25 May 2016

IFS: Brexit could add two years to austerity

The Institute for Fiscal Studies has warned that in the short-term up to £40 billion in spending cuts or tax rises would be needed if Britain leaves Europe. UK's economy would be likely to face a hit between 2.1% and 3.5% in 2019.

Leaving the EU could directly free up about £8 billion a year, which is the UK’s likely net contribution to the EU budget over the next few years. This would help the public finances. But the overall public finance impact would depend on the economic effects of the UK leaving the EU. A fall in national income of 0.6%, relative to what it otherwise would have been, would be enough to offset this direct effect.

There is near consensus that leaving the EU would have a greater negative effect on the UK’s economy than that. The National Institute of Economic and Social Research, whose comprehensive analysis has produced estimates that are in the middle of the available range, suggests GDP in 2019 could be between 2.1% and 3.5% lower as a result of a Brexit. A hit to GDP of this magnitude would imply a hit to the public finances, after taking account of the reduced EU contribution, of between £20 billion and £40 billion in 2019–20.

These are among the main findings of a new report published today and funded by the ESRC’s UK in a Changing Europe initiative. The report examines both the direct and indirect effects of Brexit on the UK’s public finances, based on a comprehensive review of studies analysing the short- and long- term economic effects of Brexit.

Looking at the direct impacts of leaving on the public finances:

• The UK’s gross contribution to the EU budget, after our rebate, is about £14 ½ billion a year (or £275 million a week);
• The net contribution, after taking account of money received back from the EU, is about £8 billion a year (or £150 million a week). So leaving the EU would have the direct effect of strengthening the public finances by this amount;
• Claims that we would have an additional £350 million a week to spend are wrong. They imply that following a UK exit other EU countries would continue to pay a rebate to the UK on contributions it was not making. Such claims also imply we would simply stop all existing EU subsidies to farming and poorer regions (such as Cornwall and west Wales).

If, on leaving the EU, the UK were to join the European Economic Area, like Norway, its net contributions might be about halved. In this case the benefit to the public finances might be around £4 billion a year – though that would depend on the exact deal reached.

A vote to leave the EU would increase uncertainty in the short run and make trade more expensive in the long run. It would likely make the UK less attractive foreign direct investment (FDI). That is why nearly all estimates suggest leaving would reduce national income relative to what it would otherwise have been, both in the next few years, and in the longer term. Focusing on the shorter-term impact:

• On a relatively optimistic scenario of national income being just 2.1% lower in 2019 (this is NIESR’s most optimistic estimate), borrowing would be more than £20 billion higher than currently planned;
• In this scenario, just to get to budget balance, as the government aims to do, in 2019–20 would require the equivalent of an additional £5 billion of cuts to public service spending, an additional £5 billion of cuts to social security spending and a tax rise of more than £5 billion;
• On less optimistic scenarios, borrowing could be £40 billion higher in 2019–20 than currently planned;
• It is unlikely that government would respond with bigger spending cuts and tax rises in the short run. More likely “austerity” would be extended by another year (optimistic scenario) or another two years;
• In any of these scenarios public sector debt would be significantly higher than planned by the end of the parliament.

Full report

© IFS - Institute for Fiscal Studies