
aggregate spending more stable. For example, suppose the marginal tax rate is 30
percent—that is, for each additional dollar you earn, you have to pay 30 cents in
taxes. When your income goes up by $1,000, your disposable income—what is left after
taxes are paid—increases by only $700. The rest of your increased income—$300—
must cover the taxes. If the marginal propensity to consume is .8, you increase your
spending by .8 × $700, or $560. Without the increased tax bite, you would have
increased your spending by significantly more: .8 × $1,000, or $800. Because taxes
rise and fall with income, they help reduce swings in spending and, as a result, make
the economy more stable.
Taxes aren’t the only form of fiscal automatic stabilizers. Many transfer payments,
such as unemployment benefits, adjust automatically as economic conditions
change. When unemployment rises, unemployment benefits automatically
increase, thereby helping to provide income support to those who receive them. As
a result, the unemployed are not forced to reduce their consumption spending as
sharply as they otherwise would. By limiting the decline in spending, automatic
stabilizers make the economy more stable.
Automatic stabilizers influence the slope of the ADI curve. For example, the
impact of an increase in inflation on aggregate spending will depend on the tax
system. As the real interest rate rises when inflation increases and spending and
income fall in reaction to the increased cost of credit, tax payments also fall. This
decrease in tax payments cushions the decline in disposable income and household
consumption spending. It acts to limit the extent to which spending, and therefore
aggregate income, declines when inflation increases. As a consequence, an economy
that makes much use of automatic fiscal stabilizers will have a steeper ADI
curve than one without fiscal stabilizers.
The impact of automatic stabilizers on the ADI curve and the effect of spending
shocks on short-run equilibrium are illustrated in Figure 33.1. The two sets of ADI
curves show two economies, one with much stronger fiscal automatic stabilizers than
the other. The economy with the stronger stabilizers has the steeper ADI curve (the
light green line in the figure). To understand why, consider what happens if inflation
rises. When inflation rises and the central bank boosts the real interest rate, spending
falls and equilibrium income declines; but when automatic stabilizers kick in—
taxes decline and government spending, particularly transfer spending, increase
automatically—they act to cushion the decline in spending and output. The economy
lacking these stabilizers will suffer a bigger decline in aggregate spending and output—
and thus it has a flatter ADI curve, such as the blue line in the figure.
Automatic stabilizers also reduce the effect on the economy of shocks to GDP. A
fall in government purchases shifts the ADI curve to the left, but the size of this shift
is reduced by automatic stabilizers. Researchers have estimated that the federal
tax system offsets about 8 percent of the impact of shocks to GDP. 2 As shown in the
2 Alan J. Auerbach and Daniel Feenberg, “The Significance of Federal Taxes as Automatic Stabilizers,” NBER
Working Paper No. 7662, April 2000.
730 ∂ CHAPTER 33 THE ROLE OF MACROECONOMIC POLICY