No “financial hara-kiri”

How fiscal policy is currently stuck in the status quo and what can be doone to make public finances fit for the future

In her speech in October at the presentation of the draft budget for 2023, Finance Minister Yuriko Backes (DP) made great efforts to portray herself as an advocate of a cautious budget policy, especially in times of crisis.

However, no matter how well this commitment was staged, it remains to be said that the national budget is by no means on a stable footing. On the one hand, in view of the war in Ukraine and the tense economic situation, we are in an uncertain time, also for the public finances. On the other hand, there are home-made challenges that have been known for a long time but have only been tackled very timidly or not at all.

Despite the unforeseeable crises with which the government has been confronted in this legislature, the government will have to be judged on the basis of which fiscal measures it has nevertheless been able to implement. With the last state budget of this legislature, a first conclusion of the government’s financial policy, and in particular of the two DP finance ministers, is therefore in order.

The missed reform

The central government is expected to reach a deficit of 1.8 billion in 2023. The initial idea of the great tax reform in which no one loses will thus probably remain nothing but a utopia, also in the years to come.

But the need for tax policy reform remains high, given the gaping inequities in our tax system and the rising poverty risk. The next government will also have to bring the national budget back into balance and ensure sufficient funding for the enormous investment needs in public infrastructure.

In addition to the absolutely necessary tax relief for low and middle incomes, it is thus above all necessary to diversify the state’s revenues, e.g. by reforming the taxation of capital gains on real estate. The German Council of Economic Experts also recently advocated a temporary increase in the top marginal tax rate for very high incomes. Especially in the current situation, such measures would have made it possible to at least partially finance the crisis expenditures.

Furthermore, tax benefits that lead to a tax loss for the state should be systematically analysed, evaluated and adjusted. Special attention should be paid to subsidies that are harmful to the climate and the environment.

Sustainable financial centre

The financial centre accounts for about one third of our gross domestic product. The share of the financial sector in the state’s revenue is therefore also particularly high at about one third. This strong dependence of the state on the financial sector could become a problem, for example, in the event of a financial crisis.

A sustainable financial centre is indispensable and a public debate is needed on how we can make the sector fit for the future, also in terms of more climate-friendly investments.

Unfortunately, this debate is being torpedoed by conservative forces. Instead of a serious discussion about the future of the financial centre, conservative politicians, as can be read recently in a joint article by MPs André Bauler (DP) and Laurent Mosar (CSV), scandalise themselves in a display of hobby patriotism at the criticism from abroad that Luxembourg continues to help companies to save taxes. The general message: Luxembourg is doing everything right and the criticism from abroad is nothing more than a negative smear campaign.

Instead of a serious discussion about the future of the financial centre, conservative politicians, as can be read in a recent joint article by MPs André Bauler (DP) and Laurent Mosar (CSV), scandalise themselves in a display of hobby patriotism at the criticism from abroad that Luxembourg continues to help companies to save taxes.

This narrative is problematic for two reasons. On the one hand, it does not correspond to reality. Companies continue to come to Luxembourg, certainly not solely, but also for tax reasons, in order to save taxes by using complicated arrangements. In light of this, it does not help to refuse, as the Minister of Finance did, any contact with the Commission of the EU Parliament, which is investigating tax loopholes in Member States and was recently in Luxembourg. Other countries that are also regularly criticised, such as the Netherlands, deal with this more openly and make themselves less vulnerable.

On the other hand, the presentation that Luxembourg’s financial centre is flawless distracts from the actually important question of how the financial centre can become more sustainable. For the fact is that investments in climate-friendly products are still the exception today. In Luxembourg, only about 6% of investments are currently in funds with specific sustainability goals. A study commissioned by the state on the sustainability of the financial centre was simply not published, possibly because of unflattering results.

The conclusion remains that the initiatives in the area of sustainable finance have had little effect so far. In the new draft budget for 2023, it is also noticeable that the expenditures for the development of the financial centre have doubled. It remains to be hoped that these additional 12 million euros are not just for more advertising campaigns.

There would be opportunities to push green finance more strongly. For example, the state could finally bring its own funds in line with the goals of the Paris Climate Agreement.

Objective-oriented budgetary policy

The national budget is so important because it sets the financial priorities for the coming year. Therefore, expenditure should also be measured by whether or not the goals that have been set have been achieved. It is a matter of evaluating the effectiveness of measures and thus ensuring an objective-oriented budgetary policy. Unfortunately, this does not happen systematically today.

At the same time, the question arises whether the political orientation of the budget should only be measured by purely economic benchmarks. Despite promises to place greater emphasis on other indicators, the budget continues to be limited to purely fiscal indicators, first and foremost gross domestic product.

Analyses by STATEC show that rising GDP in Luxembourg does not equate to a higher quality of life and well-being of the population. While GDP per capita increased by about 22% between 2010 and 2020, the Luxembourg Index of Well-Being, an aggregate of 21 different indicators, remained virtually unchanged.

In the sense of a more goal-oriented budget policy, it is therefore overdue to include the PIBien-être as well as other more far-reaching indicators in the work around the national budget.

More financial leeway

Given the current situation, the times of carefree fiscal policy appear to be over. The next government also risks having little financial leeway for fundamental reforms, especially if a third index payment would have to be paid next year, which would result in hundreds of millions more expenses to compensate the additional costs for businesses.

In addition, the more than 600 million in price caps decided in the second tripartite expire at the end of 2023. In view of the prospect that energy prices will probably remain high next winter, work should already be done now on more targeted measures that could replace the current price caps at the end of 2023 and at the same time put less strain on the budget.

It is important to make the state finances fit for the future and to lay the financial foundation now for a far-reaching tax reform, which should be implemented as quickly as possible in the next legislature. Anything else, to use the words of the Finance Minister, would be nothing other than “financial hara-kiri”.

First publication: Luxemburger Wort, 10.12.2022 (in German)

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