What will happen to Britain’s finances if it leaves the EU?

Campaigners for both the UK leaving and remaining in the EU have made claims regarding how a Brexit will affect the country’s finances.

For the Remain campaign, George Osborne, Chancellor of the Exchequer, warned that an emergency budget will be necessary, which will involve large cuts to public spending and raising taxes. Meanwhile, the Leave campaign touts the benefits of “taking back control” and spending the EU budget contributions wherever the government deems necessary. Which of these views is correct? Or perhaps neither is? This is what we will consider in this article.

First off, it’s important to recognise that if the UK votes to leave the European Union on June 23, it will not leave immediately. What would most likely happen is that Article 50 of the EU Treaty, which details how a state can withdraw from the EU, would kick into action. A period of negotiation with the EU and its remaining 27 states would ensue, out of which the terms on which the UK leaves would be decided.

The treaty envisages a period of two years for these negotiations. During this period, the UK would still be a full member of the EU, and be subject to all of its treaties. It would therefore continue to pay its annual net contribution (currently about £8.5 billion).

Despite still being a member of the EU, however, the prospect of the UK’s leaving will have important economic consequences. There would almost certainly be a fall in foreign direct investment, and many firms may seek to reduce their presence in the UK, particularly those in the financial sector, which may fear losing their “passporting rights” to sell their services across the European economic area.

There will be considerable uncertainty over the UK’s future relationship with the EU, and this uncertainty will be damaging for investment, growth and jobs. The stock market is likely to fall, as are house prices and the value of the pound against other currencies. The probable outcome of these events would be a downturn in economic activity and a rise in unemployment. As a consequence, tax revenues would fall and welfare payments will likely rise.

Strapped for cash

So, in the interim period between a Brexit vote and the actual withdrawal from the EU, the government will be strapped for cash. In addition, the government will need to spend more to prepare for the UK’s departure. For example, arrangements would need to be put in place to set up a points-based immigration system for EU citizens who wish to come to the UK (if this is what is decided will replace free movement of labour); trade negotiators will need to be recruited and trained, and there would be numerous other reasons for extra expenditure.

Once the UK actually leaves the EU it would no longer need to pay a net contribution. But whether it will be able to use this money instead to pay for such desirable items of expenditure as the health service will depend on the performance of the economy.

Most economists agree that leaving the EU will lead to a lower level of economic activity than if we stay, in part because the post-Brexit trade arrangements the UK is likely to be able to secure will be inferior to its current deal as an EU member. This economic hit would not have to be large for the overall effect to be that fewer resources are available for extra expenditures, even after taking into account the saving from not having to make the annual contribution. This seems the most probable scenario.

Another budget on the cards? Lee Davy, CC BY

It must be remembered that there is already a fairly large budget deficit. George Osborne is committed to eliminating it by the end of the decade. Many economists have been sceptical as to whether he can achieve this without further tax increases or public expenditure cuts (and this is without Brexit).

It seems highly likely, then, that there would need to be measures taken sometime after a Brexit vote to restore confidence in the public finances. Whether there would need to be an “emergency budget”, as Osborne has suggested, is not clear. There might need to be one, and the promise made by more than 60 Conservative MPs to oppose such a budget might well increase economic instability post-Brexit if there is a crisis in the public finances.

The bottom line, then, is that it would be extremely unwise to think that Brexit will generate any extra resources which can be spent on worthy causes. In fact, the reverse is likely to be the case. Certainly, the Vote Leave campaign is in no position to make any commitments about expenditures post-Brexit. These decisions will be made by the government of the day.

Assuming the Conservative Party continues to have an overall majority in the House of Commons, it will continue to form the government, and it will continue to be bound by the commitments it made in its 2015 general election manifesto. This includes a commitment to eliminate the budget deficit by the end of the decade, and it is difficult to see how it will achieve this if there is a Brexit without spending cuts and tax rises over and above what are currently envisaged.