Cyrille Schwellnus
OECD Economic Surveys: Luxembourg 2025
Abstract
Luxembourg’s economy weathered the energy crisis of 2022-23 and global monetary tightening, but the costs have been significant. Higher borrowing costs abruptly halted a decade-long housing boom, causing a 40% drop in construction activity. Rising interest rates also impacted activity in the financial sector, a major pillar of the economy. The recovery is now underway, as substantial fiscal supports and robust private consumption bolstered by strong wage growth sustain activity. Inflation has receded, although the rollback of energy price measures in early 2025 has lead to a temporary uptick. The government budget balance was positive in 2024, but medium-term expenditure pressures from ageing, the green transition and defence are rising. A comprehensive pension reform is essential to secure the pension system for future generations, while maintaining low public debt. Raising taxes on immoveable property and VAT would provide space to meet revenue needs and make the tax system more growth-friendly.
1.1.1. Activity is gradually recovering from the energy crisis
The energy crisis of 2022-23 and the ensuing tightening of global financial conditions weighed more heavily on Luxembourg’s GDP growth than on that of the average euro area country. Having navigated the COVID-19 pandemic relatively unscathed, Luxembourg's economy began to shrink in early 2022. By the third quarter of 2024, real GDP stood roughly 1½ percentage points below its level at the end of 2021 (Figure 1.1, Panel A). The downturn was especially severe in the construction and financial sectors. Higher borrowing costs following euro area monetary policy tightening brought an abrupt halt to the housing market that had enjoyed a decade of rapid price growth. The number of transactions fell by about 50% between early 2022 and late 2023, before recovering in 2024 (Figure 1.1, Panel C). Construction activity fell by around 40% relative to pre-pandemic levels, with adverse effects on construction employment and the financial position of companies. Rising interest rates also hit the measured output of the financial sector, which constitutes around a quarter of Luxembourg’s GDP, by curbing bank lending and driving net outflows from investment funds. While manufacturing has shown signs of recovery from its initial dip caused by high energy prices, growth in non-financial services, which are closely linked to financial services, has remained largely stagnant (Figure 1.1, Panel B).
Source: OECD Analytical Database; Eurostat; and OECD calculations.
The gradual recovery in 2024 has been driven by public consumption and the recovery of net exports (Figure 1.2, Panel A). Public consumption has been bolstered by energy policy support that includes price measures, such as subsidies on fuel, gas and electricity, as well as targeted income support, cumulatively amounting to about 4% of GDP since 2022. The recovery of net exports is explained by the modest pick-up in financial services, which account for about 45% of total exports, while investment remains exceptionally weak on the back of the downturn in the construction sector (Figure 1.2). Private consumption has been resilient, bolstered by strong growth in real disposable income on the back of generous energy policy support and the stabilisation of real wages due to the indexation of nominal wages to inflation. Despite robust household spending, the savings rate remained about five percentage points higher than its pre-pandemic average, suggesting that the drawdown of excess savings could support private consumption in the near term as exceptional fiscal support has been scaled back at the beginning of 2025.
1. Annual growth rates.
Source: OECD Analytical Database; Eurostat; and OECD calculations.
1.1.2. The labour market has softened, but nominal wages have continued to grow robustly, driven by wage indexation
The slowdown in activity from early 2022, drove a gradual weakening of the labour market. Employment growth slowed and unemployment began to rise in mid-2023. Annual employment growth in the fourth quarter of 2024 was 1%, well below the pre-pandemic average of around 2½ per cent, driven in about equal measure by the weakening of resident and cross-border employment. In contrast to most other euro area countries, the unemployment rate started to rise from mid-2022, reaching 5.9% in the fourth quarter of 2024 (Figure 1.3, Panel A). Despite the softening of the labour market, businesses report persistent hiring challenges, reflecting shortages of skilled workers, especially in ICT, finance, and construction.
1. Real wages denote wage compensation per employee deflated by the consumer price index.
Source: Eurostat; and OECD Analytical Database.
Despite the softening of the labour market, nominal wage growth has remained strong, reflecting the indexation of wages to inflation. Cumulated nominal wage growth since the end of 2020 has been around 14%, broadly in line with the cumulated growth in the consumer price index (Figure 1.3, Panel B). The wage indexation system has protected real household income by preventing real wages from falling during the inflationary shock triggered by the energy crisis. However, downward real wage rigidity may limit short-term macroeconomic adjustment to adverse economic shocks, which could partly be addressed by basing the indexation on core rather than headline inflation or better taking into account productivity developments in the wage indexation process (Box 1.1).
Luxembourg's universal wage indexation system, which dates back to 1975, aims to safeguard workers’ living standards by linking wage increases to inflation. When the 6-month moving average of the National Index of Consumer Prices (NICP) rises by 2½ percent above the level since the last indexation, all wages, salaries, pensions and social benefits are adjusted upward. In principle wage indexation is automatic, but in practice the system has been modulated during crises to allow for some degree of flexibility. For instance, indexations have been postponed, or the government has temporarily compensated businesses for higher labour costs (Fornino and Jardak, 2023).
Wage indexation supports social cohesion by preventing inflation from eroding purchasing power of workers and pensioners but also raises issues for short-term macroeconomic adjustment, especially for a small and highly-open economy like Luxembourg.
In the short term, automatic wage increases driven by inflation may raise labour costs compared to neighbouring countries, where the adjustment of nominal wages to high inflation may be more gradual. In the initial stages of the energy crisis, for instance, real wages in neighbouring countries fell, whereas they remained broadly constant in Luxembourg. In the medium term, adverse effects on competitiveness typically fade as real wages in neighbouring countries catch up, but in the meantime the government may need to provide compensation to businesses, as was done during the recent energy crisis. Moreover, wage indexation generates downward rigidity of real wages, which may lead to increases in unemployment rather than real wages in the wake of adverse economic shocks. This issue becomes particularly salient in the case of shocks that may require declines in real wages in specific industries to limit increases in unemployment. For instance, despite the collapse in construction activity, real wages in Luxembourg’s construction sector did not adjust, driving the increase in the unemployment rate over the past two years.
Reforming Luxembourg’s wage indexation system would require striking a balance between preserving social cohesion and promoting a higher degree of flexibility. One avenue for reform would be to base wage indexation on core inflation, which excludes volatile items like energy and food prices. This would prevent global commodity price shocks from automatically triggering wage increases, which would make the system more responsive to underlying economic conditions, rather than to short-term price fluctuations. In Belgium, for instance, automatic wage indexation is based on the so-called Health Index, which excludes alcohol, tobacco, and energy. Potential adverse distributional effects due to the high weight of these goods in low-income households’ consumption baskets could be mitigated by direct social transfers. Another approach would explicitly take into account productivity developments to avoid adverse effects on competitiveness and employment. Moving towards sectoral wage bargaining, using core inflation as the starting point, would allow to better take into account sector-level productivity developments.
1.1.3. Inflation has eased, but competitiveness is deteriorating
As in other euro area economies, inflation has eased. By March 2025, headline inflation stood at 1.5%, down from a peak of around 10% in mid-2022 despite the partial unwinding of energy price support in January. This decline primarily reflects the unwinding of supply shocks, particularly energy, as well as continued energy price support. Core inflation declined to 1.5% in February on the back of weakening demand, down from around 5% in mid-2022, with pressures from services inflation having eased significantly over the past year (Figure 1.4, Panel B).
Source: Eurostat; and OECD Price database.
