What we need, then, are ways around our politicians. The first would be to expand automatic stabilizers—those tax and spending provisions that automatically expand when the economy weakens, thereby cushioning the blow, and automatically contract as the economy recovers, thereby helping to reduce the deficit. A progressive tax code is one such automatic stabilizer. The tax code takes less of your income as that income declines, so after-tax income tends to decline less in response to an economic shock than pre-tax income. Since spending is based on after-tax income, the impact on the economy is cushioned. Alan Auerbach of the University of California at Berkeley has found that, as a result, the tax code has, over the past 50 years, offset about 8 percent of the initial shock to GDP from economic downturns. For the same reason, making the tax code more progressive would strengthen its role as an automatic stabilizer. Unemployment insurance is another automatic stabilizer; as the economy weakens, unemployment insurance expands, providing a boost to demand right when the economy needs it.
Other automatic stabilizers are possible as well. For instance, rather than simply extending and expanding the existing payroll-tax holiday, as President Obama has proposed, policymakers should permanently link the tax to the unemployment rate. Consider a system under which the payroll tax would be reduced by 6 percentage points whenever the quarterly average unemployment rate exceeded 7.5 percent or increased by more than 2 percentage points over the previous year. Since a cut in the payroll tax is a powerful form of stimulus, this would be a built-in way to ensure a quick and effective government response to an economic downturn.
Beyond automatic stabilizers, we also need more backstop rules: events that take place if Congress doesn’t act. In this sense, the fiscal trigger created as part of the debt-limit negotiations is a good step forward. It leads to automatic spending reductions if Congress doesn’t enact measures to reduce the deficit; in other words, it changes the default from inaction to action.