During a recession, how do automatic stabilizers affect tax revenue and government spending?

• A. They decrease both tax revenue and government spending automatically.
• B. They decrease tax revenue and increase government spending automatically.
• C. They increase tax revenue and decrease government spending automatically.
• D. They increase both tax revenue and government spending automatically.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand what automatic stabilizers are. Automatic stabilizers are economic policies and programs that automatically adjust government spending and taxes in response to economic fluctuations without additional legislative action.
2. Step 2: During a recession, economic activity slows down, leading to lower incomes and profits. This causes tax revenues to fall automatically because taxes are often based on income and profits.
3. Step 3: At the same time, government spending increases automatically during a recession because more people become eligible for social safety net programs such as unemployment benefits and welfare.
4. Step 4: Therefore, automatic stabilizers work by decreasing tax revenue (due to lower incomes) and increasing government spending (due to higher demand for social benefits), which helps to stabilize aggregate demand.
5. Step 5: Summarize that automatic stabilizers act counter-cyclically: they reduce tax revenue and increase government spending during recessions, helping to cushion the economy from further downturns.