The increase in unit labour costs of about 15% since the end of 2021 has not been reflected in the CPI-based real effective exchange rate (Figure 1.5), as headline consumer price inflation in Luxembourg has been comparable to the euro area average. This is partly explained by policy measures that sought to limit the impact of automatic wage indexations on businesses’ costs by temporarily reducing social security contributions. The unit labour cost-based real effective exchange rate temporarily appreciated during the energy crisis but has since come down, as nominal wages in neighbouring countries caught up with productivity (Figure 1.5).
Source: OECD Economic Outlook database; and OECD National accounts database.
1.1.4. The economic recovery will continue
Real GDP is projected to grow by 2.1% in 2025 and 2.3% in 2026 (Table 1.1). Private consumption will remain strong as households’ real disposable income will be boosted by another round of wage indexation and low inflation. Lower interest rates will help the financial and construction sectors to gradually recover. Core and headline inflation are projected to continue to decline, reaching around 2% by the end of 2026, although headline inflation ticked up slightly in January 2025 as energy price supports were scaled back.
The risks to the growth outlook are broadly balanced. On the upside, a quicker-than-anticipated recovery in the finance and construction sectors could bolster growth. By contrast, a slower growth in the euro-area in 2025 and 2026 due to escalating trade tensions might dampen the expansion by curbing export demand. Longer-term vulnerabilities that could lead to major changes in the outlook include a surge in global energy prices, heightened financial market volatility and a decline in the number of companies that channel pass-through financial investments through Luxembourg (the so-called SOPARFIs) and contribute about 2% of GDP in business taxes (Table 1.2). In the longer term, Luxembourg’s economy is heavily dependent on its large financial sector, which is dominated by cross-border activities and international firms, for employment and tax revenues. While these activities are long-established in Luxembourg and there is a strong local eco-system around these activities, there is nevertheless a risk that activities could shift over time to other jurisdictions.
Source: OECD.
Some progress has been made on enhancing macroeconomic resilience and better targeting fiscal support (Table 1.3). Yet, there is scope for further reforms to secure the sustainability of public finances, make the tax system more growth friendly, and improve housing affordability, which are among the key priorities of the new government that took office in late 2023 (Box 1.2). Long-term growth could be boosted by 0.35 percentage points annually – raising the level of real GDP by 9% by 2050 – by reforming the pension system and undertaking structural reforms in the areas of skills, innovation, and competition (Table 1.4).
The 2023-2028 Luxembourg coalition agreement aims to strengthen the economy, foster social cohesion, and position the nation as a leader in digital and environmental innovation within the EU. The key themes are the following:
1. Fiscal Policy: The government commits to prudent fiscal policies while supporting public investment. The tax system will be reformed to alleviate the burden on low- and middle-income earners. A broad consultation process, involving the social partners and civil society, will be initiated to find consensus on reforms to secure the pension system's long-term viability.
2. Housing and Infrastructure: To address the housing crisis, Luxembourg will increase financial support to municipalities for affordable housing initiatives. Additional reforms in taxation aim to stimulate land use and increase housing availability. Urban planning initiatives include infrastructure upgrades and sustainable public transport networks.
3. Modernisation of the State and Digitalisation: A priority is placed on digital transformation to streamline administrative processes and improve citizen services, including by adopting the "once only" data-sharing principle to minimise redundant information requests from citizens.
4. Environmental and Climate Action: The new government pledges to uphold climate goals, investing in sustainable technologies and infrastructure, and continuing efforts to reduce greenhouse gas emissions.
5. Education and Workforce Development: Emphasis is placed on developing skills for the digital economy, improving access to early childhood education, and modernising public education to prepare for the future job market.
6. Foreign Policy and Security: Luxembourg is committed to increased defence spending aiming to modernise the military, with a focus on cybersecurity and collaboration with European partners.
Impact on the level of real GDP by 2050, in %
1. Chapter 4 focuses on measures to promote adult skills rather than student skills, but adult skills are not modelled in the OECD Long-Term Model.
Source: OECD Long-Term Model.
The financial sector is a key driver of Luxembourg’s economy, accounting for about 25% of GDP and 10% of employment. In the national accounts, financial services output is measured as the sum of financial intermediation services indirectly measured (FISIM) and fees, for instance on account keeping, credit cards, brokerage, financial advice and asset management. FISIM is not directly observed and is estimated by imputing a reference interest rate on loans and deposits. Trading profits and other interest income, for instance on bonds and derivative products, are excluded from the national account measure of financial services output. Given the large size of Luxembourg’s fund industry, financial services output in the national accounts only provides a partial measure of financial sector activity.
In terms of assets, the financial sector is dominated by the investment fund sector, with assets amounting to about 77 times GDP. Its initial growth in the late 1980s and early 1990s is explained by Luxembourg being the first country to adopt the EU Directive on Undertaking for Collective Investment in Transferable Securities (UCITS) in 1988, which allowed Luxembourg investment funds to market securities to investors from other EU member states by virtue of passporting rights. Over the past decades, the rapid development of a financial ecosystem supported by responsive regulation, stable institutions and the availability of specialised skills has driven sustained growth and diversification into non-UCITS funds (regulated and unregulated alternative investment funds). The large banking sector, with assets amounting to about 12 times GDP, is dominated by international banks, with domestically-owned banks accounting for about 8% of banking assets (around 100% of GDP). Only about one-fifth of banking assets are related to commercial banking activities, whereas banking business models are dominated by private banking and fund management activities. The insurance sector specialises on the life insurance segment, with assets amounting to about 3 times GDP. Luxembourg is also host to a systemically-important international central securities depository (Clearstream Banking Luxembourg), as well as a large number of other financial intermediaries – mainly intragroup holdings (so-called SOPARFIs that are discussed in more detail below).
Euro area monetary policy tightening from mid-2022 was quickly passed on to bank lending rates for Luxembourg residents, driving downturns in the credit and housing cycles. Interest rates on loans to non-financial corporations and floating-rate mortgages have increased from about 1½ percent in mid-2022 to above 4% in October 2024 and credit standards have tightened. Consequently, loans to non-financial corporation and mortgages have declined and house purchases collapsed, with real house prices having fallen by about 20% from over the past two years.
Note: Panel B: Annual growth rates
Source: Central Bank of Luxembourg.
High interest rates and the downturn in the housing market are putting pressure on some borrowers, but banks’ capital buffers remain comfortable. The ratio of non-performing loans increased from 1% in mid-2021 to 2.3% in the fourth quarter of 2024, according to internationally comparable data that cover domestic banks and subsidiaries of foreign banks (Figure 1.7, Panel A). Despite the housing market downturn, collateral values – houses for mortgage loans and land for commercial real estate companies – remain robust since a significant share of outstanding loans were contracted before the house-price peak. Moreover, wider net interest margins due to higher interest rates have allowed banks to increase profitability despite higher loan-loss provisions, lower commissions and valuation losses in the bond portfolio, with banks’ capital buffers remaining well above the euro area average (Figure 1.2, Panels B and C). Banks’ liquidity buffers are robust and there are regulatory limits to intra-group exposures, but subsidiaries of weak foreign parent banks could nonetheless be vulnerable to rapid deposit outflows due to large unexpected cash withdrawals by their parents.
Source: International Monetary Fund (Financial Soundness Indicators).
