After falling exceptionally to 16% in 2023 as part of the measures to combat inflation (Solidaritéitspak 2.0), the VAT rate returned to its initial level – 17% – in 2024. In January, the annual inflation rate in Luxembourg reached 3.5%, compared with 3.0% a month earlier. However, the indicator calculated by Statec is in line with the trend observed in the eurozone, where prices rose by 2.8% in January 2024 (FDEF).
“VAT does have an impact on inflation, but only in the short term, as prices are mainly affected by energy prices and the geopolitical situation,” explains Christos Koulovatianos, Professor of Economics at the Faculty of Law, Economics and Finance.
The European Central Bank (ECB) considers 2% to be the ideal inflation rate. This target was last met in the eurozone in mid-2021, but since then the impact of the war in Ukraine in early 2022 has boosted the cost of living.
“There is now a risk of stagflation in the eurozone, meaning high unemployment and inflation rates”, explains the economist. Luxembourg seems to have been spared: its unemployment rate was 5.5% in December 2023, compared with 6.4% in the eurozone.
The weight of cross-border commuters
“Luxembourg is a small, open economy, and it is important to take account of national specificities when reading the statistics,” warns François Koulischer, economist and assistant professor of Sustainable Finance. “For example, cross-border commuters account for half of the country’s workforce. However, these workers switch to unemployment in their country of residence when they lose their job, and are therefore not taken into account in the national unemployment statistics. Given that the construction industry mainly employs cross-border commuters, and that this sector is currently in crisis, it is likely that Luxembourg’s unemployment figures overestimate the health of the economy at the moment.”
The label of richest country in the world sticks to Luxembourg’s skin. This is due to the fact that the cross-border workforce is considered in the creation of national wealth. “But if we take into account only residents, who reckon for around 52% of workers in Luxembourg, our GDP would actually be closer to that of the Netherlands,” says Christos Koulovatianos.
In his view, aligning with the inflation rate recommended by the ECB is good for the competitiveness of Luxembourg, which has an open economy. On the other hand, soaring interest rates have a stronger downside than in neighbouring countries: “High property prices generate higher volumes of borrowing, so the market is more heavily impacted by rising interest rates,” he observes. The price of bricks also influences inflation, note the two economists.
“From my point of view, Luxembourg has a similar profile to Switzerland: it is a country that positions itself as an island of economic, political and social stability surrounded by areas of instability and tension. As in Switzerland, this translates into high property prices,” says Christos Koulovatianos.
The price of serenity is high, especially as the cost of living in Luxembourg is often higher than in neighbouring countries. And yet, whether at 16% or 17%, its VAT rate is the lowest in the European Union. By way of comparison, it is 27% in Hungary.
Upcoming lecture
At the Open Day on 16 March 2024, Prof. Christos Koulovatianos will give a lecture in English about “The importance of financial decisions of households for our understanding of markets”.