OECD analysed Luxembourg's public finance system

Luxembourg needs to rethink its approach to public financial management, according to a new report by the Organisation for Economic Co-operation and Development (OECD). Although the country maintains one of the lowest levels of public debt in Europe, expected demographic changes, investments in defence and environmental policies could increase the pressure on the budget. The OECD recommends reforming fiscal policy in four key areas: revising budget rules, introducing performance-based management, modernising financial mechanisms and improving the transparency of budget documents.

Luxembourg has traditionally pursued a cautious fiscal policy, which has allowed it to maintain its AAA rating and keep public debt below 25% of GDP. However, government spending is rising: supporting the economy during the pandemic, increasing public sector wages and new social commitments have led to the budget surplus seen until 2019 (+2.7% of GDP) being replaced by a deficit of -0.7% of GDP in 2023.

The main long-term risk remains the pension system. Unless action is taken, pension costs are projected to rise by 9 per cent of GDP by 2070, and public debt could exceed 100 per cent of GDP as early as 2060. In addition, defence costs are expected to rise and climate and digital transformation will need to be financed.

The first step should be a revised budget policy. Since the EU abandoned the concept of the Medium-Term Budgetary Target (OMT), Luxembourg has lost its main anchor for budget planning. The country now needs to develop a national financial management strategy, prioritising whether the aim is to stabilise debt, prepare for an ageing population or finance long-term investments.

The second area of reform relates to the introduction of performance-based financial management. The OECD recommends that Luxembourg strengthen the system of public expenditure evaluation to ensure that budget spending is directed towards specific strategic objectives, such as sustainable development and gender equality. In other OECD countries, such a system is based on assessing the effectiveness of budget programmes, reviewing their performance and revising spending that has not met expectations.

Another important aspect is the modernisation of the budget process. The Luxembourg system is highly rigid, resulting in the use of many exceptions and budget adjustments during budget implementation. The OECD recommends simplifying and making the budgeting process more transparent and increasing the autonomy of ministries in the management of funds.

One of the main proposals is to improve the transparency of budget documents. Currently, differences in the presentation of data make them difficult to interpret, and the lack of information on the results of government programmes reduces the effectiveness of budget decisions. The OECD suggests harmonising the approach to publishing budget data and using digital platforms to make them openly available.

An important step could be a change in the budget planning calendar. The OECD recommends submitting the Medium Term Financial Programme (LPFP) in the spring, which would better synchronise the process with European requirements and allow for a more strategic allocation of resources.

The OECD recommendations are based on the successful experience of other countries, such as Germany, the Netherlands and Sweden, where medium-term budget planning has already become the main tool for financial management. Although the proposed reforms look ambitious, their implementation will allow Luxembourg to maintain fiscal sustainability amid new challenges and improve the efficiency of public spending.