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Automatic stabilizers are the way in which elements of government fiscal activity automatically increase or decrease in response to changes in the overall economic activity of a country. They mainly consist of two elements: changing tax revenues and changing welfare payments, though import levels can also play a role. Whether they are an advantage or a disadvantage is disputable, both in the extent of the effect they have, and in approaches to economics.
Tax and welfare spending contain the most dramatic automatic stabilizers. When the economy is in good shape, businesses are doing well, and employment levels are high, the government tends to take in more money from taxes such as income and corporation taxes. Contrarily, these revenues fall when economic activity declines. At the same time, welfare payments tend to have an inverse relationship to overall economic activity: a slump or recession means more unemployment and thus higher overall welfare payments.
A key element of automatic stabilizers is that the factors change not only in raw numbers, but as a percentage of overall economic activity, usually measured as gross domestic product. This is not true of all forms of taxation. For example, while the amount collected in sales tax will rise or fall in line with economic activity, specifically how much people have available to spend, the proportional relationship between total sales tax take and GDP is much more consistent.
The main advantage of using automatic stabilizers is stability. The combination of tax and welfare spending means that when the economy is doing well, it is likely that overall more money will move from individuals and business to the government, while when the economy is in poor shape then overall more money will move from the government to individuals. This should mean that booms and slowdowns are both tempered, meaning extreme swings in the economy are less likely.
The most significant disadvantage of the automatic stabilizers is that they cause an exaggerated effect on government finances. When the economy is in good shape, the combination of rising revenue and falling expenditure effectively means a double benefit for the overall fiscal position; a poor economy means a doubly negative effect. In theory, this could be avoided by stockpiling the surplus during good times to make up for a deficit in bad times. In practice, political and electoral constraints make this hard to do.
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