OECD Economic Outlook, Volume 2018 Issue 1

Luxembourg

Growth is projected to remain strong, as domestic demand, notably private consumption, is boosted by strong wages and exports of financial and other business services. The accommodative monetary policy stance in the euro area will support access to credit and valuations of financial assets. Continued strong job creation, even though partly benefitting cross‑border workers, is projected to reduce unemployment further to 5½ per cent.

Fiscal space is being used for a welcome tax reform incentivising labour market participation. In addition, increases in taxes on transport fuels could be used to further promote green growth. The financial sector remains the main engine of growth and the efforts to diversify the economy, focussing on digital technology and renewable resources, are thus welcome. Diversification policies should be complemented by policies facilitating the relocation of labour, including measures to increase the supply of housing.

Resilient domestic demand is driving growth

Economic growth remains robust on the back of resilient household consumption. The financial sector’s, performance has been mixed; the weaker performance of banks is being offset by the investment funds, benefitting from accommodative monetary policy supporting inflows into investment funds through portfolio rebalancing, search for yield and positive valuation effects. As a result, assets under the management of investment funds continue to grow. The unemployment rate is declining thanks to strong job creation. But a persistent rise in the vacancy rate is raising concerns about constraints in the supply of skilled labour. The external position remains strong, with financial services trade making up for the deficit in goods and non‑financial services. The general government budget is in surplus, gross public debt is low at 20.8% of GDP, and net public debt is negative, reflecting assets held by the social security administration.

Luxembourg

Source: OECD Economic Outlook 103 database.

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Structural reforms are needed to enhance green growth and improve housing supply

The ongoing tax reform will lower the marginal tax rate for second earners by introducing the option of individual taxation for married and co‑habiting workers and possibly make the tax system more gender neutral. Non‑residents will by default be taxed individually, but could benefit from joint taxation, if they meet certain income thresholds. In addition, corporate income tax rates will be reduced further in 2018. The tax reforms are welcome and projected to encourage private consumption and, to a lesser extent, also business investment, at the cost of an affordable reduction in the general government fiscal surplus. However, to enhance green growth, recent changes in the tax treatment of in‑kind benefits that incentivise firms to invest in fleets of low polluting and hybrid vehicles should be complemented by higher taxes and excise duties on transport fuel.

Luxembourg. Demand, output and prices

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House prices have been growing strongly. On the demand side, the main driver of growth is net immigration, while the supply of housing is constrained by limited availability of building land, resulting in protracted under‑investment. Weak incentives for owners and developers to use the land available for construction should be strengthened by the introduction of time‑limited building permits and increased taxation of non‑used constructible land.

Growth is projected to stay robust

Growth is projected to rise toward 4% by 2019, well above the euro area average. Private consumption will benefit from the continuing reduction in personal income taxes and firming wage growth, while private investment will be boosted by the reduction in the corporate income tax. A new round of wage indexation, projected to take place toward the end of 2018, will lift both inflation and disposable incomes. Activity will also be supported by continuing accommodative monetary conditions in the euro area that contribute to strong financial services exports. The main downside risk to the projection is an earlier and stronger rise in euro area inflation that could lead to an earlier end of the accommodating monetary policy measures. On the upside, Luxembourg’s established financial sector may become even more attractive in the wake of Brexit, especially if Luxembourg keeps its attractiveness to the international labour force.