In the debate concerning the challenges presented to a society by an ageing population, immigration is often mentioned as one of the possible solutions to securing income for the public purse. But, is it in fact a solution? Is it sensible from an economic point of view to increase immigration—for the economy in general, and for the public finances in particular? Moreover, is the answer to this question the same irrespective of the type of immigration and the type of welfare society under consideration? These questions are discussed in this paper. The focus will be on the effect of immigration on public finances, because the effects on the economy as a whole are likely to be small for the average citizen, being mainly distributional in character (Borjas 1990).Footnote 1 We examine specifically a particularly challenging case, namely that of Denmark—a society with extensive tax-financed welfare programmes that provide a high social safety net.

The high social safety net in Denmark makes it especially difficult for the country to make immigration a contributory factor to fiscal sustainability, in particular immigration from poor countries. On the one hand, the expensive income-tax-financed welfare programmes require a high average employment rate for the operation as such to be fiscally sustainable, and on the other hand, the high social safety net induces high effective minimum wages that make it difficult for newcomers to get into employment unless they are very productive to begin with, which many immigrants from poor countries tend not to be. Thus, for immigration to improve fiscal sustainability in a high-spending welfare country, the immigrants’ skills need to be both high and compatible with the requirements of the labour market. To what extent this is the case is the topic of this paper.

Specifically, we ask to what extent the various population groups in Denmark contribute to public finances today, and how much we can expect the immigrant groups to contribute if we look forward in time. We are interested in the total net effect—including indirect effects from demographic changes, from educational attainment, from the labour market, etc.—and for consistency, we therefore make a forecast for the entire Danish economy. We compute how the net contributions to the public purse from people of Danish origin and from immigrants and second-generation immigrants of both Western and non-Western origins—with and without the refugee group—are expected to change over time.Footnote 2

In all the computations, public transfers related to individuals (unemployment benefits, child benefits, taxes, etc.) and all publicly provided services linked to individuals (education, visits to the doctor, etc.) are assigned to each population group according to actual use. With regard to the remaining public expenditures, i.e. the costs of fixed public goods (armed forces, construction of roads and bridges, central administration, etc.), computations are made both on average where these costs are allocated equally across all individuals, meaning that immigrants are assigned the average cost of fixed public goods, and on the margin where these costs are ignored, meaning that the cost of providing fixed public goods to immigrants is assumed to be zero. The marginal approach is only relevant when considering immigration flows that are small relative to the size of the population.

In the following, we focus on three computations. First, we compute the annual net contributions to the public sector from each population group in each year from 2014 and onwardsFootnote 3 with the costs of fixed public goods being allocated equally across all individuals.

Second, subject to the assumption of equally distributed fixed public goods, we compute the present values of lifetime net contributions for both the entire cohort born in 2013 and for each of the population groups studied. We control for both the number of years of residence in the country and for the particular period of life when individuals resided in the country.Footnote 4 These computations are also conducted for non-Western immigrants disregarding the group of refugees. This is relevant, because granting asylum to refugees is motivated by a wish to help, and thus to be compared with foreign aid rather than being evaluated as an investment to the country.

The results up until this point, with the costs of fixed public goods allocated equally to both natives and immigrants, suggest that immigration from non-Western countries represents a net cost to the public purse, while immigration from Western countries (richer countries) generates a net contribution. However, very small changes in the population size do not change the cost of providing fixed public goods. So, these results are not directly applicable for policy changes that only marginally affect the size of the population. The net fiscal benefit of small (enough) changes in the immigration population for instance should rather be assessed by setting the cost of providing fixed public goods to the newcomers to zero. Immediately, we can conclude that the net benefit to the public purse of Western immigration is positive on the margin, because this was the case even when the immigrants were allocated their full share of the cost of fixed public goods. But what about the benefit to the public purse on the margin when considering immigration from non-Western countries? To answer this question, we conduct a third computation by changing the yearly inflow of immigrants while keeping the total costs of fixed public goods unchanged, and then examining how this would affect public finances, measured in terms of fiscal sustainability. The fiscal impact of immigration from non-Western countries is found to be negative even when the provision of fixed public goods is unaffected by their number.

