## _spn0923 - Executive Summary

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---

### Overview and purpose
- Fiscal policy can stabilize the economy during cyclical swings, but discretionary fiscal policy suffers from implementation lags and is not automatically reversed when conditions improve.
- Automatic fiscal stabilizers provide a prompter, self-correcting fiscal response; “the size of the stabilizers approximately equals the share of government in the economy times the output gap.”
- The paper examines ways to enhance automatic stabilizers without increasing the size of government, distinguishing between:
  - Permanent changes in tax and expenditure parameters (e.g., changes in tax progressivity); and
  - Temporary, trigger-based changes (e.g., measures contingent on severe downturns).

### Key conceptual points
- Automatic stabilizers are revenue and some expenditure items that adjust automatically to cyclical changes (e.g., falling revenue and rising unemployment benefits when output falls).
- The impact of stabilizers depends on government size and the cyclical responsiveness of taxes and expenditures (progressivity of tax system is one determinant).
- Stabilizers widen the budget deficit when the output gap increases and narrow it as the gap decreases—appropriate for demand shocks but not for supply shocks (which may require fiscal adjustment to avoid inflation).
- Common estimation method: the elasticities approach.

### Advantages of strong automatic stabilizers
- Timeliness and minimal implementation lags: stabilizers react automatically without political decision-making delays.
- Self-reversal: fiscal loosening in bad times is automatically followed by tightening in good times, which can enhance confidence and reduce solvency concerns relative to discretionary measures.
- Potentially valuable in advanced, emerging, and low-income countries where discretionary policy tends to be procyclical.

### Important caveats and constraints
- Financing and debt-sustainability constraints may prevent a country from allowing stabilizers to operate effectively; often more binding in developing economies with shallow domestic debt markets or limited external access.
- Automatic expansion is inappropriate in the presence of large supply shocks (would create inflation).
- Increasing automatic stabilizers via raising government size or taxes may yield equity benefits but can produce efficiency costs beyond some level of government size; evidence cited suggests decreasing returns to fiscal stabilization once public expenditure approaches 40 percent of GDP.

### How to enhance stabilizers without increasing government size
- Use tax and expenditure policy design and fiscal rules to increase cyclical responsiveness rather than overall government size.
- Tax-policy observations:
  - Income taxes have higher output-gap elasticities (personal income taxes due to progressivity; corporate taxes linked to profitability). Taxes on goods and services, payroll taxes and social security contributions generally have lower elasticities.
  - Taxes on capital gains, financial transactions, and real property can respond to volatile asset prices beyond the economic cycle.
  - Recession-related deterioration in taxpayer compliance can deepen revenue losses unless tax administrations act to counter it.
- Cross-country composition:
  - Personal income taxes and payroll/social security contributions are more important in advanced economies; corporate income taxes and consumption taxes are relatively more important in many emerging economies.
- Quantitative illustrations preserved from the source:
  - “A shift in the composition of tax revenue by 5 percentage points (which is a very large change) from indirect taxes to personal income tax across G-20 countries would increase the automatic stabilizers on average by about 0.05 percent of GDP.”
  - “Increasing the elasticity of the personal income tax by 10 percent would increase the automatic stabilizers by only 0.01 percent of GDP (in response to a one percentage point increase in the output gap).”
  - “If income tax progressivity in the U.S. were equal to that of Germany, the U.S. automatic stabilizers would only increase by 0.03 percent of GDP.”

### Personal income tax design considerations
- Raising progressivity (higher marginal rates or expanding income-related benefits like refundable tax credits) can reinforce equity and stabilization objectives, but higher marginal rates increase distortionary impacts on labor supply and savings.
- Tax base broadening that removes benefits favoring better-off households can raise progressivity without raising government size.
- Refundable tax credits act like transfer payments in downturns and are relatively more important for low-income earners, providing stronger stabilizing effects than tax deductions that primarily benefit higher-income taxpayers.
- Flat tax reforms have ambiguous effects on progressivity and stabilizers; if combined with a tax-exempt threshold, stabilizers can increase or decrease depending on pre-reform schedules and taxpayer distribution.

### Corporate income tax and cyclical transmission
- Corporate income tax responds strongly to the economic cycle, but transmission to tax collections is typically lagged because companies often pay income taxes in installments during the year assessed on either last year’s actual income or on the basis of estimated income for the current year.
- To strengthen links between corporate tax payments and the economic cycle, advance corporate income tax payments could be made during year t at the end of Q2, Q3, and Q4 on the basis of estimated income for year t rather than on the outturn from the previous year, with a final payment at the end of Q1 in year t+1 adjusted to reflect final income in year t (and interest charges to penalize deliberate postponement of payments). Any change in corporate profits would then more quickly be reflected in corporate tax collections.

