Question

During a boom, how do proportional income taxes act as an automatic stabiliser?

Options

• GDP rises → tax collection rises → government spending is cut immediately

• GDP rises → taxes remain unchanged → inflation accelerates

• GDP rises → tax collection rises → disposable income rises by less → consumption spending is dampened

• GDP rises → tax collection falls → disposable income rises sharply → consumption spending increases

Answer 1

In a boom, rising GDP automatically increases tax collection, so disposable income rises by less than GDP. This dampens consumption spending and moderates the expansion — all without any new policy action.