Why the state pension cannot survive without immigration

The beginnings of Britain’s state pension were humble. The Victorian era had seen people start to live much longer lives, but they were unable to keep on working. So the Government stepped in.

Since then, Britons have continued to get older, with the average life expectancy rising to 79 for men and 83 for women. But Britain’s ageing population has resulted in a sky-rocketing tax bill to cover state pensions as well as health and social care. 

As a result, the once-humble state pension now comes at a colossal cost to the Treasury.

And at the same time, Britons are having fewer children, which is increasing the ratio of older people to tax paying workers.

Experts say it is immigration that must now help to pay for these growing costs.

Net migration at a record 606,000 last year will boost public finances by £66bn, according to consultancy the Centre for Economics and Business Research.

Yet the state pension’s continued reliance on an increasing population is a “recipe for disaster”, a leading economist at the Office for Budget Responsibility (OBR) has warned.

Economists warn that the Conservative triple lock promise is unsustainable, the state pension age needs to rise, and public sector pension schemes are ripe for reform.

An ageing population

Sir Steve Webb, a former pensions minister and now a partner at consultancy LCP, says Britain has “stopped having babies” and needs labour and taxes from abroad.

“The fertility rate in the UK is dropping as it is in many countries,” he says. 

“We’re producing fewer workers of the next generation to pay these taxes. If you were to stop people coming from outside to work in the UK, if we’re not producing our own then that’s a massive tax burden on the working age population that’s left.”

He says Britain “needs lots of workers paying National Insurance” and other taxes to help pay for the state pension, which is unfunded, meaning today’s workers pay for today’s pensions on an ongoing basis.

“It doesn’t matter whether they are British or migrant – £1 of National Insurance is £1 of National Insurance,” he says. “In terms of today, next year and the year after, it’s great news if someone comes to the UK, works and pays National Insurance, because that just helps with the cost of state pensions, and more generally, the health service.”

On average, he says younger people who come to Britain are fitter and are not making the same demands on the health service. Those in their 30s and 40s are typically “net contributors” to the exchequer.

However, immigrants who come to the UK and pay National Insurance do build up rights to the state pension, so the UK will have to pay them a pension in a generation. “It’s not an entirely free lunch,” Webb says.

The most beneficial are those who come to the UK and retire in their countries of origin, he says.

“From the taxpayer’s point of view, that’s absolutely brilliant,” he says. 

“It is when we are all old that we make the heaviest demands on the public purse – we use the health service, we use social care, etc. If the people who’ve come to work in the UK then retire somewhere else, they’ve paid lots of taxes in but drawn relatively little out.

He says Britons would have to pay more in taxes if there was no net migration and key services for pensioners would be in trouble, including care homes. “The NHS would collapse,” he says.

Record migration

The Conservative government is certainly bringing in tax cash from immigration. Net migration last year, which hit record levels, will add £3.3bn a year to public finances by 2025, according to analysis for The Telegraph by the Centre for Economics and Business Research (CEBR).

Tax receipts will be £9.4bn bigger, but public spending will cost an extra £6.1bn. The size of the British economy will be 0.94pc bigger, as measured by GDP.

The CEBR estimates that this will amount to £33bn over 10 years and £66bn over the lifetime of these migrants.

The analysis considered the difference between the taxes paid by migrants such as income tax, National Insurance and council tax, and the value of public services they receive such as benefits, pensions, NHS care or education.

Kay Neufeld, head of thought leadership at the CEBR, said there are also additional economic benefits that were not part of the calculations, such as the expansion of labour supply and the productivity-enhancing benefits of greater diversity.

In older studies, EU migrants were considered to be more economically beneficial than non-EU migrants, but the picture is changing as it depends on the skills of those entering the country, he says.

A 2018 study by Oxford Economics commissioned by the Migration Advisory Committee had similar findings, reporting that migrants who arrived in 2016 would make a net positive contribution of £26.9bn to the UK’s public finances over the entirety of their stay, equivalent to putting 5p on all income tax bands in that year.

Migrants vary in their economic benefits

Alan Manning, a former chairman of the Migration Advisory Committee, which advises the Government on migration, says different types of migrants have varying impacts on the public purse, with some contributing to pension obligations more than others.

Most of the migrants in the past year have been students and workers, which Manning says are likely going to be positive for public finances. 

Migrants who come to the UK without dependents – i.e., children and spouses who do not work – are perceived as most economically beneficial in the short run, as are international students, who are a key funding source for universities.

David Bell, the current chairman of the Migration Advisory Committee, says international students are also barred from taking benefits and pay more in the immigration health surcharge than they are likely to use.

Manning says an inability to work means asylum seekers make a negative fiscal contribution because they cannot pay taxes. But he points out that Britain takes refugees for humanitarian reasons, not because of their economic contribution. 

Around 70 to 80pc of asylum applications are approved, particularly after appeals are factored in, Bell says.