Strengthening macroprudential regulation over the long term, when cyclical conditions allow, would further enhance the stability of the banking system and protect borrowers. While owners with fixed-rate mortgages are protected from interest rate increases, some owners with variable-rate mortgages (around 30% of all mortgages) may face difficulties in servicing their debt. In 2022, the average owner was spending about 34% of disposable income on mortgage payments, well above the EU average (about 20%), with the majority of owners in the bottom quintile of the income distribution spending more than 40% (OECD, 2024e). In the medium term, once the housing market recovers, reviewing loan-to-value limits – which currently stand at 100% for first-time buyers – would reduce the risk of household defaults when economic activity weakens or interest rates rise. There is also a need for better coordination of macro-prudential policies with fiscal policy measures, especially those related to the housing sector. While fiscal demand-side support to the housing market may be justified in the short-term to stabilise the market, in the medium term help-to-buy policies, such as tax credits for house purchases (see below), the tax deductibility of mortgage interest payments and low recurrent taxes on property are likely to exacerbate structural supply shortages and the volatility of the house price cycle, which could make macroprudential measures less effective.
The investment fund sector has broadly maintained its global market share, even though it experienced losses in the exchange traded fund (ETF) segment. This is mainly due to rapid inflows into Irish ETFs, which benefit from a double tax treaty with the United States. Investment funds’ cash deposits in the banking sector have declined, but banks’ liquidity coverage ratio remains around the euro average and well above regulatory requirements (Figure 1.7, Panel D). The insurance sector has also experienced financial outflows, as policy holders shifted from fixed-rate products to higher-yielding assets and paid back variable interest rate policy loans (loans backed by an insurance policy as collateral).
Stress tests suggest that the financial system as a whole would be able to withstand severe adverse shocks, even though solvency and liquidity issues may arise in a small number of weaker institutions (IMF, 2024). The banking sector as a whole would be resilient in the adverse scenario thanks to strong average capital and liquidity buffers, but 6 weaker banks (out of 120 resident banks) would come under solvency or liquidity pressure. Recapitalisation by private means in the adverse scenario would be manageable, amounting to about 0.5-1% of GDP. Likewise, the investment fund and money market fund sectors as a whole would be able to withstand adverse shocks from falls in net asset values, higher interest rates and redemptions, but a small number of investment funds and money market funds show vulnerabilities in stress tests and warrant further monitoring. While risks in the fund sector are mainly borne by the investors, they may nonetheless spill over to the broader financial sector. The insurance sector is largely immune to adverse scenarios, thanks to the large share of unit-linked policies in the life insurance sector that transfers market risk to policyholders, and the low sensitivity of non-life insurers to market and credit risks.
1.3.1. Fiscal policy has supported activity through the energy crisis
Luxembourg has a history of prudent budget management, with large budget surpluses before the 2020 global pandemic, gross public debt below 30% of GDP and net government financial assets of about 50% of GDP. Despite vigorous fiscal support during the pandemic and the energy crisis, the budget balance in 2024 was positive and well above the OECD average, and public debt is the second lowest in the OECD (Figure 1.8). The new government has re-iterated its support to prudent fiscal management in the coalition agreement, with the medium-term projections in the draft 2025 budget law foreseeing a budget deficit of 0.4% of GDP in 2028 and public debt of 26% of GDP (Ministry of Finance, 2024).
2023
Note: Gross government debt (Maastricht criterion for European countries).
Source: OECD Analytical Database.
The fiscal stance will be broadly neutral in 2025. Spending on energy policy support declined only marginally in 2024, as most energy policy support measures were extended, including targeted income support for low-income households and energy price measures. At the same time, employers’ social security contribution rates were temporarily reduced to partially compensate them for higher labour costs related to the third indexation tranche of 2023; personal income tax brackets were adjusted up by 10% to partially account for past inflation; and the authorities introduced a housing market support package. The neutral fiscal stance in 2025 is driven by the planned scaling back of energy policy support that will be broadly offset by higher public investment.
This broadly neutral stance in 2025 strikes a balance between the need to exit exceptional fiscal support related to the energy crisis and supporting a gradual recovery from the ongoing cyclical downturn. Given the projected easing of euro area monetary policy, the overall macroeconomic policy stance will remain mildly supportive. While this appears appropriate in 2025, energy price measures should be fully phased out and replaced by targeted income support for the lowest-income households. The pace of fiscal consolidation should be accelerated from 2026, as the recovery takes hold, to re-build fiscal buffers, including by better targeting help-to-buy policies in the housing sector to the lowest-income households.
1.3.2. Expenditure pressures are rising
Under unchanged tax and spending policies, gross public debt would be on a stable trajectory until the late 2040s but would rapidly increase from the early 2050s as ageing-related expenditure rises, given very large pension commitments (Figure 1.9). Pension expenditure is projected to increase by about 3% of GDP between 2024 and 2050, which under current pension rules would lead to the depletion of the pensions reserve fund (IGSS, 2024). The growth in pension expenditure is projected to accelerate after 2050, with the projected increase over 2050-70 amounting to about 5% of GDP, while assets in the pension reserve fund will have been depleted, so by the late 2040s public debt will be on a rapidly rising trajectory.
Gross public debt, % of GDP
Note: The “Existing tax and spending policies” scenario assumes that the structural primary fiscal balance before accounting for gross ageing-related costs remains constant at 2026 levels. Gross ageing-related costs are defined as changes in expenditure on old-age pensions, health and long-term care. The “Pension reform” scenario assumes that the pension system remains balanced in the long term by adopting the pension reform in Chapter 2 and that the structural primary fiscal balance is maintained at the 2026 level, which requires offsetting non pension-related ageing costs by tax and spending measures. Initial financial surpluses in the “Pension reform” scenario are accumulated in the pension reserve fund rather than being used to pay down gross debt. The “No pension reform and fiscal tightening” scenario assumes gradual fiscal consolidation of 1% of GDP over 2027-30, with initial government budget surpluses used to pay down public debt.
Source: OECD calculations.
The most effective way to address the challenge of large increases in ageing costs is to undertake a comprehensive reform of the pension system, as discussed in Chapter 2. Given large imbalances in projected cohort sizes and very high expenditure per pensioner, the most coherent reform path would be to balance pension-related revenue and spending in the long term, largely shielding other areas of fiscal policy from ageing-related expenditure pressures. Balancing the pension system in the long term requires an ambitious reform package of higher pension contributions to allow for the accumulation of financial assets in the pension reserve fund over the 2030s and 2040s to finance projected expenditure increases over 2050-70; a gradual reduction in the level of pension benefits, which are currently among the highest in the OECD; as well as raising the effective retirement age, which is currently the lowest in the OECD, by requiring longer careers for people who spend long periods in education and fully indexing early and statutory retirement ages to life expectancy. A comprehensive and timely pension reform would be consistent with a broadly stable gross debt-to-GDP ratio, while building substantial reserves to meet future pension costs. (Figure 1.9).
If an ambitious pension reform is not undertaken, a tighter fiscal policy to reduce the debt-to-GDP ratio would help to prepare for the future, but would not address the underlying pressures in later years or avoid an unsustainable path for the debt ratio over the long term. For illustrative purposes, a fiscal tightening of around 1% of GDP without pension reform would put gross debt on a lower path in the near term, but would be insufficient to avoid a rapid increase in the debt ratio after 2060 (Figure 1.9). A very large fiscal consolidation in the short term, amounting to about 3% of GDP, would be needed now to reduce the debt ratio enough in the near term to avoid reaching very high levels in the longer term. The reason is that, unlike pension reform, fiscal tightening would not reduce the costs associated with ageing.