The calculations were carried out using the Danish Rational Economic Agents Model (DREAM), a dynamic computable general equilibrium model with overlapping generations. One advantage of working within this model framework is that it ensures that indirect effects are also included in the calculations. For instance, the tax revenue from income—for example, profit income—earned by natives, because of immigration, is included in our computation, thanks to the general equilibrium properties. Furthermore, the model encompasses projections of population growth, educational attainment, demographic characteristics and country of origin two generations ahead. The model predicts the total budget of the public sector year by year, which we will summarise and present both as the sustainability indicator (SI)Footnote 5 measured in percentages of GDP and as the average annual budget surplus in Euro.

The forecast is based on the economic structures of 2008Footnote 6 and assumes a continuation of these, except that we have taken into account future changes that will occur as a consequence of reforms approved by Parliament up until 2012. These years represented an all-time low for the immigrant-native employment gap in Denmark. Aiming to study the potential contribution of immigration, 2008 is an obvious year on which to base expectations in order to answer our key question, namely, to what extent might immigration contribute to fiscal sustainability in a generous welfare state, and does this contribution vary between different immigrant groups? For robustness, we also simulate a scenario where—like in the years following 2008—immigrant unemployment is hit disproportionally hard by a permanent shock.

Historically, the mix of immigrants coming to Denmark has on average been weak with respect to labour market qualifications. This was particularly the case up until the late 1990s, and in consequence, immigration resulted in a huge deficit to the public purse around the year 2000. This deficit was solely attributable to immigrants from poor countries (non-Western). At around the same time, Germany was managing to attract both better-educated and more experienced immigrants than Denmark (Tranæs and Zimmermann 2004).Footnote 7

The main reason for the unfavourable mix of immigrants to Denmark in terms of their employability at the time mentioned was the fact that Denmark received relatively few migrants who came to the country for work and study purposes. Around the year 2000, only 25% of the residence permits issued to people from non-Western countries were for employment or education purposes, the remaining 75% being issued to refugees or family reunification immigrants.

The Danish immigration policy was not in general unusual at the time, apart from during the decade following the very liberal 1983 immigration act that was mainstreamed in the years after (see Bauer et al. 2004). Otherwise, it was based on a strict employment migration control enacted under the economic crises in the early 1970s like in many other European countries. Similarly, the within-EU migration, the asylum rules and family unification possibilities was also regulated by more or less the same rules under the EU and the UN, respectively.

However, the new immigration policy introduced around 2000 changed the picture described above dramatically, so that by 2008 the share of residence permits granted to non-Western immigrants for employment and education purposes had reached 80%, and in addition, the total number of such permits granted had increased.Footnote 8 This trend in residence permits seems to have been associated with an upward trend in employment rates among non-Western immigrants in Denmark that peaked in 2008 (Tranæs 2012). The gap between the employment rates of native Danes and non-Western immigrants dropped from 33 to 23 percentage points between 2000 and 2008, and consequently, the contribution from immigration to the public finances improved significantly over that period. Nevertheless, in 2008, the employment rate of non-Western immigrants was still only 56%, compared to 79% for natives, and immigration from non-Western countries still created a deficit even under the assumption that the cost of providing fixed public goods to immigrants was zero, as shown by Gerdes et al. (2011).Footnote 9 With the coming of the recession, the improvement in employment integration came to a halt, and in the years 2011 to 2013, it remained constant at a somewhat lower level than previously, with an employment rate gap between natives and non-Western immigrants of 26 percentage points. However, the most substantial economic recession in decades did not send the employment gap back to where it was even around 2000, which suggests that the policy change during the 2000s has had some structural effects. All in all, 2008 is a good baseline for a projection if we want to study the potential effect of immigration based on historical experience, and the recession years should then be considered for robustness.

