However, past publications by the National Institute of Statistics and Economic Studies (STATEC), the Organisation for Economic Co-operation and Development (OECD), and the International Monetary Fund (IMF) have all concluded that this approach is unlikely to work in Luxembourg.
Tax reductions lead to a fall in the state’s tax income, imposing a fiscal burden. In cases where the state lacks a surplus, it would need to finance such a measure either by accumulating debt to offset the tax loss or by implementing budgetary cuts, affecting areas such as investments, social transfers, or operational expenses.
During a recent roundtable discussion hosted by our colleagues from RTL Radio, Luc Frieden reiterated his belief in the self-sustaining nature of his proposed tax cuts for all citizens. He argued that reduced taxes would stimulate consumer spending, subsequently boosting the economy. This anticipated growth in GDP would, according to Frieden, result in increased tax revenues that could fund the reform, in an approach commonly known as trickle-down economics.
On Saturday, Frieden said, “I want to respond very briefly to an assertion that comes up constantly, namely that a policy of tax cuts would not have a positive effect. There are a number of OECD studies that prove the opposite.”
Host Maxime Gillen intervened, noting, “I think we’ve already heard the arguments for and against several times over the past few weeks...”
But Frieden persisted, stating, “I don’t want to list the pros and cons again […], I want to repeat: ‘It works!’”
In 2012, STATEC conducted an assessment of the cost-cutting measures implemented by then Minister of Finance Luc Frieden. The study found that the multiplier effect of these measures, which targeted households and businesses through tax reductions, social transfers, or subsidies to the economy, was minimal at 0.1. In other words, every euro injected into the economy via these means resulted in just a 10-cent increase in GDP. To illustrate, a tax reform costing the state €500 million and providing citizens with an extra €500 million in disposable income would only generate a €50 million increase in GDP. It is crucial to emphasise that this pertains to “an increase in GDP” and not an increase in taxable income derived from these economic gains.
STATEC cited the reason for this limited impact as Luxembourg’s highly open economy, where a substantial portion of goods consumed, including food, clothing, and electronics, is imported from abroad. In 2012, STATEC noted that “Due to the high level of imports (140% of GDP), Luxembourg’s multipliers are lower than those of the major economies.”
This is also confirmed by the OECD, quoted by Frieden. Specifically, the OECD notes that in economies with greater openness, the impact of fiscal measures tends to be diluted. The dispersion of effects across other countries via imports plays a pivotal role in diminishing multipliers, as noted in a 2013 OECD study. Smaller open economies, like Belgium, often exhibit smaller multipliers, as the report indicates: “Multipliers tend to be smaller in more open economies, because the more open an economy is the more a shock will spread into other countries through imports, and small open economies such as Belgium have small multipliers.”
In essence, this means that what may be achievable in larger nations, where a substantial portion of goods is domestically produced, may not be replicated to the same extent in smaller countries.
When the IMF assessed the Luxembourg government’s tax reform in 2016, it came to the same conclusion. The reform, which included measures like lowering the tax scale to alleviate low and middle incomes, abolishing the temporary budget balancing tax (0.5%), increasing tax credits for lower incomes, and reducing corporate income tax, was projected to incur a cost of €878 million over two years, covering 2017 and 2018. The IMF’s 2017 report acknowledged that the reform would indeed stimulate domestic demand but noted the limited multiplier effect attributed to substantial import leakages: “The tax reform will increase domestic demand but the multiplier would be modest due to sizeable import leakages.”
In addition, STATEC’s 2012 analysis stressed that measures benefiting financially vulnerable households tend to yield higher multipliers compared to those affecting wealthier or all households indiscriminately. This difference can be attributed to savings behaviour, as households with greater savings capacity are less inclined to expend the additional income derived from tax cuts. In other words: the rich don’t spend more money when they have to pay less tax.