In addition to pensions, there are other medium-term challenges to fiscal policy from rising spending pressures and from uncertainties about tax revenues. Luxembourg’s commitment to raise defence spending from 1.3% of Gross National Income to 2% by 2030 (an increase of about 0.5% of GDP over the period) will add to the ageing-related spending pressures over the medium term. At the same time, there are substantial net fiscal impacts of the climate transition: compared to 2024, these are estimated at around 2% of GDP annually by 2050 (Box 1.3), primarily due to lower revenues on motor fuels. Moreover, the medium-term stability of corporate income tax revenue cannot be taken for granted, including due to ongoing changes in global tax rules (Statec, 2021). A clear fiscal strategy is required over the medium term to manage this range of pressures, as well as to accommodate required changes in the pension system. This would be supported by identifying scope for growth-friendly adjustments to the tax system and areas where spending efficiency could be increased.
The energy transition and climate change mitigation and adaptation policies will have a material impact on Luxembourg’s economy and on the public finances through changes in the growth path, tax revenues and government spending. While many countries are developing integrated models of the economy and climate, relatively few have undertaken detailed modelling of the impact on the public finances. In this area, , Luxembourg’s statistical institute STATEC has been a leader, developing consistent modelling of the climate, economy and public finances for Luxembourg in a transparent manner, sharing all underlying working assumptions and details of its projections.
This box is based on an experimental modelling framework named OECD-EDISON developed by the OECD’s Governance Directorate for the assessment of the budgetary implications of the climate transition by independent fiscal institutions (IFIs). It draws on work undertaken by the UK Office for Budgetary Responsibility and the Irish Fiscal Advisory Council.
The framework uses estimates of climate transition policies and their impact on economic growth from existing modelling work and translates this into an assessment of the impact on public spending and tax revenues based on detailed bottom-up estimates across a wide range of policies. Estimates are made up to 2050, although uncertainty about climate, economic and policy developments increases over the horizon.
The application for Luxembourg is based on estimates of growth adjusted for the climate transition from the OECD’s Long-Term Model (Guillemette and Château, 2023) and detailed estimates of revenue paths and energy demands from modelling by the Luxembourg statistical office STATEC.
The climate transition slows growth modestly due to required policy action. Energy use is projected to remain broadly stable in line with past trends as energy-efficiency gains roughly offset growth of the economy and the population. There is a shift away from fossil fuels for transport and heating, while reliance on electricity expands at a fast rate.
Policies in model are based on the government’s stated policies in the National Climate and Energy Plan, as updated in 2024, including programmed increases in the national carbon tax. STATEC estimates that if these 200+ policy measures were to be fully and timely implemented, Luxembourg would achieve its overall climate objectives by 2050, even though some sectoral targets, for example in the housing sector, will not be attained.
The modelled impact on the public finances is based on the current policy framework and does not allow for possible adjustments in spending or the development of new tax bases, for example charging motorists for the distance driven.
The framework shows the fiscal impact of the current approach to managing the climate transition. It does not show the potential costs of failure to tackle climate change more actively at the global level. There is significant uncertainty around the estimates and alternative scenarios are available within the OECD-EDISON framework.
On the revenue side, tax revenue will fall over time due to the shift from internal combustion engine vehicles to electric vehicles, which are less taxed per unit of energy (Figure 1.10). This shift is caused by policy measures, such as the planned increase in carbon price, and assumed structural technological changes. Over the coming decade, the decline in fiscal revenue will be only partially mitigated by increases in the national carbon tax. In the case of Luxembourg, these effects are magnified by the fact that these developments will reduce fuel tourism. In line with the gradual expansion and enhancement of public transport, the number of purchases of new cars is expected to decline towards the end of the forecast.
Source: OECD calculation based on OECD-EDISON.
On the spending side, the main spending item is continued investment in public transport, with further spending on supports for upgrading of home heating and insulation and the transition in power and business sector subsidies. Infrastructure spending will support growth and reduce congestion, as well as helping to reduce emissions. Given that Luxembourg has already ramped up climate-related support, this will have little additional impact on the public finances in the years ahead. It is projected that this spending will gradually decline from 2030, as technology matures and low-emission solutions become more competitive, reducing the need for public subsidies, such as those for the purchase of new electric vehicles. There will be some increase in costs due to managing more frequent flooding episodes.
Taken together, these trends are projected to reduce the budget balance by around 2% of GDP by 2050 compared to the 2024 level, mainly driven by the fall of revenues (Figure 1.11).
Source: OECD calculation based on OECD-EDISON.
Note: This box has been prepared by Simone Romano.
While debt is currently low, a new national fiscal rule is needed following the 2024 EU governance reforms to replace the EU-mandated medium-term objective that was defined in terms of the structural budget balance (OECD, 2024f). Under the revised EU fiscal governance framework, Luxembourg will no longer be required to submit a medium-term objective to the EU institutions. Luxembourg should take the opportunity to reduce the reliance on the structural budget balance – which depends on uncertain estimates of the output gap – and transition to a net spending rule with adjustments for discretionary revenue measures, in line with the new EU governance framework. If the sustainability of the pension system is secured through a pension reform along the lines of Chapter 2, the net spending rule should aim for the stabilisation of gross debt, accounting for the rise in non-pension related ageing costs. Given that pension expenditure accounts for about 80% of the rise in projected ageing costs, while health and long-term care account for the remaining 20%, the rule would provide room to address expenditure pressures in other areas, including investment needs related to the green and digital transitions.
Introducing a national fiscal rule would be supported by an enhanced role for the fiscal council. The fiscal council’s current mandate closely follows minimal EU requirements and includes the monitoring of compliance with the medium-term objective; the triggering of an automatic correction mechanism in case of non-compliance; as well as the evaluation of the government’s macro-financial projections. A first reform avenue would be to broaden the council’s mandate to conduct assessment of long-run debt dynamics and sustainability of the public finances. The Italian Parliamentary Budget Office (UPB), for instance, conducts debt sustainability analyses to assess the amount of fiscal consolidation needed to comply with the new European fiscal framework. Second, given that the existing medium-term objective will become obsolete under the new EU fiscal framework, validation and monitoring of the national fiscal rule will become a purely national process. A strong “comply-or-explain” procedure should be anchored in national legislation, with the government required to publish a detailed response to the council within a reasonable amount of time. In Spain, for instance, a strong “comply-or-explain” procedure forced the government to better explain budgetary risks in response to concerns raised by the fiscal council (AIRef), as well as triggering a debate on the social security’s medium-term financial sustainability (Beetsma, 2023).
1.3.3. There is scope to make the tax system more growth friendly
Tax revenues have increased as a share of GDP since 2010, but they nonetheless remain around the euro area average (Figure 1.12, Panel A). The tax mix could be made more growth-friendly, by relying to a greater extent on taxes on immovable property and taxes on goods and services – which are relatively low in Luxembourg.
The taxation of immovable property takes the form of a municipal land tax (“impôt foncier”) in Luxembourg. While the tax rate is set by the municipalities, typically ranging from 3-10%, property values are determined by the national-level property register dating to 1941. Revenues from the land tax are among the lowest in the OECD, with revenues amounting to about 0.1% of GDP as compared to an OECD average of 1% (Figure 1.12, Panel C). The reform of immovable property taxation foreseen by the authorities aims to update the property register and to introduce a surtax on unoccupied land and housing (see below). Despite the update of the property register, the authorities expect tax revenues from the land tax to remain broadly constant. The tax base will typically increase as the property register becomes more closely aligned with market values, but the increase in the tax base is likely to be offset by a slight general reduction in tax rates by municipalities. The rates of the surtax on unoccupied land will initially be low and only gradually increase over time. While broad revenue neutrality during the phase-in of the new property register and the surtax on unoccupied land is appropriate to ease the transition, there is scope to raise overall revenues from immovable property taxation in the medium term to bring it more in line with other OECD countries.
