Question

Explain what is meant by the stabilization effects which are one of the purposes of the income tax?

Answer 1

Most taxes have a stabilizing effect because they automatically move with economic growth. For example, personal and corporate income tax collections decline during recessions along with income and profits, and payroll tax collections decline when employment and wages fall. Tax cuts increase household demand by increasing workers’ take-home pay. Tax cuts can boost business demand by increasing firms’ after-tax cash flow, which can be used to pay dividends and expand activity, and by making hiring and investing more attractive.

During excess demand or inflationary gap, federal should increase existing income tax rate. This would lower the personal disposable income of households. The purchasing power of payers will decrease. Aggregate demand will fall. Excess demand will be corrected.