“We made a single decision after these conversations: both partners absolutely want to preserve the triple-A rating and will not do anything that might call it into question. Why is this important? Because if the state has to borrow, we need to be able to benefit from a reasonable rate.” The CSV and the DP, coalition partners-to-be, concluded their first week of talks on Friday. In front of Senningerberg Castle,  (CSV) explained why the two parties have decided above all else to preserve the country’s triple-A rating.

“We’re going to look at debt trends,” he said. “The debt must not perpetually rise, of course--but we have to look at its underlying nature as well. There is a big difference between the debt used to invest in the country’s future and that which finances current expenditure. We will also be looking at repayment capacity.” Luxembourg shares the AAA rating with just eight other nations.

At the end of February, the state treasury successfully placed a bond issue for €3bn (€1.25bn at 10 years and 3% and €1.75bn at 20 years and 3.25%), and at the beginning of July the state also repaid a loan for €2bn taken out in 2013. According to the treasury, public debt stood at €17.2bn as of 30 September.

Employment down, pensioners up

At the end of the discussions with the government’s big paymasters, Frieden noted other rather negative news, which will further erode his room for manoeuvre.

“The situation is very difficult; the macroeconomic situation is not good,” he explained. “Statec believes that the figures they presented a few months ago will no longer be accurate by the end of the year, and that we will be in a situation of stagnation or even regression. This reflects what is happening in a number of countries around us. It’s a very difficult situation, and one reflected in the national finances. We are lagging behind. But even there, financial specialists are saying that the situation at the end of the year could be much worse than what they were describing in the spring. There are external influences, such as the war or energy prices, but also a series of decisions that have been taken at national level, particularly in the context of the tripartite, which will weigh on the budget.”

He summed up the situation: “For 2023, the deficit will be higher than anticipated.”

Turning to “implicit” debt, another gloomy topic, Frieden said: “We have listened to social security and Adem. The trend in employment is less positive than it has been in previous years, which has repercussions. The number of retirees and those due to retire in the next few years will grow faster than the number of people entering the labour market.” This has an impact on another factor that is less often highlighted: the state’s “implicit” debt. Year after year, the state makes commitments that it must honour over time, such as pensions. We had PwC economists estimate this implicit debt as part of the debates organised by Paperjam in the run-up to the general election, and the results are staggering: while the debt is currently 24% of GDP, the hidden debt is 495% of GDP, significantly higher than that of our neighbours (274% for Belgium, 113% for France and 105% for Germany).

In 2022, for the first time, €2.6bn had to be withdrawn from the reserve to finance pensions, reducing the reference coefficient from 5.2 to 4.3, this figure being the ratio between the reserve and the annual requirement expressed in years of reserve. At 4.3, Luxembourg is still very well placed compared with its neighbours, but the trend is concerning.

The financial centre under close observation

By Friday evening and Saturday morning, observers were already predicting the end of the tax-relief-for-all promise made by the CSV’s Frieden during the campaign. This promise will have to be prioritised in relation to some of his others, such as returning to a nominal corporate tax rate closer to the average or resuming his sweetheart treatment of the financial centre.

Frieden also spoke about this on Friday evening in front of the château, where meetings in small groups continued over the weekend. He commented: “A provisional budget will be presented to the chamber, so that the next government in office in the next few weeks or months can present a new budget based on figures that are closer to reality. For example, figures that show the impact of taxes on the financial sector. It is still too early to make forecasts for 2024.”

Regarding how taxes influence the financial sector, comparison is natural with competitors Dublin, Paris and Frankfurt. If Luxembourg wants to continue to rely on this sector, it needs to give some “slack” to all financial players and in particular to those who have substance in the country and have therefore also had to put up with repeated indexations. Public finances are highly dependent on revenues from the financial centre. In 2021, according to figures from the Economic and Social Council, the financial centre paid 79.7% of local authority income tax, 85% of wealth tax and 74.5% of municipal business tax, not to mention the €1bn it paid in 2018, 2019 and 2020 in council tax.

“I can’t listen to promises of tax cuts if we don’t have the budgetary leeway to take them on,”  (DP) said in September during a debate at the Chamber of Commerce, referring to Frieden’s campaign promises and calling for the economy to be put back on track before imagining tax cuts (“gifts”) against a backdrop of rising fuel prices and the housing crisis.

This article in Paperjam. It has been translated and edited for Delano.