Aging, the World Economy and the Coming Generational Storm

Studies | Economy

No. 273
Friday, February 04, 2005
by Laurence Kotlikoff, Hans Fehr, and Sabine Jokisch

Can Immigration Help?

Table VII - IX

“Though immigrants pay more taxes, they also earn benefits.”

Increased immigration is often mentioned as a way to ease the burdens that will be imposed by the aging populations of developed countries. Will this policy option solve the problem?

Importing additional workers will certainly raise the payroll tax base. But more immigrants also mean increased expenditures on education, public safety, water and sewer systems, and a host of other public goods, including pension and health care benefits. Immigrants also accrue their own rights to pension and health care benefits. Moreover, most developed countries provide benefits to the elderly on a progressive basis. And since immigrants tend to be disproportionately low-wage earners, they typically receive more benefits per dollar of tax payments than do native workers.

“Doubling immigration would have little long-run effect.”

Closed Economy Simulation. We assume a doubling of immigration in each region starting in 2001 and continuing through 2050. This means that every year over the next half century the United States experiences immigration of 2 million people, Europe 900,000 people, and Japan 108,000 people.

“Europe’s exorbitant tax rates are reduced in the long run by only 3 percentage points.”

Even though the proportional increase is the same in all three regions, the quantitative impact of immigration policy is quite different. In the United States, the effective labor supply will be 13 percent larger in 2030 and 31 percent larger in the year 2100. Taken alone, one would expect this to lower tax rates considerably. But the immigrants necessitate increased spending on public goods and they acquire their own entitlement benefits. Consequently, combined taxes on labor income fall from 37.5 percent to only 35.8 percent in 2030 and from 41.3 percent to only 40.2 percent by the end of the century. (See Table VII vs. Table I.)

“In Japan the reduction is only 1.4 percentage points.”

In Europe, immigration is lower than in the United States. Consequently, doubling immigration in Europe has a smaller effect on the macroeconomy. Effective labor supply increases by only 6.5 percent in 2030 and by 21 percent in 2100. However, Europe benefits more from immigration due to its more extreme population aging. Payroll and wage income taxes fall from 59.2 percent of income to 57.5 percent by 2030 and from 68.0 percent to 65.1 percent by 2100. (See Table VIII vs. Table II.)

“The effect of immigration is similar when trade and capital flows are included.”

Japan sees very modest immigration. Doubling immigration increases the effective labor supply by only 2.5 percent in 2030 and 10 percent in 2100. Therefore, the impact on payroll and wage taxes is also modest. The tax on labor income will fall from 58.5 to 57.8 percentage points by 2030 and from 63.8 to 62.4 percent by 2100. (See Table IX vs. Table III.)

Table X - XII

Europe’s, exorbitant tax rates are reduced in the long run by only 3 percentage points. In Japan, the long run reduction is only 1.4 percentage points. In the United States the long run reduction is even smaller.

Open Economy Simulation. Though the doubling of immigration in open economies is very similar to that of the closed economies, capital flow shifts cause additional immigration to have a different impact on the world interest rate. Compared to the closed economy model, interest rate reductions are weaker in Europe, and the increase is stronger in the United States and Japan. Consequently, Europe’s capital income taxes fall less, and progressive wage taxes increase less compared to the closed economy. (See Tables X, XI and XII vs. Tables IV, V and VI.)

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