What determines the net fiscal effects of migration?

Passive migration policy and weak integration efforts

The different immigration experiences of Germany and Denmark in the late 1990s and early 2000s reveal the scope for designing migration policies. Germany had for decades been the European country with the highest number of immigrants, heavy inflows and outflows, and a comparatively large share of non-natives in the population. But in Denmark the absolute number of immigrants had been rather small, resulting in a high share, given the small total population. Neither country actively managed immigration with comprehensive selection criteria for labor migrants, responding instead to public reactions to migration inflows. Both had similar legal standards for immigrant access to the labor market and social transfers (except labor permits for refugees), while their social security legislation worked differently.

Denmark in the late 1990s had a substantially lower education level of immigrants than Germany, mainly as a consequence of its higher share of non-Western immigrants [1], [3], [4]. The Danish education system was obviously more successful in promoting immigrants’ further education than the system in Germany, while even second-generation immigrants in Germany were confronted by more discrimination in the education system than those in Denmark.

Labor market integration in both countries was burdened with severe disadvantages. In Denmark, a continually declining participation rate due to the lack of selection criteria prior to entry and the wrong labor incentives in the welfare system crowded down non-Western immigrants to the lower end of the labor market hierarchy. But Denmark succeeded (modestly) more than Germany in securing early labor market payoffs for qualified migrants.

After the mid-1990s, Denmark—unlike Germany—practiced a rather successful employment policy that established the country among Europe’s top labor market performers. That makes the deficits in the economic integration of immigrants even more striking. Besides the negative effects of lacking language skills, the labor market and social exclusion of too many (non-Western) migrants without high qualifications indicated the strong need to rethink migration strategies in both countries.

Net fiscal accounting: Do expenses outweigh revenues?

Against this background, a clear negative fiscal balance of immigrants’ social and economic integration could be expected—a finding that might easily underscore widespread prejudices against immigration at large—and provoke criticism of undesirable migration into the social security system. But calculating the fiscal effects reveals that, even without an economically driven economic policy, the results could be positive.

Migrant shares of welfare and unemployment benefit recipients were above average for both Germany and Denmark at that time—with significant differences between earlier and later immigrant cohorts and between ethnic groups, underscoring the substantial effect of the structural composition of migrants [1], [2]. Legal eligibility standards and different compositions of qualifications, income, household size, and age structure define the intensity of social transfer benefits. A fair assessment would need to add a long-term perspective and compare migrants and native households with the same characteristics. Under identical preconditions, migrants receive welfare benefits to the same extent or even less often than natives—another reason for practicing a selective migration policy [5].

Are the expenses for unemployment benefits, welfare, pensions, and other social security services too dominant over the lifespan? Are they more or less balanced? Or are they even outnumbered by revenues in the form of social security contributions, lower pension claims, and direct and indirect taxes? What can be learned from a country comparison of generational accounting results?

The net fiscal balance depends heavily on the demographic and qualification structure of migrants, with the redistribution measures in a state’s fiscal policy also playing a major part. Taxes and transfers are redistributed between members of the same as well as different generations. Intragenerational redistribution aims at reducing the gap between wealthy and poor parts of the population; intergenerational, between those who are of working age and those who are not. If the migrant population has a more “unfavorable” structure than the native population in education, employment, income health, or family status, the volume of this redistribution can increase. If “favorable,” however, it can have a reverse, positive, effect.

A further aspect of intergenerational distribution that is especially relevant in the light of demographic aging concerns the shifting of consumption opportunities over time due to a public deficit, which restricts future latitude in public budgets. Since the resulting interest burden cannot be covered by taking on new lending in the long term, primary budget surpluses are needed at a future date to ensure government solvency. If they can be achieved only through higher taxes or lower transfers, (labor) migration can ease the burden for natives, given the sharing of the existing burden of adjustments among more people [1], [2], [6].

Tax and transfer levels shift over time when the population of migrants ages, while migrants have children who, as tax contributors and transfer recipients, also influence public budgets. This effect even increases when the present level of public revenues and expenditures is not sustainable in the long term, because the growing deficit per capita in an aging society requires some correction of fiscal policy. Assessing the net fiscal effects of immigration therefore needs to incorporate a demographic perspective in the intertemporal analysis.

