Taxes work as an automatic stabilizer, which of the following explains this role of taxes most appropriately?

[A] Tax revenues automatically increase as GDP falls, which prevents consumption and real GDP from falling further

[B] Tax revenues automatically decrease as GDP falls, which prevents consumption and real GDP from falling further

[C] An automatic decrease in tax revenues causes government spending to decrease, which prevents real GDP from falling further

[D] None of the above

Answer: B

Notes:

When real GDP falls, incomes tend to fall. When incomes fall, taxes on that income will also fall. This means that disposable income that households have may increase which may drive consumption. As a result, the decrease in tax revenue offsets some of the impact of a recession.
Tax revenues automatically decrease when GDP falls, not increase. A decrease in real GDP will lower incomes so that less tax revenue will be collected.
During a recession, there is a decrease in tax revenues. However, this does not necessarily mean that government spending will necessarily decrease. Governments can run deficits during a recession when tax revenue is less than government spending.

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