The UK government is said to be ready to agree an ‘improved’ offer on the financial settlement with the EU, also known as the Brexit ‘divorce bill’. Some sources have suggested a figure of £40bn. But whatever the exact number, the more important question is what, if anything, the UK would be getting in return.

Starting from first principles, the ‘divorce bill’ is the amount of money that the UK is expected to pay to settle its share of the financial obligations accumulated by the EU while the UK was a member. It should therefore be separate from any costs that might arise after Brexit as the result of new agreements, such as continued participation in EU research and education programmes, or Norway-style payments in return for tariff-free access to the Single Market. In any event, countries are not usually expected to pay a fee just to start trade talks.

What’s more, the UK would be on strong legal ground if it simply decided to stop contributing to the EU budget after March 2019. This is based on the argument that Article 50 will end all Treaty obligations at this point, including financial obligations, unless there is some agreement to the contrary. Indeed, the UK should receive some money back, including the €3.5bn (£3.1bn) in capital that the UK has contributed to the European Investment Bank (EIB).

Nonetheless, the UK has said it will look past the strict legal position and honour commitments made during the period of membership. This is presumably because this is seen as ‘the right thing to do’ but also to secure a better deal in negotiations over the future relationship. Consistent with this, David Davis has stressed that the financial settlement should be in accordance with both the law ‘and the spirit of the UK’s continuing partnership with the EU’. And the Prime Minister said in her Florence speech, ‘I do not want our partners to fear that they will need to pay more or receive less over the remainder of the current budget plan as a result of our decision to leave’.

The ‘current budget plan’ here refers to the EU’s Multiannual Financial Framework (MMF), which runs from 2014 to 2020. In effect, the UK has therefore already offered to pay an amount equivalent to its expected annual contributions between March 2019 and the end of 2020. These numbers are not yet fixed. UK sources have suggested a figure of around £20bn, but this is at the low end, and the EU will be thinking in euros anyway. However, the total on this basis would be unlikely to exceed €25bn (£22.5bn at current exchange rates), net of the UK’s rebate and EU spending in the UK.

This would, of course, be far below the bill of around €100bn (£89bn) suggested by some EU officials earlier in the negotiations. That figure was always ridiculous, as it assumed that the UK would have to pay its full share of all the EU’s gross liabilities (with no allowance for assets) and a large chunk on top for the contingent liabilities of the EIB as well.

However, the EU is still expecting the UK to make a further large contribution, perhaps another €25bn, towards spending that has already been agreed in principle but could take place well after 2020, including long-term commitments known by the French term ‘reste à liquider’ (RAL). The EU is also reported to be asking for €10bn towards the pensions of EU officials. This implies a total bill of around €60bn (£54bn), even before considering the EIB.

A revised UK offer of €45bn (£40bn) would therefore fall well short of the EU’s demands. The EIB issue should at least be relatively easy to resolve. The EIB is reluctant to repay the UK’s capital until the loans this money is helping to back actually mature. But the sums are small and mostly invested in worthwhile projects (some in the UK itself) that make a reasonable return. It would certainly make more sense for the UK to leave its capital with the EIB than to make large contingency payments now against the possibility that some borrowers might default.

The case for making a clean break appears to be stronger in respect of pensions. Unfortunately, the EU’s estimate of the liabilities here is highly sensitive to the assumptions made, particularly the choice of discount rate. One solution might be for the UK to continue contributing towards the pensions of all EU officials every year, as it does now. That would be hard to explain to the British public. Another might be for the UK to take full responsibility for the EU pensions of the relatively small number of UK nationals, but not the rest. That would probably be unacceptable to Brussels. It therefore seems likely that the UK will end up making an additional one-off payment for pensions too.

However, even if £40bn were enough for the EU, many would ask why the UK should stump up anything at all. This is a political judgement that can perhaps only be made by the people in the room. In favour, £40bn (or more) might be a small price to pay in return for a ‘good deal’ with economic benefits potentially lasting many decades. Looked at this way, £40bn could be thought of a one-off payment equivalent to only a few billion each year (and much better value than HS2!). What’s more, since the ‘divorce bill’ is money that the UK would have to pay anyway if it had remained a member, it would be wrong to regard it as an additional cost of Brexit.

Against this, what would the British taxpayer be getting in return, especially if the default position is that the UK could walk away without paying a penny and ‘no deal’ would not be the disaster many fear? ‘Goodwill’ alone is surely not enough, and should in any event be shown by both sides.

At the very least it seems reasonable to expect the EU to agree to fast-track talks on a comprehensive free trade deal, including an explicit agreement on a time-limited transition period where trade remains as frictionless as possible. The UK could then make some of the money conditional on the success of these talks – perhaps anything more than the €30bn (£27bn) or so required to cover the period until the end of 2020 and something for pensions.

Julian Jessop

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Julian Jessop is an independent economist with over thirty years of experience gained in the public sector, City and consultancy, including senior positions at HM Treasury, HSBC, Standard Chartered Bank and Capital Economics. He was Chief Economist and Head of the Brexit Unit at the IEA until December 2018 and continues to support our work, especially schools outreach, on a pro bono basis.