Generational accounts

Generational accounting measures the present value of contributed taxes and received transfers of representative individuals over their whole lifespan. Generational accounts consider the marginal costs of providing public goods and real expenditures to show how much specific generations relieve or burden the public budget (see [6], [7]). Calculating the specific generational accounts of migrants and natives shows the fiscal redistribution between the two groups [7], [8]. Such generational balances of migration, available for several countries, show considerable variation depending on the immigration policy and the resulting migrant structure.

Generational balances of migration are available for many countries (but not for direct country comparisons). The outcomes show considerable variation, depending on the immigration and integration policy applied and the resulting migrant structure. Even for experienced immigration countries such as Canada, positive results from immigrant generational accounting are not self-evident. Recent research reveals clear deficits and a potential need to reform selection criteria and integration efforts for Canada, but the opposite for Australia [9].

Surplus or deficit: Balancing tells

For Denmark and Germany, in a first step, generational accounting calculated the average age-specific net tax payments of native and immigrant individuals by striking the balance of taxes paid annually (including social contributions) and transfer payments received. This procedure requires extensive examination of numerous data sources, not only to develop fiscal age profiles and avoid contortions by cyclical shocks but also to secure comparable results across the countries evaluated.

Age-specific tax payment profiles reflect the development of average incomes throughout people’s careers and the given tax laws (see Figure 1).

Migrants generally make lower tax contributions than Germans or Danes in the same age group. The gap results from backlogs in migrant incomes. The profile is dominated by the employment rates and wages during the phase of occupational activity. Tax payments decline less sharply in Denmark than in Germany. The main reason lies in the different taxation of pensions, which are taxed more in Denmark. The 20–40 age group lags behind in Denmark more than in Germany.

Now note the striking differences between Denmark and Germany in the public transfer payments received (see Figure 2). German adolescents generate higher public expenditures because migrants tend to start their working lives earlier, and Germans often remain in publicly financed educational establishments longer. In Denmark, migrants received more transfer payments than natives during the 25–55 age span. One possible cause for the difference is the materially generous protection of the unemployed in Denmark during that period. Low-skilled individuals benefitted from higher income replacement rates (up to 90%) and shorter eligibility requirements (shorter minimum insurance). Even more important is the low average labor market participation of migrants, which leads to high per capita welfare benefits [1], [2].

As a direct result of aging and a continuously growing share of public spending for retirement, health, and care, transfer payments are concentrated among the older native and migrant population in both countries (with early retirement provisions in place at that time). But due to shorter employment histories, lower incomes, and thus lower pension claims, transfer payments to natives were significantly above those to migrants.

So, were migrants net recipients or net contributors to public finances in Germany and Denmark at that time? Even under the “non-optimal” framework of a passive migration policy practiced by Germany, the migrants’ net contributions were still predominantly positive (see Figure 3). Migrants not actively involved in the employment phase—as well as their German counterparts—benefitted from the public redistribution between older and younger generations. Connecting the identified net contribution profiles with the age structure of the population yields the average contributions of the migrant population under age 80 at €2,100 per capita in 1996, almost catching the €2,700 of German natives. Working-age migrants (20–60) contributed a net tax payment of €6,900 (natives: €10,500) in the same year [1], [2].

The fiscal position of migrants was far less favorable in Denmark, where migrants under age 30 were net recipients of public transfer payments in 2000. This was due to relatively low taxes, social security payments for people just beginning to work, and high transfer payments for all migrants of working age. As a consequence, the positive net tax payments of this migrant age group ranked far below the German level, resulting in a negative net balance across all age groups of €–1,400 in 2000 (native: €4,000) [1], [2].

Denmark suffered a substantial structural shift in its migrant population—younger cohorts mainly represented non-Western ethnicities. Separating the net tax payments between Western and non-Western migrants makes this apparent (see Figure 3). The net tax payments of Western migrants did not differ much from those of natives of the same age group, whereas the balance of non-Western migrants reflects their poor integration into the Danish labor market, remaining (almost) consistently negative.

This snapshot analysis for one fiscal year of course neglects aging effects over time that will partially level the differences in the age structure of natives and migrants. The proportion of migrant net transfer recipients in retirement will adjust to that of the native population, causing the average per capita net contributions of the migrant population to decline. These shifts are measurable through the generational accounts, which capture the present value of all net tax and transfer payments from a given time until death for a representative member of a specific age group. The generational accounts relate the age-specific net tax payments per capita with the age-specific survival rates of a birth cohort, assuming a constant fiscal policy and economic growth rate.