In the question given below there are 2 statements marked as Assertion (A) and Reason (R). Choose the correct alternative from the following options.
Assertion: The indirect taxes act as an automatic stabiliser in an economy.
Reasoning: The proportional income tax makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP.
Answer & explanation
Correct answer: option 4
The correct answer is Option 4: (A) Is false but (R) is true.
Assertion: The indirect taxes act as an automatic stabiliser in an economy. This is false. The proportional income tax acts as an automatic stabiliser – a shock absorber because it makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP.
Reasoning: The proportional income tax makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP. This is correct. When GDP rises, disposable income also rises but by less than the rise in GDP because a part of it is siphoned off as taxes. This helps limit the upward fluctuation in consumption spending. During a recession when GDP falls, disposable income falls less sharply, and consumption does not drop as much as it otherwise would have fallen had the tax liability been fixed. This reduces the fall in aggregate demand and stabilises the economy.