Fiscal Policy

Choose the Correct Answer

Correct Answer : Option a

Explanation
Automatic stabilizers refer to aspects of fiscal policy that automatically cushion the economy as it moves through the business cycle, such as taxes and unemployment insurance.
Statement-l is correct: In a progressive tax system, as people's incomes fall during a recession, they automatically pay less tax, which increases their disposable income.This helps maintain consumption and demand in the economy without any new fiscal policy intervention. Hence, progressive taxation is a classic example of an automatic stabilizer.

Statement-II is correct: During downturns, tax collections fall and welfare spending rises (due to more unemployment claims, subsidies, etc.), leading to an expansionary fiscal effect. During booms, taxes rise (more income, more corporate profit) and welfare claims fall, resulting in a contractionary fiscal effect.This self-correcting mechanism helps stabilize the economy without active policy changes.

Statement-II explains statement-I: Statement-II provides the broader conceptual framework within which the specific example of Statement-I operates. Progressive taxation is a type of automatic stabilizer that helps maintain economic stability during recessions. When incomes fall in a downturn, a progressive tax system automatically reduces individuals’ tax liabilities, thereby increasing their disposable income and supporting aggregate demand. When incomes rise in an upturn ,a progressive tax system increases individuals’ tax liabilities, thereby decreasing their disposable income and reducing aggregate demand.