### Loss carry-forward and carry-backward: automatic stabilizer implications
- Firm losses increase during a slowdown; their tax treatment affects automatic stabilizers.
- Loss carry-forward provisions:
  - All G-20 countries allow at least 5 years of carry-forward, with many providing indefinite carry-forward.
- Loss carry-backward provisions:
  - Some countries allow losses to be offset against past profits (loss carry-backward), typically restricted to profits in the most recent 2–3 tax years; carry-backward qualifies a loss-making company for an immediate tax refund.
  - Carry back increases automatic stabilizers but is often limited due to fear of abuse and reluctance to make current tax payments contingent on future profitability.
  - Where tax administration capacity is sufficient, consider loss carry-backward against the last 2–3 tax years, possibly only on a temporary basis during recessions.
- Table 2: G-20 Countries: Features of the Corporate Tax (selected entries preserved exactly)
  - Argentina: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 35
  - Australia: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 30
  - Brazil: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 15-25
  - Canada: Carry-forward 10 yrs.; Carry-backward 3 yrs.; Corporate income tax (ordinary) 29-35
  - China: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 20-25
  - France: Carry-forward Indefinitely; Carry-backward 3 yrs. (tax credit); Corporate income tax (ordinary) 33.3
  - Germany: Carry-forward Indefinitely; Carry-backward 1 yr.; Corporate income tax (ordinary) 15.83
  - India: Carry-forward 8 yrs.; Carry-backward None; Corporate income tax (ordinary) 30
  - Indonesia: Carry-forward 5-8 yrs.; Carry-backward None; Corporate income tax (ordinary) 28
  - Italy: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 27.5
  - Japan: Carry-forward 7 yrs.; Carry-backward 1 yr. (suspended); Corporate income tax (ordinary) 22-30
  - Korea: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 11-22
  - Mexico: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 28
  - Russia: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 20
  - Saudi Arabia: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 20
  - South Africa: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 28
  - Turkey: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 20
  - United Kingdom: Carry-forward Indefinitely; Carry-backward 3 yrs.; Corporate income tax (ordinary) 28
  - United States: Carry-forward 20 yrs.; Carry-backward 2 yrs.; Corporate income tax (ordinary) 35
- More permissive treatment of tax losses in recessions (including in mergers and acquisitions) can act as stabilization and catalyze necessary restructurings.

### Expenditure policy, unemployment benefits, and social spending
- Unemployment benefits have stabilizing effects on disposable household income; prevalence differs across countries, being important in advanced economies and much less widespread in developing economies.
- Differences in unemployment benefit design:
  - U.S. has shorter benefit duration than most other advanced economies; typical maximum duration of unemployment insurance is 26 weeks, funded by state-level taxes.
  - Extended Benefits program (co-funded with the federal government) provides an additional 13 or 20 weeks in states where unemployment exceeds trigger thresholds.
  - During recessions, discretionary federally funded extensions of unemployment benefits have been enacted (e.g., Extended Unemployment Compensation program in July 2008).
- Social spending patterns:
  - Level of social spending is highest in Europe, much lower in emerging markets, with Japan and Anglophone advanced economies roughly in the middle.
  - Most cross-country differences relate to pensions and unemployment insurance; public spending on health is more uniform (relative to GDP).
- Table 3: G-20 Countries: Unemployment Programs (selected entries preserved exactly)
  - Australia: Unemployment assistance — No limit duration; Initial Payment (percent of EB) 20
  - Canada: Unemployment insurance — Duration 9; Initial Payment 55; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
  - France: Unemployment insurance — Duration 23; Initial Payment 57-75; Earnings Base Gross; Duration (months) 6; Max. Benefits (percent of average wage) 17
  - Germany: Unemployment assistance — Duration 12; Initial Payment 60; Earnings Base Net; Duration (months) No limit; Max. Benefits (percent of average wage) 10
  - Japan: Unemployment insurance — Duration 10; Initial Payment 50-80; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
  - United Kingdom: Unemployment insurance — Duration 6; Initial Payment 10; Earnings Base Average wage; Duration (months) No limit; Max. Benefits (percent of average wage) 10
  - United States: Unemployment insurance — Duration 6; Initial Payment 53; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
- In emerging economies without comprehensive unemployment support, introducing well-designed unemployment insurance could yield macroeconomic gains; where reforms take time, targeted cash transfers or public work programs can be scaled up during crises.

### Fiscal rules, fiscal federalism, and interaction with stabilizers
- Fiscal rules can require discretionary changes that offset automatic stabilizers; impacts depend on rule type:
  - Expenditure rules setting ceilings prevent cyclically-sensitive spending (e.g., unemployment insurance) from responding in downturns.
  - Debt ceilings constrain stabilizers only if debt is close to the ceiling; otherwise no immediate constraint.
  - Simple fiscal balance rules (nominal or percent of GDP ceilings) and subnational balanced budget rules (e.g., U.S. state rules) work against automatic stabilizers by forcing offsetting discretionary tightening when cyclical balances deteriorate.
  - Revenue rules and earmarking can also induce procyclicality.
- Options to avoid procyclicality:
  - Balance-over-the-cycle rules: allow deficits during downturns and surpluses in upswings; implementation challenge is judging cycle timing and data revisions—independent fiscal councils can help date cycles and monitor compliance.
  - Structural (cyclically-adjusted) balance rules: allow automatic stabilizers to operate but are weakened by deficiencies in cyclical adjustments; credibility enhanced by transparent adjustment methods and oversight by an independent fiscal agency.
- At the subnational level, balance-over-the-cycle and structural rules are hard to apply; better approach is increasing central-to-subnational transfers in response to cyclical swings. Example: by mid-2009, most U.S. states used federal stimulus transfers to close budget gaps; 24 out of 25 states reporting to the National Conference of State Legislatures have used federal transfers to close their budget gap.

