IFS warns Brexit would extend austerity for two more years

Britain’s leading tax and spending thinktank, the Institute for Fiscal Studies, has warned that leaving the European Union would force ministers to extend austerity measures by up to two years to achieve a budget surplus.

In a blow to the Vote Leave campaign, the fiercely independent IFS said the impact of lower GDP growth and extra borrowing costs would knock a £20bn to £40bn hole in the government’s finances by 2020 and leave ministers struggling to balance the books before 2022, two years later than forecast.

The intervention comes after a string of warnings from UK and international bodies highlighting the risks of leaving the EU, but is the first to assess the likely impact on the exchequer.

In a move that will put further pressure on an already embattled Vote Leave campaign, the thinktank disputed the claim that the UK sends £350m to Brussels every week, saying the figure was more like £150m once the rebate was deducted from the total and funds for research and business subsidies are taken into account.

The IFS said that even on an optimistic forecast for the UK’s economic performance after leaving the EU, the £150m financial benefit would not compensate for a loss of income from falling foreign investment and overseas trade that would leave taxpayers to pick up a huge bill.

Carl Emmerson, IFS deputy director and an author of the report, said: “The precise effects of leaving the EU on the British economy and hence the knock-on impact on the public finances is uncertain. But the overwhelming weight of analysis suggests that the economy would shrink by more than enough to offset the positive effect on the public finances of the reduced financial contribution to the EU budget.”

Boris Johnson and the Vote Leave campaign have made the £350m claim a key campaign issue and have argued strenuously that it is legitimate to say the money can be used for extra public spending or tax cuts following a vote for Brexit.

Earlier this week, Johnson dismissed a report by the Treasury that claimed house prices could fall by as much as 18% following a leave vote and that households would be £2,300 worse off by 2030. George Osborne said the short-term economic impact of Brexit would trigger a recession and mean GDP was 3.6% lower after two years than it would be if Britain votes to remain.

However, the IFS said: “Ignoring the rebate is clearly inappropriate. It is equivalent to suggesting that were the UK to leave the EU and not make any financial contribution to the EU’s budget then remaining EU members would continue to pay the rebate to the UK. That is clearly absurd.”

Deducting the rebate brings down the UK’s EU contribution from more than £18bn a year to £14.4bn, while support for British regions, agriculture and infrastructure projects brings the net total down to £8bn, the IFS said. Paying to join the European Economic Area, as Norway does, would cost an estimated £4bn.

Labour’s shadow chancellor, John McDonnell, said the IFS analysis showed an economic shock following Brexit would hit the public finances and put at risk the fragile recovery.

“Things could be even worse if a Tory Brexit led to more austerity to try and meet George Osborne’s self-imposed and self-defeating deficit targets,” he said.

The IFS report used forecasts by the National Institute for Economic & Social Research (NIESR) to judge the impact of Brexit on the economy and then used its own experts to judge the impact on the public finances.

NIESR’s forecasts were based on two scenarios, which envisaged the UK paying to remain inside the European Economic Area, and another that left firms to export to the rest of the world based on World Trade Organisation rules. An optimistic and pessimistic forecast was drawn up for each forecast.

Much of the impact will come from higher borrowing costs as Britain’s debt rating is downgraded and international investors lose confidence in the UK. Falling property prices will hit stamp duty tax receipts and tighter immigration rules will limit GDP growth, according to NIESR’s predictions.

Under the most optimistic forecast where the UK joins the EEA, the IFS said the impact on the government’s finances would amount to £20bn by 2020. If the UK is left out in the cold and struggles to reach trade deals with the EU and the rest of the world, the cost could be £40bn.

Vote Leave countered that the IFS had underestimated the UK’s annual net contribution to the EU by more than £2bn and based its forecasts on NIESR figures that “have been wrong time and time again on the EU”.

Andrea Leadsom MP, the energy minister, said: “It’s no wonder people are being turned off this debate given the continuous campaign to do down the British economy from EU-funded organisations.

“So many of these studies are based on entirely negative assumptions about our economy and the future decisions a UK government outside the EU would make, but ignore the pressing need of EU countries to continue trading with the UK.

“They also ignore the very real risk of what will happen if we vote in; more money and power to a Brussels interested only in propping up an ailing eurozone.”

The IFS director, Paul Johnson, said economists that forecast a bright future for the UK outside the EU were in a minority.

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“There is an overwhelming consensus among those who have made estimates of the consequences of Brexit that it would reduce national income in both the short and long runs. The economic reasons for this – increased uncertainty, higher costs of trade and reduced foreign direct investment – are clear.

“Our estimates suggest that the overall effect of Brexit would be to damage the public finances. On the basis of estimates by NIESR, the effect could be between £20bn and £40bn in 2019–20, more than enough to wipe out the planned surplus. In the long run, lower GDP would likely mean lower cash levels of public spending.

“To put this in context, dealing with the public finance effect would require at least an additional one or two years of ‘austerity’ – spending cuts or tax rises – at the same rate as we have experienced recently to get the public finances back to balance,” he said.