Workers' new best friend.

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The World's Most Taxed Workers Get a Break

Jean-Michel Paul is founder and Chief Executive of Acheron Capital in London.
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Last week Belgium's one-year-old government announced measures, radical by that country's standards, to move the burden of taxation to consumption from labor.  The measures are being hailed as the start of a new social contract in the heart of Europe. While the fiscal impact may be limited, the change to taxation may give the country some breathing room to tackle its large public debt. And it may give other high-tax countries some useful ideas.

Belgium is an open economy in the middle of Europe with a particularly large exposure to international trade. It is also heavily indebted, with a ratio of debt to gross domestic product of 106 percent and a deficit of about 3 percent. In order to sustain large government expenses of more than 50 percent GDP on top of servicing its debt, Belgium became the OECD's second most-taxed economy.

Before the euro came into existence, Belgium made a choice: It decided to heavily tax labor, which it figured, wrongly, was stuck. At the same time, it decided to provide attractive tax treatment to highly mobile capital. The gambit meant that Belgium attracted a large number of wealthy families from higher tax countries, particularly France and the Netherlands, eager to take advantage of the low rates of tax on capital. However, Belgian workers got hammered. In 2014 Belgian workers were the most taxed labor in the developed world, taking home only 46 percent of employers' labor costs.

This unusual policy mix has increasingly created problems. First, human capital proved not to be as immobile as expected. Educated professionals and entrepreneurs, those most in demand in other countries, have voted with their feet in borderless Europe. As a result, productivity growth has been limited and Belgium's economy remained low-growth. Its business start-up rate is the second lowest of the EU. Indeed, despite a relatively high unemployment rate, Belgium has among the highest rate of job vacancies in the EU.

Further, local production became too expensive for a trading nation unable to increase productivity. Whole segments of the country's industrial tissue, such as the automobile sector, have gradually closed down, negatively affecting the balance of trade. This has led to what the European Commission described as "a chronic underutilisation of labour" (read: unemployment) especially among the least qualified and the young. Youth unemployment stands at over 22 percent.

The Commission has also criticized Belgium for its high hourly industrial wage rate, the EU's second highest after Sweden. In its 2015 country report the Commission noted that this “reflects Belgium's high social security charges on labour, which add to the large tax wedge" and “underscores the importance of a broad-based tax shift toward non-labor tax bases."

The new policy has been spearheaded by Belgium's unorthodox finance minister, Johan Van Overtveldt, who has a PhD in economics and real world business experience. His idea is to reduce taxes on labor and increase indirect taxes to compensate. Social Security taxes on companies are being reduced to 25 percent from 33 percent over the next two years, bringing an increase in the net after-tax income of 100 euros ($113) per month for low and middle-wage earners. This is mainly financed by an increase in value added tax on electricity consumption.

Belgium isn't the first to consider a tax-shift formula. Denmark in 1987, Germany in 2007 and Hungary in 2009 tinkered with similar policies. But Belgium is the first to implement what some call a "social VAT" (a tax on consumption to finance social security).  The new tax policy is expected to lower unemployment and improve exports, but without the overall associated pain of an internal devaluation in a fixed-exchange regime. Most importantly, it rewards work and may well change the entitlement mind-set that has hampered innovation and job growth for decades.

The macro impact of the tax-shift formula shouldn't be overstated.  With a net impact of less than 1 percent of GDP, the strategy is too marginal in size to solve Belgium's bigger problem of indebtedness. It could be even more ambitious, seeking to further broaden the tax base.  It is nevertheless a significant step in the right direction, correcting some of the worst distortions of Belgium's social model.

Political trailblazer is an unfamiliar position for Belgium; as a Belgian, I welcome it. Van Overtveldt's change also sends a message to Europe that the current tendency toward Hold Your Breath Economics -- the pursuit of policies which avoid real solutions to rising debt and low growth in favor of muddling through-- isn't the only option.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Jean-Michel Paul at JPaul@acheroncapital.com

To contact the editor responsible for this story:
Therese Raphael at traphael4@bloomberg.net