### Automating the discretionary fiscal response: design, triggers, and policy options
- Objective: temporary fiscal policy changes triggered by economic developments aim to speed fiscal response, reduce political interference, and reduce uncertainty—making discretionary policy more timely and akin to increasing automatic stabilizers, though responses may be lumpier.
- Symmetry and fiscal space:
  - Triggered measures could be symmetric (expansion in downturns offset by tightening in upswings) to avoid adding to deficit bias, but frequent policy changes impose costs; better to underpin triggers with explicit medium-term fiscal space (e.g., anchored by an appropriate medium-term fiscal rule).
- Key design issues:
  - Macroeconomic trigger selection must capture underlying deterioration and be forward-looking enough to be timely; cautious design to avoid frequent activations.
  - Economic trigger indicators:
    - Official recession dating by an independent agency is retrospective and slow.
    - Quarterly GDP growth triggers are delayed because GDP compiles with several months lag.
    - More timely data: monthly employment or unemployment data (lags of, at most, weeks). Example: Feldstein (2007) proposed triggering conditional fiscal stimulus by a three-month cumulative decline in payroll employment, ending when employment rises or reaches pre-downturn level.
    - Forward-looking triggers offer timeliness but risk projection errors and credibility problems; credible forecasts may require an independent fiscal council.
  - Automatic tax policy design:
    - Temporary tax measures targeted at low-income households (credit/liquidity constrained) have larger multipliers—examples: rebates of personal income or payroll taxes providing refunds to wage earners with no current tax liability.
    - Temporary reduction in consumption taxes (such as the VAT) can boost consumption.
    - Temporary investment tax incentives aimed at overcoming liquidity/credit constraints may be powerful but can induce timing distortions if firms anticipate triggers.
    - Temporary job creation tax credits when unemployment exceeds thresholds are well-targeted but may encourage firing/rehiring around thresholds.
    - Temporarily allowing losses to be offset against profits from the last 2–3 years (tax refunds) could be considered, subject to careful design to limit abuse.
  - Automatic expenditure policy design:
    - Temporary transfers targeted at low-income or liquidity-constrained households, enhancement of unemployment benefits when unemployment exceeds thresholds (automating discretionary extensions), and rules-based transfers to states in federal structures can reduce subnational need for offsetting fiscal cuts.
    - Transfers should ideally reflect regional recession depth (e.g., regional unemployment rates or regional GDP growth) to avoid rewarding past fiscal profligacy.
- Trade-offs:
  - Trigger-based packages should emphasize fiscal items with high multipliers.
  - Political economy considerations: preapproved contingent policy changes can be controversial; policymakers may prefer visible post-crisis action.

### Discussion of automated fiscal policy and academic views
- Solow (2005) considered an “automated” Fiscal Policy Board with a “standard stabilization package” that would allow for discretionary expansionary or contractionary adjustments automatically keyed to change in some economic indicator.
- Solow expressed skepticism about:
  - How effective frequent changes in expenditure programs and temporary changes in tax rates would be in influencing private behavior.
  - Practical challenges and likely resistance to proposals perceived as removing discretionary authority from policymakers.

### Conclusions — General assessment of approaches to enhance automatic stabilizers
- Permanent changes in tax and spending parameters are unlikely to be effective in enhancing automatic stabilizers and could involve undesirable side-effects.
- Shifts from indirect to direct taxes or increases in the progressivity of the personal income tax have very limited impact on the stabilizers and may weaken economic efficiency.
- Measures in the class of permanent changes that could be considered:
  - Switching from tax deductions to uniform, refundable tax credits for socially-valued activities.
  - Assessing the corporate income tax on the basis of estimated current income rather than last year’s actual income.
  - Developing alternative safety net mechanisms in countries without comprehensive unemployment insurance (e.g., targeted cash transfer programs in emerging market economies and public works programs in low-income countries).
  - Designing fiscal rules that would avoid the need for discretionary actions that would offset the automatic stabilizers (e.g., targeting the cyclically adjusted fiscal balance).

### More promising: temporary, state-contingent changes (recommended)
- Temporary changes to tax and expenditure parameters in response to macroeconomic developments include:
  - Temporarily providing a time-bound rebate in personal income tax or a reduction in VAT or sales tax rates during severe recessions.
  - Temporarily allowing corporate tax losses to be offset against past profits (loss carry-backward) during recessions qualifying some taxpayers for tax refunds, and possibly a more permissive attitude to transfer of losses.
  - Providing a state-contingent response in unemployment insurance extending and/or scaling up benefits when unemployment exceeds a certain threshold.
  - For federal structure countries, automating a system of federal transfers to states during severe recessions.
- Even with these measures, care is needed in selecting appropriate triggers; practical constraints do not seem insurmountable.

### Appendix 1 — Estimating automatic stabilizers: methods overview
- Two common estimation approaches:
  - Elasticities approach:
    - Estimates elasticities with respect to the output gap for different budget components separately.
    - OECD methodology used to derive cyclically adjusted series; European Commission applies same methodology for EU surveillance.
    - IMF uses a similar approach with simplifying assumptions where detailed data are not available.
    - Advantages: methodological consistency for cross-country comparisons; captures heterogeneous tax impacts.
    - Shortcomings:
      - Elasticities effectively time-invariant because updated infrequently; methodological refinements complicate vintage comparisons.
      - Recent tax policy changes may not be fully reflected (example: OECD elasticities reflect tax legislation in 2003).
      - Restrictive view on cyclical expenditure categories (typically includes only unemployment benefits), whereas evidence suggests age- and health-related social expenditure and incapacity/sick benefits can be cyclical.
  - Regression-based approach:
    - Estimates stabilizers directly by regressing changes in a fiscal measure (e.g., primary balance or decomposed fiscal variables) against changes in the output gap.
    - Issues:
      - Likely endogeneity between fiscal variables and GDP and possibility of reverse causality.
      - Most regression estimates use annual data, raising concerns about fiscal-GDP feedback.
      - Separating exogenous from endogenous fiscal policy requires removing cyclically adjusted components; for cross-country studies this imposes constraints on country coverage and types.
      - Shortcomings in the elasticities approach used to derive cyclically adjusted data will affect econometric results.

