Public finances: the long-term is a pressing issue

A special budgetary procedure in a special year. As it does every five years, and on 8 October this year owing to the general election, Parliament has been debating a transition budget of “provisional twelfths” [1]. With just a few exceptions, the provisional budget appropriations for the first four months of 2024 equate to 4/12 of the appropriations approved for 2023. New spending not included in the budget approved for 2023 is therefore banned. This procedure can therefore be described as relatively mechanical. While it doesn’t make much sense to be drawing any budgetary or financial conclusions just yet given the current geopolitical and macroeconomic conditions, it is worth remembering that public finances are not just a guarantor of trust in the economy and a driver of infrastructure building, but are subject to numerous challenges and headwinds. To put in simply: urgent action is needed, on both content and form [2].

According to a recent memo from the National Economic and Financial Committee (CEFN), 2023 could end with a recession amounting to -0.8% of GDP, at best! This would be an unprecedented and unexpected contraction. A loss of momentum has been seen in recent months, as reflected in the latest Economic Barometres from the Chamber of Commerce, for both the first and second halves of 2023. They reveal a level of concern not seen since the launch of this business confidence survey, even during Covid [1]. In 2024, GDP could grow by just 1.5% at a time when monetary policy is likely to be restrictive, or even tougher for much of the year, while market volatility and geopolitical conditions limit the propensity of households to spend and businesses to invest. So the Luxembourg economy will have stood still at best, and growth will have been absent for two years, despite the positive demographic trends on which future plans are based, the social model is consolidated, and the AAA is protected.

As Luxembourg’s public finances are closely correlated to macroeconomic developments, the impact on budget balances will be significant. The public deficit is set to reach €1.5 billion (1.9% of GDP) in 2023 and €2.3 billion (2.7% of GDP) in 2024, and that’s without considering the possibility of a downward revision to growth.

Luxembourg’s budget is also weakened by the economy’s flagging competitiveness and profitability, the stagnation of productivity, the non-selective social model, the unsustainability of the pension system, and the level of investment needed to manage growth.

Fundamentally, if the last parliament can be summed up by the word “crises”, then short-termism will be the best way of describing the fiscal policy seen in recent years. It’s now about the long term, preparing the country and society for future challenges while limiting the increase in public debt.

Reining in payroll expenditure through simplification and digitalisation

The exceptional help measures introduced to protect the economic fabric, support households and maintain social cohesion, while commendable and necessary in times of socioeconomic trouble and great uncertainty, had the effect of constantly increasing government spending. Furthermore, payroll expenditure rose by 8.3% in 2023 due to changes in the sliding scale for wages (+4.9%) and other factors such as career advancement (+3.4%). This ongoing expenditure, which is rigid and hard to reverse, will therefore continue to grow strongly in 2024. Such a prospect is all the more troublesome as public sector recruitment keeps rising, outstripping demographic growth and commercial sector employment. In this budgetary context, a real digitalisation of administrative procedures, for which the Chamber of Commerce has been calling for many years, seems more pressing than ever. Firstly because it would address businesses’ and individuals’ desire for simplification, but also because it would generate productivity and efficiency gains in public action, curbing this increase in recruitment and expenditure. There is also a need to clear away the administrative jungle and redundancy that taxpayers often face, and that makes public policies more expensive but not more efficient.

As revenues are not rising as quickly as expenditure, this scissors effect means that deficits are widening, and public debt surging dangerously towards the 30% ceiling, however low that may be considered outside Luxembourg. According to the CEFN memo, this limit will be breached in 2026, with debt equalling 32.4% of GDP in 2027.

For more resilient public finances

The next government must urgently focus on establishing a standardised level of increase in public spending to limit its growth and stabilise public debt (the rise of which could eventually threaten Luxembourg’s AAA rating, especially in the absence of structural measures to address age-related expenditure), while drawing up long-term budget policies to plan for the future. It’s about restoring the leeway needed to tackle any new shocks and keep providing effective support for the ecological and digital transitions.

With general expenditure under better control, doubling the minimum annual allocation to the intergenerational sovereign wealth fund could contribute towards this goal. Current annual payments are nowhere near enough for the instrument to stabilise public finances, and to benefit future generations if Luxembourg’s prosperity were to suffer (or even stagnate). They are very low considering the vulnerability of public revenues, especially fuel and tobacco duty and the subscription tax.

Imbalances in the different social security regimes will also have to be contemplated soon, as will the introduction of general tax reforms. These two key issues have yet to receive the attention they deserve, not just with regard to public finances directly but also Luxembourg’s attraction and competitiveness. According to the technical review published by IGSS in April 2022, spending by the general pension insurance fund will increase from 7.6% of GDP in 2020 to 12.4% in 2050 under the baseline scenario. This means the compensation reserve, which amounted to some 36% of GDP on 31 December 2021, will have been used up by around 2047. The system will have to change in 2027 as benefits will exceed contributions. Trends in health-maternity insurance are not much more encouraging, even if short-term figures are positive due to index-linking.

“Could do better”

Regarding the form of budget documents and budgetary architecture in general, Luxembourg may find itself marked “could do better”. Some progress has been made (long-term budget finally adopted, breakdown of public investment by theme, etc.), but the budget is still a long way from being a tool for guiding and evaluating public policy, as it should. The new government will therefore need the resources to improve its management of public finances with a new budgetary architecture based on the “missions-programmes-actions” triptyque, which would include performance indicators to systematically assess the effectiveness of past spending and the chance the adjust or optimise certain sources of revenue.

The next government will have a packed in-tray, and need to take rapid, coherent and ambitious action to make public finances resilient again and retain the AAA rating that is essential for the viability of the country’s economic, social and budgetary model. The competitiveness of Luxembourg’s businesses could be a strong catalyst.

[1] For the first time since the health crisis, the Economic Barometre score has dropped below the symbolic mark of 50 out of 100, reaching 48.9. This sharp deterioration of the business climate can be seen in nearly all economic indicators.

[1] Parliament has not been able to debate the draft budget for the following year, i.e. 2024. Under the principles of annuality and seniority, Parliament’s budget approval, which is limited in time, must be renewed every year, and the budget must be passed before the start of the financial year to which it relates. Moreover, there is a European requirement for national budgets to be adopted by 31 December at the latest.

For all of these reasons, waiting for the appointment of a new government is therefore not an option. The Law of 12 July 2014 on the coordination and governance of public finances, as amended, introduced an exceptional procedure: provisional twelfths.

[2] This was reiterated in booklet 6 entitled “Guaranteeing sustainable public finances, pensions and social protection for every generation”, published ahead of the general election.

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