Friday 9 December 2016

Why Britain’s public finances will suffer if Brexit reduces migration

By Ian Preston
Centre for Research and Analysis of Migration (CReAM) at University College London

Brexit will have high fiscal costs and a large part of that will be a consequence of what happens to migration numbers. That was the conclusion widely drawn from the Office for Budget Responsibility’s most recent Economic and Fiscal Outlook published in late November – the first since June’s referendum vote. It was illuminated further by supplementary analysis published on December 8.

To be precise, Brexit is forecast to lead to a cumulative £59 billion more in public sector borrowing over the next five years – £16 billion of which is attributed to the effect of reduced migration because of the unfavourable balance between its effects on tax revenue and government spending. Whereas the negative impact of other Brexit factors peaks in 2018-19, the effect of migration is forecast to still be rising by 2020-21.

What will happen to migration

The likely fall in migration is difficult to quantify, given the uncertainty about Brexit negotiations. As a result, the OBR’s approach to capturing it is necessarily rough and ready.

The changing political atmosphere since the vote may discourage immigration, as potential migrants expect a less welcoming reception. Eventually, the terms under which the UK withdraws may permit more restrictive migration policies for arrivals from the EU.

What the OBR does is to note that without Brexit it would have raised its estimate of future migration by about 80,000 a year. This is influenced by recent high migration levels, which have been confirmed again in the most recent migration figures. Given the referendum outcome, the OBR assumes that this increase will no longer happen and it treats this as the Brexit effect.

Past and projected net migration to the UK. Office for Budget Responsibility

This reduction falls some way short of meeting the government’s stated aspiration of cutting net migration to the tens of thousands, so it may be that the fiscal consequences of Brexit are being substantially understated. On the other hand, that target is politically contentious and widely viewed as impossibly ambitious.

Lowering net migration leads to a lower population and alters its composition. In particular, since migrants are typically young, well educated and arriving to work it leads to a population which is older and less likely to participate in the labour market. Effects of this on public finances could come through either side of the public sector balance sheet, through revenues or through spending.

Impact on tax revenues

The deleterious effect on the revenue side is easiest to understand. The lower population means less economic activity on which taxes are paid. Given that migrants tend to be younger than the average UK citizen, the OBR also predicts that fewer migrants coming in will lead to a decline in the employment rate, which reduces tax revenue further.

Because the inflow continues at the lower level year after year, the effect on the population builds up, which is why the annual effect on tax revenues continues to grow.

In its supplementary set of tables, published on December 8, the OBR explains that about half of the reduction comes through lower income tax and national insurance contributions and about a quarter through lower consumption tax receipts such as VAT. By 2020-21, the cumulative fall in tax receipts is forecast to have reached £17.3 billion. This is much the most important factor driving the increase of £16 billion in forecast borrowing by that year that the OBR attributes to lower migration as a result of Brexit.

Not much change to spending

On the expenditure side, things are more complicated. Welfare spending is treated as sensitive to migration because benefit claims are affected by the size and composition of the population, albeit that average welfare spending on migrants is lower than in the population as a whole. By 2020-21, cumulative welfare spending is forecast to be lower by £2.1 billion as a result of the lower migration. Offsetting this is an increase of £0.6 billion in debt interest spending as a consequence of the lower tax receipts.

But the largest part of spending – on public services such as education, health, police, defence and so on – is treated as fixed by prior plans. The OBR assumes that reduced migration will not lead to cutbacks in spending on these items over the horizon it considers.

Of course, migrants are entitled to use public services even if, contrary to popular perception, there is little evidence that they make excessive demands. So the OBR’s projected reduction in numbers of migrants without any change in planned spending means that pressure on those public services is implicitly being allowed to diminish somewhat. Falling population numbers are not being matched by commensurate spending cutbacks on these services and the projected increase in borrowing cannot therefore be straightforwardly interpreted as the cost of the migration changes. What the OBR is doing is making a forecast for borrowing, not evaluating the cost of lower migration after Brexit.

What the cost will be

It is perhaps helpful to compare the OBR figures to the best comprehensive costing available for the public finance impact of recent migration provided by economists Christian Dustmann and Tommaso Frattini.

Their calculations suggest that recent migration to the UK from the European Economic Area (EEA) over the period 2001-2011 benefited the exchequer by about £22 billion – with taxes paid exceeding spending costs imposed by about 34%. Over the ten-year period which they consider, EEA immigration expanded the economy by about 7m immigrant-years – calculated as about 1.4m immigrants each being in the country for an average of about five years. The net benefit to the exchequer was therefore of the order of £3,000 per additional immigrant, per year (in 2011 prices).

To compare, the OBR forecasts an increase in borrowing of £16bn over 2016-2021 for about 1.2m fewer immigrant-years. This suggests a forecast impact on borrowing of about £13,000 per missing immigrant per year. This is a significantly higher figure – but that is because it is an answer to a different question and evaluated over a different period coming after a decade of output growth and rising prices. Between 2011 and 2021, the OBR forecasts nominal GDP to rise by about 40%.

What is missing

The OBR projections ignore many possible economic effects of migration. If immigration affects UK workers’ wages or returns to capital, if it affects innovation and productivity, or affects the cost of providing public services then this is not accounted for. Although the OBR does allow for reduced migration to reduce housing demand and cut house prices, no effects on receipts from stamp duty, for example, are incorporated in the calculations of effects of migration.

Its projections also allow for no changes in the composition of migrants. If low-skilled migrants are more discouraged by Brexit than high-skilled migrants, say, then the fiscal consequences might be less pessimistic since the discouraged migrants would have paid less in taxes. However, the reductions needed to bring the government near to its target of net migration in the tens of thousands would need to cover more than the low-skilled.

International migrants are on the whole the sort of productive, economically motivated individuals that governments ought to be keen to attract. Making the country a less welcoming place and adding bureaucracy to economic relations with its nearest neighbours is not a promising route to attracting the most fiscally lucrative migrants.

Ian Preston is the Deputy Research Director of CReAM and Professor in the Department of Economics at UCL

Acknowledgement: This piece was first published at The Conversation

The Conversation

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