### Box 2 — Elasticities approach: key summary statistics (OECD member countries, 26 countries)
- Corporate income tax: Average (unweighted) 1.49; Median 1.52; Min 1.08; Max 2.08
- Personal income tax: Average (unweighted) 1.25; Median 1.18; Min 0.70; Max 1.92
- Social security contributions: Average (unweighted) 0.68; Median 0.69; Min 0.00; Max 0.92
- Indirect tax: Average (unweighted) 1.00; Median 1.00; Min 1.00; Max 1.00
- Current expenditure elasticity: Average (unweighted) -0.11; Median -0.11; Min -0.23; Max -0.02
- Total fiscal balance semi-elasticity: Average (unweighted) 0.44; Median 0.45; Min 0.22; Max 0.59
- Interpretation: On average, an increase in the output gap by one percentage point would lead to a deterioration in the budget balance by 0.44 percentage point of GDP.

### Appendix 2 — Impact on automatic stabilizers of increasing PIT progressivity: simulations and results
- Base data:
  - Weighted revenue elasticities for 26 OECD countries (using OECD estimates for PIT, corporate, social security, indirect taxes) average 1.07 percent.
  - In the base case, an increase in the output gap of one percent would be associated with a deterioration in the budget balance of 0.44 percent of GDP.
  - Germany: revenue elasticity 1.13; automatic stabilizers 0.48 percent of GDP.
  - United States: revenue elasticity 1.07; automatic stabilizers 0.33 percent of GDP.
- Three illustrative simulations (assume no behavioral response to progressivity changes):
  - Case I — PIT elasticity set equal to one across all countries:
    - Weighted revenue elasticity falls from 1.07 to 1.02.
    - Automatic stabilizers fall from 0.44 percent of GDP to 0.42 percent of GDP.
  - Case II — PIT elasticities increased by 10 percent in all countries:
    - Weighted revenue elasticities increase to 1.10 percent (from 1.07).
    - Impact on stabilizers is small: increase in budgetary sensitivity by 0.01 percent of GDP (to 0.45 percent of GDP).
  - Case III — All countries have the same PIT elasticity as in Germany:
    - Weighted revenue elasticities increase to 1.17.
    - Automatic stabilizers increase by 0.04 percent of GDP (to 0.48 percent).
    - In the U.S., automatic stabilizers would increase by 0.03 percent of GDP.
- Country average (unweighted) row: Elasticity of PIT in base case 1.23; Base case weighted revenue elasticity 1.07; Case I 1.02; Case II 1.10; Case III 1.17; Base case impact on budget balance 0.44; Case I 0.42; Case II 0.45; Case III 0.48.

### Key policy implications and recommendations
- Permanent tax or spending parameter changes to boost automatic stabilizers are unlikely to deliver large stabilization gains and may reduce economic efficiency.
- More effective strategies likely involve:
  - Designing temporary, state-contingent fiscal responses (time-bound tax rebates, temporary VAT/sales tax reductions, loss carry-backward provisions, scaled-up unemployment insurance, automated federal-to-state transfers during severe recessions).
  - Considering reforms that improve safety nets in countries lacking comprehensive unemployment insurance (targeted cash transfers, public works).
  - Implementing fiscal rules that preserve automatic stabilizers (e.g., cyclically adjusted fiscal balance targets).
- Feasible increases in PIT progressivity are unlikely to substantially increase automatic stabilization; very large increases would be necessary to produce noticeable gains and could create efficiency losses.

*Source: Executive Summary of IMF staff paper _spn0923 - Executive Summary.*

### Executive Summary ......................................................................................................

### _spn0923 - Executive Summary

### Overview and purpose
- Fiscal policy can stabilize the economy during cyclical swings, but discretionary fiscal policy suffers from implementation lags and is not automatically reversed when conditions improve.
- Automatic fiscal stabilizers provide a prompter, self-correcting fiscal response; a rule of thumb noted in the source is that “the size of the stabilizers approximately equals the share of government in the economy times the output gap.”
- The paper examines ways to enhance automatic stabilizers without increasing the size of government, distinguishing between:
  - Permanent changes in tax and expenditure parameters (e.g., changes in tax progressivity); and
  - Temporary, trigger-based changes (e.g., measures contingent on severe downturns).

### Key conceptual points (Box 1)
- Automatic stabilizers are revenue and some expenditure items that adjust automatically to cyclical changes (e.g., falling revenue and rising unemployment benefits when output falls).
- The impact of stabilizers depends on government size and the cyclical responsiveness of taxes and expenditures (progressivity of tax system is one determinant).
- Stabilizers widen the budget deficit when the output gap increases and narrow it as the gap decreases—appropriate for demand shocks but not for supply shocks (which may require fiscal adjustment to avoid inflation).
- Common estimation method: the elasticities approach (see Appendix 1 and Fedelino et al. (2009)).

### Advantages of strong automatic stabilizers
- Timeliness and minimal implementation lags: stabilizers react automatically without political decision-making delays.
- Self-reversal: fiscal loosening in bad times is automatically followed by tightening in good times, which can enhance confidence and reduce solvency concerns relative to discretionary measures.
- Potentially valuable in advanced, emerging, and low-income countries where discretionary policy tends to be procyclical.