2023
Note: “Other property taxes” in Panel B includes the net asset tax on corporations.
Source: OECD Revenue Statistics database.
Increasing reliance on indirect taxation and environmental taxes would further increase the efficiency of the tax system. Revenues from indirect taxes on goods and services are well below the EU and OECD averages (Figure 1.12, Panel B), which is explained by the relatively low standard VAT rate (17%) as the VAT revenue ratio is among the highest in the OECD (84%); the large size of the financial sector that is generally exempt from VAT, as in other countries; and low excise taxes, despite a carbon tax partially compensating for low excise taxes on fuels since 2021. Shifting the burden of taxation from income to indirect taxes, such as VAT, has generally been found to raise economic growth (Arnold et al., 2011). But the risk for a highly-open economy, such as Luxembourg, is that consumption may be shifted across the border. For instance, higher taxes on fuels may lead to a larger negative impact on fuel consumption than elsewhere, as domestic and foreign consumers can easily shift fuel consumption across the border. However, the sizable gap in the standard rate between Luxembourg (17%) and its neighbours (20% on average in Belgium, France and Germany) suggests that there is some room to raise rates without large negative effects on consumption. At a minimum, the authorities should ensure the carbon tax is increased according to schedule (Chapter 3). While the adverse distributional consequences of increasing VAT need to be carefully weighed against potential increases in revenues, distributional consequences could be mitigated by maintaining preferential rates for basic goods and services (Brys et al., 2016).
Higher revenues from land taxes and VAT could be used to finance the higher government contribution needed to put the pension system on a sustainable footing as part of the comprehensive pension reform set out in Chapter 2. If the current financing structure were maintained and additional financing needs of 1.2% of GDP were evenly split between the government, employers and employees, then additional transfers from general government revenues of around 0.4% of GDP would be required. Given that the marginal rate of income tax plus social security contributions is above the OECD average (Figure 1.13), the government could consider raising the reliance on taxes on immoveable property and consumption – which have smaller adverse effects on consumption – to partially compensate employers and employees for higher pension contributions.
Marginal rate of income tax plus employee contributions less cash benefits, single earner, no children (100% of average wage), 2023
Source: OECD (2024c)
Reforming the net wealth tax on corporations would reduce distortions and promote growth. Corporations are subject to a tax of 0.5% on net assets up to threshold of EUR 500 million and a rate of 0.05% above that threshold. Corporate income taxes can be deducted from the net wealth tax to shield businesses that pay corporate taxes in Luxembourg, but companies are subject to a minimum net wealth tax. The net wealth tax on corporations is highly uncommon internationally and, to the extent that it cannot be offset by the corporate income tax, raises distortions to investment. Businesses that temporarily incur losses, for instance due to high investment expenditures or volatile sales, pay higher overall business taxes (corporate taxes plus net wealth tax) in the medium term than businesses with more stable income streams, which may discourage investment and risk taking. The net wealth tax also magnifies debt financing bias since equity financing increases a company’s asset base without a corresponding increase in liabilities, whereas debt financing increases both assets and liabilities. But an outright suppression of the net wealth tax on corporations would lead to revenue losses of about 1.4% of GDP. Revenue could be preserved by maintaining the net wealth tax only for pass-through investment entities (the so-called SOPARFIs), while suppressing it for all other corporations, but this may be legally challenging since SOPARFIs are legally equivalent to other corporations. A legally viable reform may be to exempt corporations with sales below some threshold from the net wealth tax, with the threshold calibrated to ensure that most SOPARFIs continue to pay the minimum tax, while most small and medium-sized enterprises in the non-financial economy are exempted.
Tax incentives for investment in R&D and the digital and green transitions would be more effective in boosting investment than across-the-board corporate income tax cuts (Hanappi et al., 2023). The combined statutory corporate income tax rate – consisting of the national rate of 17%, a surcharge to finance the unemployment fund and the local business tax – stood at 24.9% in 2024. The 1 percentage point cut of the national rate from 17% to 16% in January 2025 brings the combined statutory CIT rate close to the OECD average of 23.9% (OECD, 2024b).
The envisaged introduction of mandatory individual taxation in 2026 is likely to have positive effects on growth by improving incentives for women to work full time. Overall, women in Luxembourg are well-integrated into the labour market with women’s average hourly wages nearly on par with men’s and female labour market participation, at just below 87%, among the highest in the OECD, supported by a range of favourable policies including free childcare during school terms. However, high female labour market participation in Luxembourg conceals a significant reliance on part-time work. Around 30% of women are employed part-time, a rate 20 percentage points higher than for men (Figure 1.14, Panel A). While this pattern may partially reflect individual preferences, it may also be explained by joint taxation of couples that disincentivises full-time work for secondary earners, who are often women, as many households still view men as the primary breadwinners. The current system of joint income taxation benefits couples with large income disparities by reducing their overall tax burden, as the higher earner leverages the lower tax rates and tax-free allowance of the lower earner. However, the system comes with a drawback, as the secondary earner faces taxation at the couple's marginal rate on any additional income, rather than enjoying lower rates and the basic tax-free allowance under individual taxation. As a result, the tax wedge of the secondary earner, often the woman, is relatively high in Luxembourg (Figure 1.14, Panel B).
2023
Note: The gender part-time gap in Panel A is defined difference in the prevalence of part-time work between women and men. The tax wedge differential in Panel B is defined as the difference in the tax wedge between a secondary earner at 67% of the average wage (the primary earner is assumed to earn 100% of the average wage and the couple is assumed to have no children) and a single earner at 67% of the average wage.
Source: OECD Labour force statistics; and OECD Taxing Wages 2024.
The government is considering a shift towards individualised income taxation by 2026. Since the 1970s, several countries, including Austria, Canada, Denmark, Finland, Ireland, the Netherlands, Sweden, and the United Kingdom, have shifted from joint to partial or full individual taxation. Evaluations of these reforms have consistently shown that individualising personal income tax increases female labor force participation (Selin, 2014; Doorley, 2018; Crossley and Jeon, 2007) and would reduce the burden on people living alone. However, the shift would raise taxes on couples with a single earner or with large differentials between the earnings of the primary and secondary earners, as – under the existing parameters of the tax system -- the primary earner would no longer implicitly benefit from the tax-free allowance and the lower tax rates of the secondary earner. This could be particularly challenging for older couples who have set up their career choices based on the current tax system. To smooth the transition and ensure a balanced outcome, the introduction of individualised personal income taxation could initially allow for the full or partial transferability of the basic tax-free allowance for the non-working partner, which would then gradually be phased out. The United Kingdom, for example, introduced a tax allowance for married couples when it moved to individual taxation in 1990, which, for most couples, was phased out over a decade, with only couples with one partner born before 1935 continuing to be eligible. While the individualisation of personal income taxation would have positive effects on female labour supply and growth, it should be designed in a revenue neutral way rather than leading to higher revenues. Lower taxes on working couples should initially broadly offset higher taxes on couples with a single earner or with high income disparities.
