Introduction to Finance

transfer payments
,
 
or government income 
payments for which no current productive service is rendered.
Another important automatic stabilizer is the pay-as-you-go progressive income tax. 
Pay-as-you-go refers to the requirement that tax liabilities of individuals and institutions be 
paid on a continuing basis throughout the year. The progressive nature of our income tax 
means that as income increases to various levels the tax rate increases also. In other words, 
as incomes increase, taxes increase at a faster rate. The reverse is also true: at certain stages 
of decreased income, the tax liability decreases more quickly. The result is, generally, imme-
diate since, for most wages subject to withholding taxes, tax revenues change almost as soon 
as incomes change.
These programs are a regular part of our economy. In times of severe economic fl uctu-
ations, Congress can help stabilize disposable income. Income tax rates have been raised to 
lower disposable income and to restrain infl ationary pressures; they have been lowered during 
recessions to increase disposable income and spending. Government spending can also be 
increased during recessions to increase disposable income. Likewise, it could be cut during 
prosperity to reduce disposable income, but for political reasons attempts to do this have not 
been successful.
When a recession is so severe that built-in stabilizers or formulas are not adequate to 
promote recovery, there is seldom complete agreement on the course of action to take. A 
decision to change the level of government spending and/or the tax rates must be made. 
Increased spending or a comparable tax cut would cost the same number of dollars ini-
tially, but the economic eff ects would not be the same. When income taxes are cut, dispos-
able income is increased almost immediately under our system of tax withholding. This 
provides additional income for all sectors of the economy and an increase in demand for 
many types of goods.
Congress may decide to increase government spending, but the eff ects of increased gov-
ernment spending occur more slowly than those of a tax cut, since it takes time to get programs 
started and put into full operation. The increased income arises fi rst in those sectors of the 
economy where the money is spent. Thus, the initial eff ect is on specifi c areas of the economy 
rather than on the economy as a whole.