### Important caveats and constraints
- Financing and debt-sustainability constraints may prevent a country from allowing stabilizers to operate effectively; this is often more binding in developing economies with shallow domestic debt markets or limited external access.
- Automatic expansion is inappropriate in the presence of large supply shocks (would create inflation).
- Increasing automatic stabilizers via raising government size or taxes may yield equity benefits but can produce efficiency costs beyond some level of government size (evidence cited suggests decreasing returns to fiscal stabilization once public expenditure approaches 40 percent of GDP).

### How to enhance stabilizers without increasing government size
- Use tax and expenditure policy design and fiscal rules to increase cyclical responsiveness rather than overall government size.
- Tax-policy observations:
  - Income taxes have higher output-gap elasticities (personal income taxes due to progressivity; corporate taxes linked to profitability). Taxes on goods and services, payroll taxes and social security contributions generally have lower elasticities.
  - Taxes on capital gains, financial transactions, and real property can respond to volatile asset prices beyond the economic cycle.
  - Recession-related deterioration in taxpayer compliance can deepen revenue losses unless tax administrations act to counter it.
- Cross-country composition:
  - Personal income taxes and payroll/social security contributions are more important in advanced economies; corporate income taxes and consumption taxes are relatively more important in many emerging economies.
  - Some countries have substantial revenue shares from property taxes or taxes on capital gains/financial sector (examples listed in source).
- Quantitative illustrations preserved from the source:
  - “A shift in the composition of tax revenue by 5 percentage points (which is a very large change) from indirect taxes to personal income tax across G-20 countries would increase the automatic stabilizers on average by about 0.05 percent of GDP.”
  - “Increasing the elasticity of the personal income tax by 10 percent would increase the automatic stabilizers by only 0.01 percent of GDP (in response to a one percentage point increase in the output gap).”
  - “If income tax progressivity in the U.S. were equal to that of Germany, the U.S. automatic stabilizers would only increase by 0.03 percent of GDP.” (See Appendix 2.)
- Personal income tax design considerations:
  - Raising progressivity (higher marginal rates or expanding income-related benefits like refundable tax credits) can reinforce equity and stabilization objectives, but higher marginal rates increase distortionary impacts on labor supply and savings.
  - Tax base broadening that removes benefits favoring better-off households can raise progressivity without raising government size.
  - Refundable tax credits act like transfer payments in downturns and are relatively more important for low-income earners, providing stronger stabilizing effects than tax deductions that primarily benefit higher-income taxpayers.
  - Flat tax reforms have ambiguous effects on progressivity and stabilizers; if combined with a tax-exempt threshold, stabilizers can increase or decrease depending on pre-reform schedules and taxpayer distribution.

### Policy preferences and recommendations (implicit in the source)
- Favor temporary, trigger-based fiscal measures (contingent rules) over permanent increases in government size to enhance stabilization while minimizing efficiency costs and disruption to other fiscal goals.
- Avoid fiscal rules that introduce procyclicality, which would offset existing stabilizers.
- Strengthen tax-administration responses to prevent recession-induced deterioration in tax compliance from becoming entrenched.
- Consider refundable tax credits or income-related transfer mechanisms that automatically support disposable income in downturns without proportionally increasing long-run government size.

*Source: Executive Summary of IMF staff paper _spn0923 - Executive Summary.*

### 15.      Another tax that responds strongly to changes in the economic cycle is the corporate

### 15.      Another tax that responds strongly to changes in the economic cycle is the corporate

### Corporate income tax and cyclical transmission
- Corporate income tax responds strongly to the economic cycle, but transmission to tax collections is typically lagged because companies often pay income taxes in installments during the year assessed on either last year’s actual income or on the basis of estimated income for the current year.
- To strengthen links between corporate tax payments and the economic cycle, advance corporate income tax payments could be made during year t at the end of Q2, Q3, and Q4 on the basis of estimated income for year t rather than on the outturn from the previous year, with a final payment at the end of Q1 in year t+1 adjusted to reflect final income in year t (and interest charges to penalize deliberate postponement of payments). Any change in corporate profits would then more quickly be reflected in corporate tax collections.

### Loss carry-forward and carry-backward: automatic stabilizer implications
- Firm losses increase during a slowdown; their tax treatment affects automatic stabilizers.
- Loss carry-forward provisions:
  - All G-20 countries allow at least 5 years of carry-forward, with many providing indefinite carry-forward.
- Loss carry-backward provisions:
  - Some countries allow losses to be offset against past profits (loss carry-backward), typically restricted to profits in the most recent 2–3 tax years; carry-backward qualifies a loss-making company for an immediate tax refund.
  - Carry back increases automatic stabilizers but is often limited due to fear of abuse and reluctance to make current tax payments contingent on future profitability.
  - Where tax administration capacity is sufficient, consider loss carry-backward against the last 2–3 tax years, possibly only on a temporary basis during recessions.
- Table 2: G-20 Countries: Features of the Corporate Tax (selected entries preserved exactly)
  - Argentina: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 35
  - Australia: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 30
  - Brazil: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 15-25
  - Canada: Carry-forward 10 yrs.; Carry-backward 3 yrs.; Corporate income tax (ordinary) 29-35
  - China: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 20-25
  - France: Carry-forward Indefinitely; Carry-backward 3 yrs. (tax credit); Corporate income tax (ordinary) 33.3
  - Germany: Carry-forward Indefinitely; Carry-backward 1 yr.; Corporate income tax (ordinary) 15.83
  - India: Carry-forward 8 yrs.; Carry-backward None; Corporate income tax (ordinary) 30
  - Indonesia: Carry-forward 5-8 yrs.; Carry-backward None; Corporate income tax (ordinary) 28
  - Italy: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 27.5
  - Japan: Carry-forward 7 yrs.; Carry-backward 1 yr. (suspended); Corporate income tax (ordinary) 22-30
  - Korea: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 11-22
  - Mexico: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 28
  - Russia: Carry-forward 10 yrs.; Carry-backward None; Corporate income tax (ordinary) 20
  - Saudi Arabia: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 20
  - South Africa: Carry-forward Indefinitely; Carry-backward None; Corporate income tax (ordinary) 28
  - Turkey: Carry-forward 5 yrs.; Carry-backward None; Corporate income tax (ordinary) 20
  - United Kingdom: Carry-forward Indefinitely; Carry-backward 3 yrs.; Corporate income tax (ordinary) 28
  - United States: Carry-forward 20 yrs.; Carry-backward 2 yrs.; Corporate income tax (ordinary) 35
- More permissive treatment of tax losses in recessions (including in mergers and acquisitions) can act as stabilization and catalyze necessary restructurings.

