The main public policy priority in Belgium continues to be to implement structural reforms (tax reform and reform in labour and product markets) to increase potential growth. This has to be done in the context of reducing the large public debt. Debt reduction is necessary to respect the Maastricht Treaty, which calls for gross public debt to be reduced to less than 60 per cent of GDP, but more importantly to prepare for the future budget costs of population ageing. It is also necessary for substantially lowering the tax burden, which is one of the highest in the OECD. Taxation of labour incomes is particularly high, with adverse employment consequences for the low skilled. The employment record of older workers is also poor, with Belgium having one of the lowest employment ratios for workers aged 55-64 in the OECD. The government’s strategy for dealing with these challenges is to maintain fiscal policy settings that drive down public debt, to cut taxes, especially on low skilled labour, as budget margins become available and to reduce incentives for premature withdrawal from the labour force. It is to the government’s credit that it has continued to make progress on all of these fronts despite a weakening international economy and a complex institutional framework. Belgium’s economic challenges will be easier to meet insofar as tax and benefit reforms strengthen market incentives, and reforms in product and labour markets increase economic dynamism.

Economic activity slowed sharply from the beginning of 2000, with growth reaching a trough in the fourth quarter of 2001 before recovering somewhat in 2002 (Figure 1). The slowdown in the Belgian economy was largely in step with that in the euro-zone economy although, as usual, the Belgian cycle slightly leads the euro-zone cycle (probably owing to specialisation in intermediate manufactured goods) and has larger amplitude (owing to the relative openness of the economy) (Figure 2). The main cause of the slowdown was the deterioration in the international business climate, which resulted in less demand for Belgian exports and reduced business profitability. Domestic demand was also weakened somewhat  by the loss of purchasing power resulting from increases in energy prices. Declining consumer confidence further weakened domestic demand growth. Employment growth slowed with the usual two to three quarter lag and unemployment began to rise in the last quarter of 2001, after having reached the lowest rate (6.6 per cent for 2001) in 10 years. The slowdown has eased tensions on production capacity that had emerged during the upswing. The OECD estimates that the output gap has fallen from 1.7 per cent of potential GDP in 2000 to minus 1.5 per cent in 2002. This, together with appreciation of the euro, the passing of the food price shock and the abolition of the radio and television licence fees in Flanders and Brussels, has contributed to a sharp fall in inflation to around 1½ per cent in 2002.

Fiscal consolidation is of paramount importance in Belgium. Since its peak less than ten years ago the debt-to-GDP ratio has come down by about 30 percentage points. This has been achieved without a substantial increase in the revenue/GDP ratio but through spending discipline and asset sales (Figure 10). A virtuous process of debt dynamics is underway with the interest charge decreasing year after year allowing for an even quicker debt reduction or for some gradual lowering of the high primary surpluses. The Government’s medium- and long-term strategy consists of using this room for manoeuvre both for the accumulation of budget surpluses, with a view to pre-fund the costs of population ageing, and for tax cuts.

This chapter begins with a brief review of the major forces shaping tax policy. This is followed by a discussion of the impact of the tax system and reforms on labour and capital markets and on income distribution. The chapter concludes with suggestions for further tax reform.

Over the last three decades, GDP per capita in Belgium has increased substantially, by around 2½ per cent per year on average. Per capita growth was higher than in the United States, which is often taken as a reference point in this respect, but the gap relative to the United States, with a relatively high GDP per capita, has not yet been closed. In Belgium, GDP per capita (in 1995 PPP dollars) increased from around $12 500 in 1970 to $25 000 in 2000, but remained some $8 000 below the level in the United States (Figure 25).