1.3.4. The efficiency of public spending needs to be enhanced
Public spending as a share of GDP is around the EU average, though much higher as a share of GNI (Figure 1.15). The green and digital transitions will put upward pressure on public investment spending, which has amounted to about 4% of GDP over the past decade, as compared to an average of 3.1% in the EU. Social benefit spending is also relatively high and on a rising trajectory, as the large cohorts of workers who entered the labour market in the 1980s and 1990s retire, underlining the importance of reforming the pension system (Chapter 2). Meeting public investment needs while maintaining high-quality public services and adequate social protection, especially for low-income households, requires prioritising public spending and enhancing its efficiency.
2023 or latest year available
Source: OECD National accounts database.
Compensation of public sector workers is around the OECD and EU averages as a share of GDP (Figure 1.16, Panel A), but a large proportion of GDP is produced by non-resident cross-border workers that may require fewer public services than resident workers, especially in the areas of education and local public services (Bouchet, 2024). Public sector compensation is higher than in any other OECD country when expressed as a share of gross national income, which excludes goods and services produced by cross-border workers. While scaling public sector compensation by gross national income likely results in an overadjustment relative to the conventional GDP-based measure, given that cross-border workers consume some public services, such as social security and transport, on balance public sector compensation appears relatively high by OECD standards. Moreover, recent public employment developments suggest scope to reduce public sector compensation without reducing the level and quality of public services. Between 2015 and 2023, cumulative public sector employment growth was around 32%, outpacing both private employment growth (26½ per cent) and growth of the resident population (17%), suggesting weak public sector productivity growth (Figure 1.16, Panel B). Moreover, the wage differential between public sector workers and similarly-qualified private sector workers appears to be among the largest among advanced economies (Abdallah et al., 2023).
Source: OECD National accounts database; and OECD Analytical database.
Upgrading human resources management would increase public sector efficiency and improve the attractiveness of public sector employment. Public sector remuneration is based primarily on seniority and grade-based advancement rather than performance pay. Public servants typically advance through predetermined salary steps based on years of service rather than performance. Promotion to higher-level career grades is possible after 6-12 years, depending on the grade, but usually requires passing promotion examinations, with a limited number of promotion slots available each year. The system is deliberately structured to reward long-term commitment to public service, with predictable career progression paths. However, this can also mean relatively slow advancement compared to the private sector, partly explaining why around 1400 public sector positions remain unfilled despite high entry-level salaries. Measures to strengthen performance incentives to increase efficiency and attract high-potential candidates to the public sector could include the introduction of fast track promotion paths for consistently high performers; linking a portion of annual salary increases to the achievement of objectives; and creating special project bonuses for exceptional contributions.
Further advancing digitalisation would enhance public sector efficiency, reducing the need for further employment expansion. Luxembourg performs well above the EU average in terms of providing digital public services to citizens and businesses (European Commission, 2022). A digital portal (Guichet.lu) acts as single point of contact for interactions of citizens and businesses with the public administration, including administrative procedures, receiving public administration documents and booking appointments. The government intends to further strengthen the digitalisation of the public administration, focusing on the principles of “digital by default” (make the digitalisation of administrative procedures the default), “once only” (require data from citizens and businesses only once) and transparency (including the use of data received from citizens and businesses). The “once only” principle implies automatic data exchange between public administrations, requiring the development of IT tools that allow exchanging data while meeting privacy requirements. While some data exchange between public administrations is already in place, developing a comprehensive data exchange tool, such as the successful X-Road platform in Estonia, would allow for full implementation of the “once only” principle (OECD, 2019). Ongoing initiatives to promote experimentation with artificial intelligence (AI) in the public administration, such as “AI4Gov”, could be expanded. In the medium-term, the use of AI tools could significantly reduce the amount of working time spent on routine tasks, such as responding to frequently asked questions by citizens and businesses.
Education is another key priority area to enhance the efficiency of public spending. Completion of upper-secondary education is below the OECD average (OECD, 2023), and results from 2018 Pisa evaluation (Luxembourg did not take part in the 2022 evaluation) suggest that student performance is below the OECD average, despite spending per student being higher than in any other OECD country (Figure 1.17). Weak results are partly explained by the comparatively high share of first-generation and second-generation immigrant students, who often struggle to master Luxembourg’s three languages used in school. But targeted support to the weakest students and their families while reducing the use of grade repetition and allowing for selection into school tracks at a later age would improve results, as emphasised by previous Surveys (OECD, 2017a). Continuing to improve support for weak students requires the reallocation of teaching resources; the strengthening of lifelong teacher training to ensure that teaching methods remain up-to-date; and a tighter link between teachers’ participation in training, pay and career progression. By contrast, lowering student-to-teacher ratios is unlikely to be the best use of public resources. Student-to-teacher ratios in Luxembourg are among the lowest in the OECD (OECD, 2024d), with the international evidence suggesting that lower ratios do not systematically raise student outcomes on standardised tests, such as the Pisa evaluation (Jepsen, 2015). Measures to improve the quality of teaching should take precedence over further expanding the teacher workforce.
Note: Cumulative expenditure per student between 6 and 15 years old in 2019 and PISA mathematics score at age 15 in 2018.
Source: OECD Government at a Glance 2023.
In the medium term, Luxembourg faces the challenge of curbing age-related spending and making spending on climate change mitigation more efficient. Comprehensive pension reform, including measures to raise the effective retirement age and contain the growth in benefits, is discussed in Chapter 2, while climate change policies are discussed in Chapter 3. Ageing-related spending could be further contained by reforms in the areas of healthcare and long-term care, which are projected to increase by approximately 2½ percent of GDP between 2024-70 (IGSS, 2024). Several approaches could help to manage these rising costs:
The healthcare system could benefit from several efficiency-enhancing measures. Standardised care pathways for common conditions could reduce duplicate examinations and unnecessary hospital visits (OECD, 2017). A national health information exchange platform could improve care coordination across providers. Digital health solutions, including teleconsultations, remote monitoring, and health apps, show promise in reducing in-person visit costs while increasing patient engagement.
In long-term care, expanding home care services and community-based options could provide more flexible and cost-effective alternatives to institutional care (Colombo et al., 2011). Additional financing mechanisms might include means-tested co-payments and voluntary private insurance schemes with automatic enrolment features, drawing on experiences from other European countries.
The overall budgetary impact of the reforms recommended in this Survey amounts to fiscal consolidation of about 1.2% of GDP over the period 2027-30 (Box 1.4), essentially reflecting the need to put the pension system on a more sustainable footing with a range of other spending and tax measures that could be embodied within a medium-term fiscal strategy.
Table 1.5 shows the illustrative medium-term fiscal impact of the recommendations in this Survey.
The comprehensive pension reform outlined in Chapter 2 would lower pension expenditure compared to the existing system through lower benefits and a higher effective retirement age, but these effects would be modest in the near term. Consequently, if the current financing structure of the pension system is maintained, pension contribution rates for the government, employers and employees would each need to increase by 1 percentage point. The higher government contribution could be financed by raising the standard VAT rate from 17% to 18% or by higher taxes on immovable property or reductions in spending in other areas.
Other measures aimed at making the tax system and public sector spending more efficient are broadly offsetting in terms of the overall fiscal balance. Measures to increase spending efficiency are difficult to quantify.
Note: The estimates in the table are based on a variety of sources and OECD calculations. The total impact on the fiscal balance matches the increase in pension contributions required to balance the pension system in the long-term under the pension reform outlined in Chapter 2.
Source: OECD.