### Expenditure policy, unemployment benefits, and social spending
- Unemployment benefits have stabilizing effects on disposable household income; prevalence differs across countries, being important in advanced economies and much less widespread in developing economies.
- Differences in unemployment benefit design:
  - U.S. has shorter benefit duration than most other advanced economies; typical maximum duration of unemployment insurance is 26 weeks, funded by state-level taxes.
  - Extended Benefits program (co-funded with the federal government) provides an additional 13 or 20 weeks in states where unemployment exceeds trigger thresholds.
  - During recessions, discretionary federally funded extensions of unemployment benefits have been enacted (e.g., Extended Unemployment Compensation program in July 2008).
- Social spending patterns:
  - Level of social spending is highest in Europe, much lower in emerging markets, with Japan and Anglophone advanced economies roughly in the middle.
  - Most cross-country differences relate to pensions and unemployment insurance; public spending on health is more uniform (relative to GDP).
- Table 3: G-20 Countries: Unemployment Programs (selected entries preserved exactly)
  - Australia: Unemployment assistance — No limit duration; Initial Payment (percent of EB) 20
  - Canada: Unemployment insurance — Duration 9; Initial Payment 55; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
  - France: Unemployment insurance — Duration 23; Initial Payment 57-75; Earnings Base Gross; Duration (months) 6; Max. Benefits (percent of average wage) 17
  - Germany: Unemployment assistance — Duration 12; Initial Payment 60; Earnings Base Net; Duration (months) No limit; Max. Benefits (percent of average wage) 10
  - Japan: Unemployment insurance — Duration 10; Initial Payment 50-80; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
  - United Kingdom: Unemployment insurance — Duration 6; Initial Payment 10; Earnings Base Average wage; Duration (months) No limit; Max. Benefits (percent of average wage) 10
  - United States: Unemployment insurance — Duration 6; Initial Payment 53; Earnings Base Gross; Duration (months) N/A; Max. Benefits (percent of average wage) N/A
- In emerging economies without comprehensive unemployment support, introducing well-designed unemployment insurance could yield macroeconomic gains; where reforms take time, targeted cash transfers or public work programs can be scaled up during crises.

### Fiscal rules, fiscal federalism, and their interaction with stabilizers
- Fiscal rules can require discretionary changes that offset automatic stabilizers; impacts depend on rule type:
  - Expenditure rules setting ceilings prevent cyclically-sensitive spending (e.g., unemployment insurance) from responding in downturns.
  - Debt ceilings constrain stabilizers only if debt is close to the ceiling; otherwise no immediate constraint.
  - Simple fiscal balance rules (nominal or percent of GDP ceilings) and subnational balanced budget rules (e.g., U.S. state rules) work against automatic stabilizers by forcing offsetting discretionary tightening when cyclical balances deteriorate.
  - Revenue rules and earmarking can also induce procyclicality.
- Options to avoid procyclicality:
  - Balance-over-the-cycle rules: allow deficits during downturns and surpluses in upswings; implementation challenge is judging cycle timing and data revisions—independent fiscal councils can help date cycles and monitor compliance.
  - Structural (cyclically-adjusted) balance rules: allow automatic stabilizers to operate but are weakened by deficiencies in cyclical adjustments; credibility enhanced by transparent adjustment methods and oversight by an independent fiscal agency.
- At the subnational level, balance-over-the-cycle and structural rules are hard to apply; better approach is increasing central-to-subnational transfers in response to cyclical swings. Example: by mid-2009, most U.S. states used federal stimulus transfers to close budget gaps; 24 out of 25 states reporting to the National Conference of State Legislatures have used federal transfers to close their budget gap.

