Two key unanswered questions about the fiscal impact of migration

Published 21 August 2012 / By Carlos Vargas-Silva

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All existing (and likely all future) analysis of the fiscal impact of migration has a common characteristic: hidden and explicit assumptions which are highly questionable. This fact does not imply that all previous analysis has been mediocre and bias, but just reflects the substantial complexity of the topic.

The political relevance of this topic has motivated much analysis of the impact of migrants on public finances. A significant share (probably the majority) of this analysis has not been conducted by academics working for academic organisations. Instead, the analysis is often conducted by government departments (e.g. Home Office) or policy oriented organisations such as think tanks (e.g. IPPR in the UK, The Urban Institute in the USA) and pressure groups (e.g. Migration Watch in the UK, the Carrying Capacity Network in the USA).

The interest of these groups in the fiscal impact of migration is understandable. As the latest economic turmoil in Europe suggests, a national government is often deemed ‘reliable’ if it is fiscally responsible. Therefore, policies that benefit the fiscal position of the government have great importance for policymakers and the public in general. If an organisation has an explicit or implicit agenda in favour or against migration, then showing that migrants have a favourable or negative impact on government finances becomes a convenient way of moving public opinion in a certain direction.

Unsurprisingly, the organisations that oppose migration tend to find that migrants are a heavy burden for the state, while organisations which generally favour migration find that migrants are extremely valuable for government public finances.

The existing potential bias in much of this analysis calls for involvement of more academics in the discussion. However, for academic researchers, especially economists, estimating the fiscal impact of migration may not be as interesting as it is an “accounting” exercise. While this in essence true, the “questions” that need answering in order to obtain better estimates of the fiscal impact of migration are of scientific value and of potential interest to academic researchers. Highlighting these questions is a way of getting more academics interested in this topic. Two of these “questions” are discussed below.

What are the broader general equilibrium implications of migration for public finances?

There are two common ways of analysing the fiscal impact of migration: the static approach and the dynamic approach.

Static approach

The static approach is based on a specific fiscal year, and simply compares the taxes paid by migrants with the services and benefits received by migrants during that year. It is fairly obvious that the static approach does not provide a clear perspective on the fiscal impact of migration.

For instance, in a static analysis, an increase in the number of school-age migrants will result in an additional fiscal burden, via extra expenditures in schools. Yet, the future taxes paid by these same migrants in their adulthood might more than compensate for the additional spending. On the other hand, many countries have unfunded defined benefit pension systems in which benefits are paid directly from current workers' contributions. An increase in the working-age migrant population might appear to lessen the fiscal burden of the pension systems. Yet, these migrants will eventually retire and many will obtain benefits from the same system.

Dynamic approach

A way of addressing this problem is to trace the fiscal effect of a migrant’s arrival through subsequent years. This is the essence of the dynamic approach to estimating the fiscal impact of migration. This approach computes the net present value of contributions and costs over the entire lifetime of migrants and, in some cases, their children. Yet, there is no dynamic analysis of the impact of migration for most countries (including the UK) and the analyses which exist for other countries tend to rely on a “partial equilibrium” analysis.

Partial equilibrium analysis examines the effects of some factor in the “equilibrium” in one particular sector, ignoring its effect in any other sectors or assuming that they being small will have little impact if any. For instance, economists looking at the determination of the price of a good in a partial equilibrium analysis would assume that the prices of all other goods remain constant.

The use of a partial equilibrium analysis in the estimation of the fiscal impact of migration has important consequences. For example, many of these analyses do not take into account the broader potential impacts of migration, such as impact on native wages, and labour force participation of natives and potential macroeconomic impacts. These impacts are important because the government’s budget constraint is also affected by these factors. For instance, an increase in migration will likely raise the labour/capital ratio of the country and, therefore, decrease wages and increase interest rates. The lower wages reduce tax revenues and the higher interest rates increase the cost of government’s debt.

It is also likely that the presence of migrants may have other indirect impacts on natives. For instance, the presence of migrants may increase housing prices (including rents) and displaced the native population from the rental sector to the social housing sector, imposing an additional burden on public finances. Alternatively, take the presence of low skilled migrant females working as nannies which allows native female workers to increase their labour supply and pay more taxes as a result.

Another example of the limitations of partial equilibrium analyses, relates to migrants and the public sector workforce. If large numbers of migrants find work in public sector jobs, they may restrain the growth of public sector wages and the need for additional tax increases to provide government services. This indirect fiscal effect of migrants is typically not included in fiscal impacts studies, but could be very important if migrants are over represented in the public sector.

In sum, it is not really possible to study the fiscal impact of migration in a partial equilibrium setting and the few general equilibrium studies which have been conducted are still limited in the ways in which they have incorporated these broader indirect effects.

What are the differences in fiscal impacts between different types of migrants?

Surprisingly few studies have focus on the fiscal impact of specific groups of migrants, instead of the entire migrant population. Having a disaggregated look at fiscal impacts is important in order to evaluate the fiscal implications of admission criteria on the part of host governments. The admission policies of host governments and the characteristics which are rewarded in the admission process determine to a large extent the characteristics of the migrant population.

Many studies keep repeating the claim that targeted migration policies which favour specific types of migrants could have a significant positive impact on the public finances of host countries. However, much of the research on fiscal impacts is still about levels of migration (current or hypothetical) and not about making clear distinctions between types of migrants and the potential contribution of each type. This fact relates, to a certain degree, to the political nature of the topic.

Liberal think tanks tend to avoid making too many distinctions among immigrants to avoid some migrants being branded “good” migrants and others “bad” migrants. On the other hand, for anti-migration pressure groups it is hard to accept that there could be some migrant selection criteria in which additional migration will have a beneficial impact on public finances. As a result, it is even more relevant for academics to start making this point and to suggest that not all immigrants should be placed in the same basket.

Answering these types of questions is imperative in order to obtain a deeper understanding of the fiscal impact of migration.  The questions are also of scientific value and may attract wide interest from academics that have not been previously interested in the topic.