Real house prices have fallen by about 20% since their peak in the third quarter of 2022, with the cumulated increase in house prices since 2015 now around the OECD average (Figure 1.18, Panel A). But housing affordability remains low, especially for owners with a mortgage. Before the turnaround in the housing market in mid-2022, house price increases had been among the largest in the OECD, with real house prices having risen about 65% over 2015-22. As many buyers contracted large mortgages, housing affordability deteriorated, especially among owners, with the average owner spending about one-third of disposable income on mortgages (Figure 1.18, Panel B). In the bottom quintile of the income distribution, the majority of owners with a mortgage spend more than 40% of their income on housing (OECD, 2024e). Housing affordability has further declined over 2023-24, as declines in real house prices have been more than offset by the doubling of interest rates on new mortgages since early 2022. While owners who contracted fixed-rate mortgages before 2022 are protected from interest rate increases, owners with variable-rate mortgages (around 30% of all mortgages) and new buyers face almost twice the interest costs than before 2022 while real house prices have come down by only 20%.
Note: Housing costs cover only those relating to mortgage costs (principal repayment and interest payments) and rental costs (for both private market and subsidised rental housing). Housing costs are considered as a share of household disposable income, which includes social transfers (such as housing allowances) and excludes taxes.
Source: OECD (2024), OECD Affordable Housing Database - indicator HC 1.2. Housing costs over income, https://oe.cd/ahd
In early 2024, the authorities took a range of measures to stabilise the housing market and improve affordability in the short term. On the demand side, these measures include an increase in the tax credit for house purchases (the so-called “Bellëgen Akt” tax credit); the introduction of a new tax credit for investment in rental housing; increased public purchases of rental housing; an increase in interest deductibility for owner-occupiers; as well as an increase in rent subsidies for low-income households with children. The authorities have also supported the creation of a special purpose vehicle (“Prolog SA”) by five banks that will purchase properties under construction to mitigate financial stress for developers. These measures are expected to stabilise the housing market by supporting housing demand in the short term. For instance, increased public purchases of rental housing will clear some of the supply overhang in the private housing market. The measures will directly improve affordability for households in the short term by reducing tax and interest expenditure for owners and rental expenditure net of subsidies for renters. Among the measures adopted in early 2024, only the planned increase in investment in construction of new affordable housing – which would cumulatively amount to about 1% of GDP over 2024-26 – would expand supply.
The key challenge for the authorities is to strike a balance between supporting housing demand in the short term, while strengthening supply in the medium term. Short-term demand-side support can help prevent further increases in bankruptcies of construction companies and a broader crisis in the construction sector, which would have adverse effects on supply in the medium term. However, exceptional demand-side support should be phased out as soon as the housing market starts to recover in order not to undermine the medium-term objective of making housing more affordable. Increased mortgage interest deductibility favours owners over renters, and mainly benefits high-income households because each euro deducted from taxable income provides a larger tax benefit when the marginal income tax rate is high. The overall financial gain from for an owner in the fifth quintile of the household income distribution is about three times the one for an owner in the bottom quintile (Figure 1.19). Given that owner-occupiers benefit from an implicit tax advantage due to the non-taxation of imputed rents – which can be viewed as a financial return paid by owners to themselves – there is no economic rationale to further favour owners over renters through housing policy support measures. Similarly, purchase subsidies (the so-called “prime d'acquisition”) and the “Bellëgen Akt” tax credit for house purchases drive up house prices, undermining affordability in the medium-term. Rent subsidies are among the most progressive housing market support measures in Luxembourg (Observatoire de l’Habitat, 2022), but they nonetheless risk driving up rents and ultimately house prices. Targeting owner support to the lowest-income households, while maintaining targeted rent support, would make the housing policy support system more neutral with respect to households’ decision to buy or rent, while making the system less regressive.
Average annual gain, 2018 household data, 2020 tax and benefit system
Note: Estimations based on household data from the 2018 EU-SILC Survey and the tax-and-benefit system of 2020. “Low income” denotes households in the first quintile of the household income distribution and “high income” households in the fifth quintile.
Source: Observatoire de l’Habitat.
Reducing the scarcity of land available for development would help boost housing supply. While construction prices have grown broadly in line with economy-wide inflation since 2010, land prices have more than doubled, suggesting that scarcity of land available for development rather than increasing construction costs is a key driver of large increases in house prices over the period. Currently, the 1000 largest landowners – about 0.15% of Luxembourg’s population – own about 45% of all land owned by physical persons (Observatoire de l’Habitat, 2023). The 10 largest real estate companies own just below 50% of the land owned by all companies. These owners may hoard land to benefit from expected future price increases, given that prices have increased continuously over the past decades. Providing stronger incentives to make land available for construction would likely make housing more affordable for most people, while limiting the extent to which rents from strong economic growth are appropriated by a small number of landowners.
The authorities are planning a major overhaul of the property tax by updating the municipal property tax base and introducing a national-level property surtax on unused land. The current base of the municipal property tax has not been revised since 1941 and may not conform to the principle of horizontal equity, as similar plots of land may be subject to widely different taxation. The reform proposal foresees a formulaic approach to calculate land values, since the small number of market transactions in some areas of Luxembourg precludes the use of market prices. The formula would include a broad range of factors, including commuting time to the city of Luxembourg; amenities and services, such as schools and retail outlets; and national-level house prices to ensure a broadly stable ratio between taxes and house prices at the national level. An evaluation study conducted by the Luxembourg Institute of Socio-Economic Research suggests that, for areas where a sufficient number of market transactions is available to estimate market prices, there is a close link between the land values calculated through the formulaic approach and market prices (Bousch et al., 2022). While the update of the municipal property tax would lead to a significant redistribution across taxpayers, the average land value would remain broadly constant, implying that at current rates average tax revenues would remain broadly constant.
The introduction of a new national-level property surtax on unused land aims to discourage land hoarding. The authorities are in the process of establishing a national register of unused land, which allows assessing the extent of housing density relative to the density allowed by municipal urban plans. The rate would initially be set to 0 but increase with the time the land remains unoccupied, with the increase particularly steep for land with access to water and sanitation in areas designated as high priority for development. Tax revenues would depend on the extent to which land is made available for construction, with initial simulations suggesting that revenues would amount to around 270 million euros (around 0.3% of 2023 GDP) after 20 years. International experience suggests that surtaxes on vacant land can discourage land hoarding and promote a more efficient land use (Box 1.5). The authorities plan to eventually introduce a national-level tax on unused housing on top of the property tax on unused land, with the objective to bring all available housing to the property or rental markets. This will require a registry of unused housing, which is currently being established.
The planned reform of the property tax is a positive step to improve horizontal equity between taxpayers and raise housing supply, but the authorities should aim to raise property tax revenues. The update of the property tax base is crucial to ensure that the owners of land with high market values pay higher taxes than those owning low-value land. However, there is room to raise recurrent taxes on land and buildings – which are currently among the lowest in the OECD (see above). Shifting the burden of taxation from labour to immobile property would not only make the tax system more growth-friendly, it would also make the tax system more neutral in terms of households’ decisions to own or to rent their house. Currently, the average recurrent land tax of 100 euros per year is dwarfed by owner-occupiers’ implicit tax advantage originating in the non-taxation of imputed rents, which amounts to about 4400 euros per year on average and about 8500 euros for high-income households (Figure 1.19).