### Automating the discretionary fiscal response: design, triggers, and policy options
- Objective: temporary fiscal policy changes triggered by economic developments aim to speed fiscal response, reduce political interference, and reduce uncertainty—making discretionary policy more timely and akin to increasing automatic stabilizers, though responses may be lumpier.
- Symmetry and fiscal space:
  - Triggered measures could be symmetric (expansion in downturns offset by tightening in upswings) to avoid adding to deficit bias, but frequent policy changes impose costs; better to underpin triggers with explicit medium-term fiscal space (e.g., anchored by an appropriate medium-term fiscal rule).
- Key design issues:
  - Macroeconomic trigger selection must capture underlying deterioration and be forward-looking enough to be timely; cautious design to avoid frequent activations.
  - Economic trigger indicators:
    - Official recession dating by an independent agency is retrospective and slow.
    - Quarterly GDP growth triggers are delayed because GDP compiles with several months lag.
    - More timely data: monthly employment or unemployment data (lags of, at most, weeks). Example: Feldstein (2007) proposed triggering conditional fiscal stimulus by a three-month cumulative decline in payroll employment, ending when employment rises or reaches pre-downturn level.
    - Forward-looking triggers offer timeliness but risk projection errors and credibility problems; credible forecasts may require an independent fiscal council.
  - Automatic tax policy design:
    - Temporary tax measures targeted at low-income households (credit/liquidity constrained) have larger multipliers—examples: rebates of personal income or payroll taxes providing refunds to wage earners with no current tax liability.
    - Temporary reduction in consumption taxes (such as the VAT) can boost consumption.
    - Temporary investment tax incentives aimed at overcoming liquidity/credit constraints may be powerful but can induce timing distortions if firms anticipate triggers.
    - Temporary job creation tax credits when unemployment exceeds thresholds are well-targeted but may encourage firing/rehiring around thresholds.
    - Temporarily allowing losses to be offset against profits from the last 2–3 years (tax refunds) could be considered, subject to careful design to limit abuse.
  - Automatic expenditure policy design:
    - Temporary transfers targeted at low-income or liquidity-constrained households, enhancement of unemployment benefits when unemployment exceeds thresholds (automating discretionary extensions), and rules-based transfers to states in federal structures can reduce subnational need for offsetting fiscal cuts.
    - Transfers should ideally reflect regional recession depth (e.g., regional unemployment rates or regional GDP growth) to avoid rewarding past fiscal profligacy.
- Trade-offs:
  - Trigger-based packages should emphasize fiscal items with high multipliers.
  - Political economy considerations: preapproved contingent policy changes can be controversial; policymakers may prefer visible post-crisis action.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0923.pdf*

### 29.      There has also been some discussion in the academic literature seeking more

### _spn0923 - 29.      There has also been some discussion in the academic literature seeking more

### Discussion of automated fiscal policy
- Solow (2005) considered an “automated” Fiscal Policy Board with a “standard stabilization package” that would allow for discretionary expansionary or contractionary adjustments automatically keyed to change in some economic indicator.
- Solow expressed skepticism about:
  - How effective frequent changes in expenditure programs and temporary changes in tax rates would be in influencing private behavior.
  - Practical challenges and likely resistance to proposals perceived as removing discretionary authority from policymakers.

### V. CONCLUSIONS — General assessment of approaches to enhance automatic stabilizers
- Permanent changes in tax and spending parameters are unlikely to be effective in enhancing automatic stabilizers and could involve undesirable side-effects.
- Shifts from indirect to direct taxes or increases in the progressivity of the personal income tax have very limited impact on the stabilizers and may weaken economic efficiency.
- Measures in the class of permanent changes that could be considered:
  - Switching from tax deductions to uniform, refundable tax credits for socially-valued activities.
  - Assessing the corporate income tax on the basis of estimated current income rather than last year’s actual income.
  - Developing alternative safety net mechanisms in countries without comprehensive unemployment insurance (e.g., targeted cash transfer programs in emerging market economies and public works programs in low-income countries).
  - Designing fiscal rules that would avoid the need for discretionary actions that would offset the automatic stabilizers (e.g., targeting the cyclically adjusted fiscal balance).

### More promising: temporary, state-contingent changes
- Temporary changes to tax and expenditure parameters in response to macroeconomic developments include:
  - Temporarily providing a time-bound rebate in personal income tax or a reduction in VAT or sales tax rates during severe recessions.
  - Temporarily allowing corporate tax losses to be offset against past profits (loss carry-backward) during recessions qualifying some taxpayers for tax refunds, and possibly a more permissive attitude to transfer of losses.
  - Providing a state-contingent response in unemployment insurance extending and/or scaling up benefits when unemployment exceeds a certain threshold.
  - For federal structure countries, automating a system of federal transfers to states during severe recessions.
- Even with these measures, care is needed in selecting appropriate triggers; practical constraints do not seem insurmountable.

### Appendix 1 — Estimating automatic stabilizers: methods overview
- Two common estimation approaches:
  - Elasticities approach:
    - Estimates elasticities with respect to the output gap for different budget components separately.
    - OECD methodology used to derive cyclically adjusted series; European Commission applies same methodology for EU surveillance.
    - IMF uses a similar approach with simplifying assumptions where detailed data are not available.
    - Advantages: methodological consistency for cross-country comparisons; captures heterogeneous tax impacts.
    - Shortcomings:
      - Elasticities effectively time-invariant because updated infrequently; methodological refinements complicate vintage comparisons.
      - Recent tax policy changes may not be fully reflected (example: OECD elasticities reflect tax legislation in 2003).
      - Restrictive view on cyclical expenditure categories (typically includes only unemployment benefits), whereas evidence suggests age- and health-related social expenditure and incapacity/sick benefits can be cyclical.
  - Regression-based approach:
    - Estimates stabilizers directly by regressing changes in a fiscal measure (e.g., primary balance or decomposed fiscal variables) against changes in the output gap.
    - Issues:
      - Likely endogeneity between fiscal variables and GDP and possibility of reverse causality.
      - Most regression estimates use annual data, raising concerns about fiscal-GDP feedback.
      - Separating exogenous from endogenous fiscal policy requires removing cyclically adjusted components; for cross-country studies this imposes constraints on country coverage and types.
      - Shortcomings in the elasticities approach used to derive cyclically adjusted data will affect econometric results.

