Why is the personal income tax considered to be one of the main features of our modern economy that helps ensure against a repeat performance of the Great Depression?

Answer 1

Income tax is considered an automatic stabilizer because tax revenue change with the level of output. The income tax acts as a shock absorber because it makes disposable income, and thus consumer spending, less sensitive to fluctuations in GDP. When GDP rises, disposable income (DI) rises less because part of the increase in GDP is siphoned off by the U.S. Treasury. This leakage helps limit any increase in consumption spending. When GDP falls, DI falls less sharply because part of the loss is absorbed by the Treasury rather than by consumers. So consumption does not drop as much as it otherwise might. Thus, the personal income tax is one of the main features of our modern economy that helps ensure against a repeat performance of the Great Depression.