The Migration Advisory Committee has urged the Government to allow asylum seekers to work after six months, even if their claims have not been processed, but it rejected their recommendation.

Currently, most are unable to do so until their claims are heard, and wait times are on the rise.

Bell says it is becoming more common for applications to take longer than 12 months. In these cases, asylum seekers can apply to the Home Secretary to work, but only on certain types of jobs.

The Committee believes the take-up numbers are extremely small as the rules as too restrictive. Bell says asylum seekers tend to earn less when they are finally able to work and are less likely to be employed, so better integrating them into the labour market early is a way to close the gap.

Critics of high immigration levels argue that additional costs of migration are not always factored in by advocates.

In a recently published report by the Centre for Policy Studies think tank, authors Karl Williams and Nick Timothy said immigration is contributing to a housing shortage, which is one of the factors driving declining birth rates.

If the population is rising and more housing is not being built to accommodate this, Bell agrees it is a problem. But he says the obvious response is to build more homes.

“As a country we are completely failing, and we have failed for decades, to build the number of houses the British people need, which is why house prices have gone up so much, and why people find it hard to get on the housing ladder,” he says.

The Government has repeatedly missed its target of building 300,000 homes each year. Bell says the argument that migrants use up public services is “silly” because it often forgets that they pay taxes and work in these fields. In the last quarter, around 70pc of all visas for work went to the health and social care sector.

The right number of migrants

Manning says a “realistic” level of net migration for the UK would be around 200,000 people a year, but even 600,000 would not be impossible to sustain if the infrastructure was put in place.

He says the plan to send illegal migrants to Rwanda “has zero chance of working”. “You can’t do that much about refugee migration,” he says. “You may want to have low numbers, but it’s not really up to you.”

In 2022, around 46,000 people were detected crossing the English Channel in small boats in 2022, according to The Migration Observatory at the University of Oxford.

Manning says the UK should generally expect to receive 40,000 to 50,000 asylum seekers a year.

Britain has obligations to take in refugees as part of international treaties, says Bell, but some MPs want to change this.

If migrant deportation flights to Rwanda are blocked by the courts, eight cabinet ministers will urge the Prime Minister to put leaving the European Convention on Human Rights at the heart of the Tory election campaign, The Telegraph understands.

Manning says family-related migration typically accounts for around 40,000 to 50,000 people a year and is difficult to control “unless you’re going to go to the extreme and say British people are not allowed to marry anybody from overseas”.

On top of this, there are students and workers who will come to the UK, which Manning says makes it easy to get to net migration levels of 200,000 a year.

“David Cameron had his policy of ‘tens of thousands’,” he says. “That means you’re going to have no immigration for work. That’s a pretty extreme policy – but in reality, you can’t really sensibly be that extreme.”

However, Bell says there is no optimal level of immigration for the economy and it is a “political decision”.

He says the population should not be falling, but it is for the Government to decide how big the population should be and work out immigration numbers from there.

Bell says an obsession with GDP – the size of a country’s economy – creates problems, and he and others on the Committee have argued that it is better to focus on how much is produced per person.

Countries like China have larger populations and a bigger GDP, so are considered richer than places like Luxembourg. But Luxembourg offers a much higher standard of living, Bell says.

Lessons from Japan 

Webb says other countries around the world give a glimpse of what could happen to the UK if it cut its immigration levels and the population continued to age.

Japan has tight immigration controls and its population is projected to fall by 57,000 from 2022 to 2025, and keep falling into the 2050s, according to the European Parliamentary Research Service.

Shigeto Nagai, head of Japan economics at Oxford Economics, says younger workers are lumbered with the rising cost of the pensions system. 

Since the late 2000s, the social insurance premiums have increased steadily and social benefit contributions now account for 11pc of household incomes.

Amid stagnant income growth, the rising social security contribution burden has reduced disposable income and restrained consumption, he says.

He says employers also pay almost half of employees’ social premiums and have felt rising pressures on labour costs.

“Concerns about the system’s sustainability will also damage public sentiment and economic growth,” he says. 

The Government had promised in 2004 that the pension system would be “sustainable for a hundred years” without any increase in premiums after 2017, but this has not been the case. 

Pension benefits have now been linked to expected revenues and will be cut to match any downward revision, and are expected to be reduced significantly.

He says there is public anxiety about the future pension benefit, which the Government has downgraded its projection for. Long-run forecasts have been repeatedly downgraded, from 263k yen in the 2009 projection to 240k yen in 2019 estimates.

“More immigration will be of some help to mitigate the deterioration in social security financing but more fundamental reforms of the entire system are indispensable to solve the problem,” he says. 

“So far the Japanese society is still reluctant to receive massive immigrants despite the rising awareness of the serious labour shortage.”

He adds that the important lesson for other economies is that an ageing population is “deflationary” and cannot be solved only by lowering interest rates.

He says automation will help to mitigate the negative impacts of population decline and ageing, but there is still a lot of uncertainty about how quickly firms can introduce labour-saving technologies. 