By considering both cases where immigrants are paying the average per capita cost of fixed public goods and that of zero under the assumption that the cost of providing these goods to immigrants is zero (the marginal approach), we are following Dustmann and Frattini (2013). Although we arrive at the same overall picture for Denmark as they do for the UK—that immigrants from richer countries reduce the fiscal burden on the natives of the country and that immigrants from poor countries perform worse in terms of their contribution than those from richer countries—we arrive at a less optimistic picture with regard to immigration from non-Western countries than Dustmann and Frattini do for non-EEA immigrants. They find that even the recently arrived non-EEA immigrants to the UK make a positive net contribution to the public purse; we consistently find sizeable negative net contributions in the case of non-Western immigration to Denmark. The employment rates of non-Western citizens in Denmark and non-EEA citizens in the UK are not that different, and although the employment rate of non-Western immigrants is slightly lower than that of the non-EEA immigrants, the similarity between the two levels suggests that the difference in the results is mainly linked to the general differences in the generosity of the two countries’ welfare systems. This view is supported by the findings in Ruist (2014). Studying the fiscal implication of immigration from the new EU countries to Sweden, he finds zero or only small positive fiscal effects, suggesting that the effects of non-EU immigration to Sweden are negative, as the employment rate for these immigrants is much lower than that for EU immigrants. Altogether this suggests that the mix of immigrants is important when assessing their fiscal impact, and that for certain immigrant groups, welfare societies like those of Scandinavia face a considerable structural challenge with respect to achieving a net surplus for the public purse as a result of immigration from non-EU countries, something that has been confirmed later by Ruist (2015) and Flood and Ruist (2015).

The methodological approach applied in the present study is related to that used by Schou (2006), who also used DREAM to assess the consequences of increasing the future yearly inflow of immigration by 5400 persons. He found that this increase would worsen the Danish fiscal sustainability problem by 0.14% of GDP or by 0.49% if all the immigrants were from non-Western countries and were considered to be paying the average per capita cost of fixed public goods. Schou does not compute the marginal costs of immigration, and immigrant employment was significantly lower in his base year of 2004 than in 2008; both factors tend to increase the financial burden. Other analyses calculating the net transfers based on cross-sectional data for first- and second-generation immigrants of Western and non-Western origin confirm this picture; see Wadensjö (2000, 2007) and Gerdes et al. (2011). Wadensjö and Gerdes (2004) also show that the net transfers per person are larger for non-Western immigrants in Denmark than in Germany; as in a similar case of the UK (Dustmann and Frattini 2013), this may be explained by differences in the mix of immigrant populations and the welfare systems of the countries, as discussed in Hinte and Zimmermann (2014).

This study goes further than previous studies of the fiscal effects of immigration by (1) considering life cycle estimates of the fiscal impact of different immigration groups by forecasting from the year with the smallest native-immigrant employment gap in recent history, (2) considering the fiscal effect of marginal changes in immigration (the marginal cost of immigration) as well as the fiscal effect of the immigration as such (the average cost), (3) computing the present values of lifetime net contributions for each population group controlling for both the number of years of residence in the country and for the particular periods of life the individuals resided in the country based on historically observed behaviour including migration patterns and (4) by assessing how much of the net cost of non-Western immigration is explained by the fact that many of these immigrants are refugees rather than ordinary immigrants and, thus, not admitted to the country based on an investment motive but on a desire to help.

This paper is organised as follows. Section 2 presents the data and the model. In Section 3, we present the baseline total net contributions year by year for the different population groups. Section 4 contains the life cycle computations, while Section 5 discusses fiscal sustainability under different possible immigration policies. Finally, Section 6 concludes and addresses the overriding question of the extent to which immigration from various parts of the world can contribute to solving the financing challenges faced by countries such as Denmark as a result of an ageing population.