Automatic stabilizer

The size of the government budget deficit tends to increase when a country enters a recession, which tends to keep national income higher by maintaining aggregate demand. There may also be a multiplier effect. This effect happens automatically depending on GDP and household income, without any explicit policy action by the government, and acts to reduce the severity of recessions. Similarly, the budget deficit tends to decrease during booms, which pulls back on aggregate demand. Therefore, automatic stabilizers tend to reduce the size of the fluctuations in a country's GDP.

In the United States, state governments are barred by their constitutions from running budget deficits so in those cases money saved in rainy day funds can be used as a stabilizer to avoid cutting services or raising taxes, both of which are contractionary to the economy.

Induced taxes

Tax revenues generally depend on household income and the pace of economic activity. Household incomes fall and the economy slows down during a recession, and government tax revenues fall as well. This change in tax revenue occurs because of the way modern tax systems are generally constructed.

• Income taxes are generally at least somewhat progressive. This means that as household incomes fall during a recession, households pay lower rates on their incomes as income tax. Therefore, income tax revenue tends to fall faster than the fall in household income.
• Corporate tax is generally based on profits, rather than revenue. In a recession profits tend to fall much faster than revenue. Therefore, a company pays much less tax while having slightly less economic activity.
• Sales tax depends on the dollar volume of sales, which tends to fall during recessions.

If national income rises, by contrast, then tax revenues will rise. During an economic boom, tax revenue is higher and in a recession tax revenue is lower, not only in absolute terms but as a proportion of national income.

Some other forms of taxation do not exhibit these effects, if they bear no relation to income (e.g. property taxes, tariffs, or capitation taxes).

Additionally, imports often tend to decrease in a recession, meaning more of the national income is spent at home rather than abroad. This also helps stabilize the economy.

Transfer payments

Most governments also pay unemployment and welfare benefits. Generally speaking, the number of unemployed people and those on low incomes who are entitled to other benefits increases in a recession and decreases in a boom. As a result, government expenditure increases automatically in recessions and decreases automatically in booms in absolute terms. Since output increases in booms and decreases in recessions, expenditure is expected to increase as a share of income in recessions and decrease as a share of income in booms.