Экономические науки/16.Макроэкономика

Angelina Virchenko, post-graduate student

Taras Shevchenko National University of Kyiv

Automatic Fiscal Stabilizers in Macroeconomic Regulation

This paper shows a significance of nondiscretionary fiscal policy in economic stabilization process. It suggests several ways of enhancing fiscal automatic stabilizers showing certain examples. It also outlines some caveats to enforce fiscal automatic stabilizers.

The global economic crisis, which has started in 2008, compelled scientists’ attention to fiscal instruments of macroeconomic stabilization. This has happened because of economic crisis has shown that during large demand shocks monetary policy may not provide a sufficient response, particularly, when its transmission mechanism is impeded by the conditions of the financial system.

They distinguish discretionary and nondiscretionary (automatic) fiscal policies subject to way the fiscal instruments have an influence on macroeconomic conditions. Discretionary fiscal policy can be used in these cases, but it has two shortcomings: firstly, it suffers from implementation lags, including a political decision-making process influenced by multiple (possibly contradictory) considerations; secondly, discretionary policy is not automatically reversed when the economic cycle improves, giving rise to a potential deficit bias.

Nondiscretionary fiscal policy is founded on built-in automatic stabilizers. The automatic stabilizers reflect revenue and some expenditure items that adjust automatically to cyclical changes in the economy Built-in automatic stabilizer is an economic mechanism, which reacts to changes in macroeconomic situation automatically, without any governmental decision-making process. Automatic changes in tax returns under progressive tax system, in unemployment benefits and social transfers are parts of automatic stabilizer [1, с. 695].

Automatic stabilizers do not suffer from the shortcomings of discretionary fiscal policy. Their implementation is well-timed and gradual as tax and expenditure respond in a countercyclical way. No political decisions are required. That means implementation lags are minimized. As for fiscal sustainability, automaticity also provides a timely turnaround of a fiscal expansion; videlicet the fiscal loosening during a recession is automatically followed by a tightening on the rise. This may enhance the impact of a fiscal expansion on demand with respect to discretionary action, as the latter may raise solvency concerns and affect interest rates.

However, there are some important caveats of implementing automatic stabilizers. Firstly, the constraints on fiscal space, financing, and debt solvency should prevent a country from implementing the automatic stabilizers. This also reinforces the importance of prudent fiscal policy during upswings. Financing constraints are typically more obligatory in developing economies with thin internal debt markets or limited access to external financing [3, c. 14].

Secondly, expanding fiscal policy would not be appropriate in the presence of large supply shocks, because of the probability of creating inflation. Thus, prudence is needed in implementing the automatic stabilizers in countries subjected to large supply shocks.

Lastly, raising the automatic stabilizers may have effects on other fiscal policy goals, especially if the increase is achieved by raising the tax and spending level.

Nevertheless, the automatic stabilizers depend on the size of government and the cyclical responsiveness of the tax system—a rule of thumb is that the size of the stabilizers approximately equals the share of government in the economy times the output gap. An important policy question is, therefore, how the automatic stabilizers can be increased without raising the size of government. It is possible due to such ways as permanent changes to the tax and expenditure rules (that enhance the traditional automatic stabilizers) and temporary changes to tax and expenditure rules triggered by specific macroeconomic thresholds being reached [2, с. 5].

Enhancing the traditional automatic stabilizers includes tax and expenditure policy changes.

The more sensible tax returns are to changes of economic conditions, the better stabilization effect they have. Among taxes, personal and corporate income taxes have the largest output gap elasticity (especially if they are progressive). Taxes on goods and services and payroll taxes and social security contributions have lower elasticities. Taxes on capital gains, financial transactions, and real property may respond the volatile asset prices over and above the economic cycle.

So, the automatic stabilizers could be enhanced by raising the share of taxes collected from income-based taxes, given their higher income elasticities. However, the increase in the automatic stabilizers would be small. The reasons are: a rebalancing the tax burden toward taxes on consumption seeking efficiency gains; a reduction in income tax progressivity; structural and institutional impediments in many developing countries that limit the achievable increase in personal income tax collections.

Increasing the progressivity of the personal income tax would be increased in two ways: by raising the marginal tax rates, or by expanding income-related benefits (which act like a negative tax). Higher progressivity will support both equity and stabilization goal s. However, increasing the marginal tax rates could worsen the distortionary impact of taxes on labor supply and savings.

As for expenditure programs, some of them, especially unemployment benefits, have a stabilizing impact on disposable household income. Unemployment insurance programs are more widespread in advanced economies, than in developing economies. It is vital to provide temporary unemployment benefits for the period of recession if an appropriate system is not available.

An alternative to enhancing the traditional automatic stabilizers is automating the discretionary fiscal responses – that means temporary fiscal policy changes triggered by economic developments. This type of stabilizers has several advantages over the previous: firstly, their implementing reduces unforeseen consequences of fiscal policy, which is especially significant during crisis; secondly, traditional stabilizations trigger too frequent alterations of taxes and expenditure, but temporary changes to tax and expenditure proceed when it is really needed: when certain macroeconomic indexes achieve some threshold levels. It is necessary to choose such trigger mechanism cautiously. Appropriate fiscal policy set should contain fiscal instruments with the largest multiplying effect.

To sum up, automatic stabilizers strongly contribute to macroeconomic stability regardless of the type of economy (advanced or developing), confirming the effectiveness of timely, predictable and symmetric fiscal impulses with huge multiplying effect.

References

1. Макроекономіка: Підручник / За ред. В.Д. Базилевича. – К.: Знання, 2004. – 851 с.

2. Baunsgaard Th., Symansky S.. Automatic Fiscal Stabilizers // IMF Staff Position Note, September 28, 2009.

3. Blanchard O., Dell Ariccia G. Mauro P. Rethinking Macroeconomic Policy//IMF Staff Position Note, February 12, 2010.

4. Ilzetzki, Ethan, and Carlos A. Vegh. Procyclical Fiscal Policy in Developing Countries: Truth or Fiction? // NBER Working Paper 14191 (Cambridge, Massachusetts: National Bureau for Economic Research), July, 2008.

5. Seidman, Laurence S., and Kenneth A. Lewis. A New Design for Automatic Fiscal Policy // International Finance, Vol. 5, No. 2, 2002, pp. 251 – 284.