IMF praise high economic activity in Luxembourg
An IMF official staff visited Luxembourg to hold consultations under Article IV of the IMF's Articles of Agreement with the authorities for monitoring of economic developments.
The IMF based on the preliminary findings says country's growth prospects remain strong but are subject to increasing downside risks from weakening international activity and stress in financial markets. Implementation of the international tax transparency agenda, which Luxembourg has embraced, could weigh on economic activity and tax revenue.
At the same time, various other competitive advantages, such as Luxembourg's triple-AAA rating and its qualified labor force, would continue to benefit the country. Against this backdrop, the fiscal stance should remain prudent and contingency measures should be prepared for the event negative shocks occur.
The limited fiscal space should be used to bolster growth prospects, while adapting the tax regime to the changing international environment and ensuring the long-term viability of the pension system. Implementation of the Banking Union will help to increase the stability and resilience of the banking system. Financial sector risks need to be monitored closely and, where necessary, Luxembourg should advocate appropriate international regulation. Building on past experience, active labor market policies should focus on integrating refugees in the labor market and further reducing unemployment.
The revenue risks of the international tax transparency initiatives and volatile financial flows make it appropriate for Luxembourg to keep the public debt ratio on a slightly declining path, in order to maintain sufficient buffers in case of need. This requires targeting a small fiscal surplus of around ½ percent of GDP in 2016 and over the medium term.
Vigorous economic activity has opened some fiscal space, which should be used to bolster long-term economic growth. In 2015, buoyant tax revenues and lower-than-expected capital outlays have contributed to a significant improvement in the fiscal balance compared to budget. Under unchanged policies, including full implementation of the Zukunftspak, the fiscal position is expected to remain in surplus over the medium term.
Available fiscal space of almost ½ percent of GDP should be used for growth-friendly measures such as infrastructure investments. The tax reform proposals unveiled at end-February contain a significant reduction in personal taxation and also in the corporate income tax starting in 2017.
Preliminary estimates indicate that these measures would reduce total fiscal revenue by up to 1 percent of GDP, fully using up the projected fiscal surpluses. It is advisable to limit the size of the tax reduction to the available fiscal space. While some of the tax measures aim to increase housing supply, the envisaged tax relief for home buyers would aggravate existing imbalances given that demand for real estate structurally outstrips supply.
The ongoing tax reform is an opportunity to solidify the tax base in a revenue neutral way and adjust to the changing international taxation environment. The international tax transparency initiatives-including those spearheaded by Luxembourg during its EU presidency in the second half of 2015-call for closing loopholes used for tax avoidance. The tax reform should aim at widening the corporate tax base and eliminating special tax regimes while lowering statutory tax rates.