### Box 2 — Elasticities approach: methodology and key summary statistics
- OECD estimates reduced-form elasticities for:
  - Personal income tax, corporate income tax, social security contributions, indirect taxes, and the impact of unemployment insurance on expenditure.
- Reduced-form tax elasticities = elasticity of tax revenue w.r.t. tax base × elasticity of tax base w.r.t. output gap.
- OECD assumptions include:
  - Unitary elasticity for indirect tax revenue for all countries.
  - For corporate tax, proceeds adjust proportionally to the profit share in GDP.
  - Only unemployment assistance is cyclically sensitive on the expenditure side (with proportionality assumption equal to its share in current primary expenditure).
- Summary of Tax and Expenditure Elasticities, and Fiscal Balance Semi-Elasticities, OECD Member Countries (26 countries):
  - Corporate income tax: Average (unweighted) 1.49; Median 1.52; Min 1.08; Max 2.08
  - Personal income tax: Average (unweighted) 1.25; Median 1.18; Min 0.70; Max 1.92
  - Social security contributions: Average (unweighted) 0.68; Median 0.69; Min 0.00; Max 0.92
  - Indirect tax: Average (unweighted) 1.00; Median 1.00; Min 1.00; Max 1.00
  - Current expenditure elasticity: Average (unweighted) -0.11; Median -0.11; Min -0.23; Max -0.02
  - Total fiscal balance semi-elasticity: Average (unweighted) 0.44; Median 0.45; Min 0.22; Max 0.59
- Interpretation:
  - The revenue and expenditure elasticities measure nominal changes in budget items with respect to the output gap.
  - Transforming elasticities into budgetary sensitivity parameters scales by the share in GDP of current revenue and current primary expenditure.
  - On average, an increase in the output gap by one percentage point would lead to a deterioration in the budget balance by 0.44 percentage point of GDP.

### Appendix 2 — Impact on automatic stabilizers of increasing PIT progressivity: simulations and results
- Intuition: Increasing progressivity of the personal income tax (PIT) is the most intuitive way to increase automatic stabilizers, but simulations indicate modest effects for reasonable increases in progressivity.
- Base data:
  - Weighted revenue elasticities for 26 OECD countries (using OECD estimates for PIT, corporate, social security, indirect taxes) average 1.07 percent.
  - In the base case, an increase in the output gap of one percent would be associated with a deterioration in the budget balance of 0.44 percent of GDP.
  - Germany: revenue elasticity 1.13; automatic stabilizers 0.48 percent of GDP.
  - United States: revenue elasticity 1.07; automatic stabilizers 0.33 percent of GDP.
- Three illustrative simulations (assume no behavioral response to progressivity changes):
  - Case I — PIT elasticity set equal to one across all countries (implies significant drop in progressivity in most countries):
    - Weighted revenue elasticity falls from 1.07 to 1.02.
    - Automatic stabilizers fall from 0.44 percent of GDP to 0.42 percent of GDP.
    - This provides a crude measure of the contribution to automatic stabilizers from existing PIT progressivity.
  - Case II — PIT elasticities increased by 10 percent in all countries:
    - Weighted revenue elasticities increase to 1.10 percent (from 1.07).
    - Impact on stabilizers is small: increase in budgetary sensitivity by 0.01 percent of GDP (to 0.45 percent of GDP).
    - Magnitude of increase is roughly equal in most countries, including the U.S.
    - Suggests feasible increases in progressivity yield modest gains in stabilization.
  - Case III — All countries have the same PIT elasticity as in Germany:
    - Weighted revenue elasticities increase to 1.17 (almost 10 percent increase).
    - Automatic stabilizers increase by 0.04 percent of GDP (to 0.48 percent).
    - In the U.S., automatic stabilizers would increase by 0.03 percent of GDP.
    - This simulation implies a very large and politically unlikely rise in PIT progressivity, with likely efficiency losses outweighing stabilization gains.
- Table A1 (illustrative country-level results, 2005–2007 average) reports:
  - Country-by-country values for: Elasticity of PIT in base case; Base case weighted revenue elasticities; Case I weighted revenue elasticities (PIT elasticity = 1); Case II weighted revenue elasticities (PIT elasticity +10%); Case III weighted revenue elasticities (PIT elasticity = Germany); and corresponding impacts on the budget balance in percent of GDP.
  - Country average (unweighted) row: Elasticity of PIT in base case 1.23; Base case weighted revenue elasticity 1.07; Case I 1.02; Case II 1.10; Case III 1.17; Base case impact on budget balance 0.44; Case I 0.42; Case II 0.45; Case III 0.48.

### Key policy implications and recommendations (synthesized from conclusions and simulations)
- Permanent tax or spending parameter changes to boost automatic stabilizers are unlikely to deliver large stabilization gains and may reduce economic efficiency.
- More effective strategies likely involve:
  - Designing temporary, state-contingent fiscal responses (time-bound tax rebates, temporary VAT/sales tax reductions, loss carry-backward provisions, scaled-up unemployment insurance, automated federal-to-state transfers during severe recessions).
  - Considering reforms that improve safety nets in countries lacking comprehensive unemployment insurance (targeted cash transfers, public works).
  - Implementing fiscal rules that preserve automatic stabilizers (e.g., cyclically adjusted fiscal balance targets).
- Feasible increases in PIT progressivity are unlikely to substantially increase automatic stabilization; very large increases would be necessary to produce noticeable gains and could create efficiency losses.

*Italic: Source — IMF staff note, extracted from the provided content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0923.pdf_