Differentiated taxes on occupied and vacant land are relatively uncommon internationally but are in use in a number of municipalities in the US states of Pennsylvania and Hawaii; the city of Seoul in Korea; and at the national levels in Finland and Ireland (OECD, 2022, Housing Taxation in OECD countries). In Pennsylvania, Hawaii and Finland, tax differentiation takes the form of split-rate taxes, with higher tax rates applying to land than buildings. In Seoul and Ireland, tax differentiation takes the form of surtaxes on vacant land, with the rate increasing over the period a plot remains vacant. In practice, both split-rate taxes and surtaxes on unused land amount to applying a higher average tax rate to vacant than to occupied land, which should make land hoarding based on expectations of future price increases less attractive relative to land development. Property owners have an incentive to construct new housing units on vacant or under-used land.
A number of studies suggest that split-rate taxes may raise housing supply and have positive distributional effects. Banzhaf and Lavery (2010) find that split-rate taxes in Pennsylvania raise housing supply by increasing density. Moreover, 85% of property owners experienced a decrease in property tax liabilities following the introduction of split-rate taxes (Hartzok, 1997), with the increases in liabilities concentrated on richer homeowners for whom land-to-building value ratios tend to be higher (Bowman and Bell, 2004). The impact of surtaxes on vacant land is likely to be similar, even though rigorous studies of the taxes in Seoul and Ireland are unavailable.
A key issue with differentiated taxes on occupied and vacant land is the interaction with other land-use policies. If the main barriers to increased housing supply are restrictive building codes and zoning laws, tax differentiation may be an ineffective policy tool. For instance, height restrictions for buildings or zoning restrictions may limit the number of housing units that can be built on a vacant plot of land. In this case, the elasticity of housing supply to changes in tax rates would be low, with most of the higher tax on vacant land resulting in higher prices rather than new housing units.
A key issue with the reform of the property tax will be to ensure that regulation of urban density is aligned to national-level housing objectives, with municipalities having little discretion over limiting density or designating areas as low priority for development. The effectiveness of the surtax on unused land in raising housing supply could be curtailed by limiting construction on newly mobilised land, including through restrictive density regulations. Local politicians may be more exposed to political pressure from local house owners than politicians at the national level, who may better take into account national-level housing needs (Glaeser and Gyourko, 2018). The current vetting of local urban plans through the central government should be vigorously enforced, and periodic updates of local urban plans should become mandatory to ensure that they remain in line with national-level housing needs.
Other reforms that would increase housing supply include the establishment of a one-stop shop for construction permits and promoting large projects with a significant impact. The existing procedures for obtaining construction permits are relatively complex, involving multiple ministries, including the Ministry of the Interior, the Ministry of the Environment, and the Ministry of Housing. This complexity results in significant delays and increased costs for housing projects. To increase the supply of housing, it is crucial for the authorities to focus on reducing delays. Consolidating the permitting process into a single, streamlined entity where all necessary approvals can be obtained and adopting the principle of “silence means consent” would simplify the application procedure and reduce the time required to secure permits.
Strong anti-corruption policies are essential for a thriving business environment. Corruption – when public office is exploited for personal gain – stifles business growth by discouraging investment and innovation (Jin, 2021). It hampers economic progress by funneling resources like capital and labor into politically-connected firms instead of those with high productivity, leading to an inefficient allocation of resources (Akcigit et al., 2023). Moreover, corruption undermines equal opportunities and erodes public trust in government. Corruption is perceived to be low in Luxembourg, though it is still slightly higher compared to some northern European countries (Figure 1.20, Panel A). The Varieties of Democracy Project highlights that the main areas where Luxembourg could improve are in addressing public sector bribery and judicial corruption (Figure 1.20, Panel B).
Note: PEERS is defined as the simple average of Belgium, Denmark, France, Germany, Ireland, Netherlands, Sweden and Switzerland. Panel B shows sector-based subcomponents of the “Control of Corruption” indicator by the Varieties of Democracy Project.
Source: Transparency International (Panel A); Varieties of Democracy Project (Panel B); World Bank (Panel C) and OECD Public Integrity Indicators (Panel D).
Luxembourg performs at or above the OECD average in several key areas of the OECD Public Integrity Indicators (OECD, 2024), including transparency in political finance and public information (Figure 1.20, Panel D). The country’s regulatory framework on political finance prohibits political parties from receiving anonymous donations, as well as any financial support from state-owned enterprises, foreign governments, or foreign businesses. Political parties are required to report on their finances, with the Court of Auditors overseeing and publishing these financial reports for the past five years. The Court also tracks and reports on cases, investigations, and sanctions related to party financing. In the area of transparency of public information, the Commission for Access to Documents publishes data on information requests and conducts inspections to ensure public sector compliance. Luxembourg also proactively discloses important datasets, including updated versions of primary legislation, draft laws, and ministerial agendas.
However, there is scope for improvement in other areas. In corruption risk management and auditing, while the country has standards of conduct for ministers, parliament members, political appointees, civil servants, and internal auditors, it lacks a comprehensive regulatory framework for internal control and auditing. The Court of Auditors oversees internal audit activities across the public sector, but there is no central body responsible for developing and harmonising these systems. As a result, Luxembourg does not fully track which public organisations have internal audits, how many have been audited in the past five years, or how many audit recommendations have been implemented. In the area of lobbying, Luxembourg has regulations that define lobbying activities and impose cooling-off periods for former government members, but not for other parliament members or lobbyists. While there is an online lobbying register, it does not reveal which pieces of legislation are being targeted by lobbyists, and there is no central government authority overseeing transparency in lobbying activities.
When it comes to tax transparency, Luxembourg aligns closely with its northern European peers, effectively curbing the potential for tax evasion (Figure 1.21, Panel A). The country also performs on par with other OECD nations in combating money laundering (Figure 1.21, Panel B). Luxembourg has a robust framework for anti-money laundering (AML) and counter-terrorist financing (CTF), underpinned by a solid grasp of its own vulnerabilities in these areas (FATF, 2023). The authorities efficiently utilise financial intelligence and collaborate well with international partners. The financial sector supervisor, the Commission de Surveillance du Secteur Financier (CSSF), has appropriately concentrated its efforts and resources on the banking and investment sectors.
Note: Panel A summarises the overall assessment on the exchange of information in practice from peer reviews by the Global Forum on Transparency and Exchange of Information for Tax Purposes. Peer reviews assess member jurisdictions’ ability to ensure the transparency of their legal entities and arrangements and to co-operate with other tax administrations in accordance with the internationally agreed standard. The figure shows first round results; a second round is ongoing. Panel B shows ratings from the FATF peer reviews of each member to assess levels of implementation of the FATF Recommendations. The ratings reflect the extent to which a country’s measures are effective against 11 immediate outcomes. “Investigation and prosecution” refers to money laundering. “Investigation and prosecution” refers to terrorist financing.
Source: OECD Secretariat’s own calculation based on the materials from the Global Forum on Transparency and Exchange of Information for Tax Purposes; and OECD, Financial Action Task Force (FATF).
However, the authorities should direct more attention to other sectors at high risk of money laundering, such as real estate and non-financial professionals providing trust and company services. Given the country’s exposure, enhancing the detection, investigation, and prosecution of complex money laundering cases is essential. Although some Luxembourg authorities understand the risks associated with terrorist financing, FATF (2023) suggests that the country needs to better articulate to both public and private stakeholders how its status as an international financial hub could be exploited for large-scale terrorist financing. A more risk-based approach to supervising the non-profit sector is recommended, including outreach to improve the sector’s currently poor understanding of terrorist financing risk.
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