The service sector is labour intensive, more difficult to automate and makes up a high share of small companies.

A ‘recipe for disaster’

David Miles, one of the three members of OBR’s executive team, warns that relying on an ever-increasing population to prop up the economy is ultimately unsustainable.

The academic says populations around the world are ageing, which poses an economic challenge as the number of over-65s grows larger in relation to working people.

If fertility rates were the only source of population growth, at 1.6 children for every woman in the UK, Miles says the population would fall.

“Let’s imagine you were in a world in which the fertility rate of the domestic population was about the reproduction rate, and net migration was a small number, so the population was pretty much constant,” he says. 

“Imagine that world, but people are living a bit longer. The ratio between people of working age and people of retirement age is going to go down.

“You might say, how do you avoid that? In some ways the only way to avoid it, in terms of the demographic structure of the population, is to have an ever-rising population, and have more young people arriving either as net migrants or as newborns. For the world as a whole, that is a recipe for, ultimately, disaster.”

Miles, who is also a professor at Imperial College London, says the world population would just keep rising, as it has done for many decades.

“In the very long run, given finite resources – the world’s not getting any bigger – it actually is not a good strategy,” he says.

“It’s far better that we adapt to a world in which the population does not need to carry on rising inexorably in order to just preserve the ratio between people, let’s say, above 65, and people of working age, and to make the health and the pension system affordable at a constant population rather than an ever-rising one.”

He says relying on a constantly rising population “doesn’t work for a relatively crowded country like the UK”.

The UK’s population has risen by about 10 million over the past 25 years – up around 400,000 a year. Just over half of this is due to inward migration.

Miles says there are other solutions, such as raising the state pension age, encouraging people to save more for retirement, and raising taxes to make the state pension and health service more affordable.

Another option to increase the workforce is to tackle the number of people who are “economically inactive” because of health reasons.

A growing pensions burden

The size of public spending on pensions is expected to keep growing in the coming years, presenting a growing burden on taxpayers.

Carl Emmerson, deputy director of the Institute for Fiscal Studies think tank, says the triple lock on state pensions is not sustainable. The mechanism, which ensures the state pension rises by the highest rate of inflation, earnings growth or 2.5pc each year, has resulted in bumper payouts to retirees.

Emmerson says: “In the good years the pension keeps pace with earnings. In less good years it grows more quickly than earnings. You can’t keep doing that, so at some point we’ll have to decide that the triple lock needs to go.”

Angus Hanton, co-founder of the Intergenerational Foundation charity, says no political party wants to lose “what they see as the electoral advantage” of keeping the triple lock.

Some will counter that the UK has the lowest state pension in Europe, but Hanton says Britain has a highest proportion of pensioners who own their own homes, which adds to their wealth.

The IFS has also warned that the state pension age may have to rise to 70 by 2050. The state pension age is currently 66 and is in the process of rising to 67.

An independent report on the state pension age by Baroness Lucy Neville-Rolfe, published in March, recommended that state pension spending should be capped at 6pc of gross domestic product. 

It currently accounts for 4.8pc of GDP, but is forecast to rise to 8.1pc in just five decades.

A 6pc limit would mean that the state pension age would have to increase to 69 between 2046 and 2048, the report found. 

The state pension bill, which is one of the country’s biggest spending commitments, rose by £6bn to £110bn last year. In the 2024/2025 financial year, these costs are expected to surge to £135bn, according to the Department for Work and Pensions.

Emmerson says the level of the state pension is another lever that could be looked at to make the system more affordable. The full state pension is £203.85 per week.

The previous Labour government implemented more means-testing of the state pension but this was rowed back amid concerns that it would discourage people to save and put more money into their private pensions, he says.

But Hanton says wealthier pensioners are currently being “over-rewarded”.

“Defined benefit” schemes for public sector workers are another costly part of the pensions system that could be reformed.

The schemes, which have nearly vanished in the private sector, guarantee an inflation-proofed income in retirement for life, regardless of stock market moves.

The OBR estimated in March that the cost to the taxpayer of unfunded public sector pensions will hit £7.9bn this year. This is the equivalent of around 0.7pc of total public spending, or £276 per household.

The annual net cost is expected to rise to almost £10bn by 2025-26, before falling both in cash terms and as a share of GDP amid a series of reforms designed to make pension costs cheaper, including linking increases in payments to the consumer prices index rather than the retail prices index and higher contributions by staff.

Emmerson says there is still room for further reforms, and questions remain about whether these schemes offer “great value for money for the taxpayer”.

“It might be that public sector workers would be happy receiving a bit more pay and a less generous pension, and that might make them better off because they are currently having their pay squeezed and struggling,” he says. 

“Maybe their pensions are more generous than they need to be, and you could do that in a way that perhaps would make them happier and also save the taxpayer money over the longer term.”

Hanton says younger people, who are footing the bill, “get a pretty raw deal”.