Which of the following works as an automatic stabiliser in the econom…

Which of the following works as an automatic stabiliser in the economy?

Answer & explanation

Correct answer: option 1

The correct answer is Option (1) → A proportional income tax

An automatic stabiliser works on its own, with no new decision. A proportional income tax takes more when GDP rises and less when it falls, so disposable income moves less than GDP.

Option (1) A proportional income tax — Correct. It makes disposable income and spending less sensitive to changes in GDP, without any new decision.

Option (2) A cut in the tax rate announced to fight a recession — Incorrect. This is a deliberate action. Such action is called discretionary fiscal policy.

Option (3) An equal rise in government spending and lump-sum taxes — Incorrect. This is a balanced budget change chosen by the government. It is discretionary, and its multiplier is 1.

Option (4) A lump-sum tax that does not depend on income — Incorrect. The tax stays the same when income changes, so it cannot absorb ups and downs in GDP.

NCERT (2026-27): “Box 5.1: Fiscal Policy … The proportional income tax, thus, acts as an automatic stabiliser – a shock absorber because it makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP. 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. We note that these fiscal policy instruments can be varied to offset the effects of undesirable shifts in investment demand. That is, if investment falls from I0 to I1, government spending can be raised from G0 to G1 so that autonomous expenditure (C + I0 + G0 = C + I1 + G1) and equilibrium income remain the same. This deliberate action to stabilise the economy is often referred to as discretionary fiscal policy to distinguish it from the inherent automatic stabilising properties of the fiscal system. …”