After four years of strong growth, the Belgian economy entered a deep recession during the second half of 2008 under the impact of the international crisis. The economy was first affected by the turmoil in the banking sector and subsequently by the collapse in international trade. The government swiftly intervened to support the financial system and implemented a moderately sized fiscal stimulus package that is broadly appropriate for a small open economy with substantial fiscal sustainability problems. The main challenge ahead is to support the economy by allowing the automatic stabilisers to work while restoring the path towards fiscal sustainability and implementing structural reforms to enhance long-term growth.

Public finances are moving further away from sustainability. Budgets were roughly balanced in the first half of the 2000s. Thereafter, budget slippages began to appear and in 2008 the public-debt-to-GDP ratio began to rise for the first time since 1993 as a result of the financial sector interventions. If fiscal policies remain unchanged, the debt ratio will continue to rise, further adding to the already high contingent liabilities associated with ageing. Thus, a credible medium-term strategy to secure fiscal sustainability needs to be implemented. Belgium made a step in this direction by stipulating in the Stability programme a path, starting in 2010, back towards a balanced budget in 2015.

There is a need for rebalancing revenue and spending responsibilities across the federation to ensure fiscal sustainability. Until now, fiscal federalism arrangements have left the federal government with slower income growth than other levels of government. Furthermore, the bulk of the responsibility for financing ageing related costs rests at the federal level. Moreover, the current system and the overlapping spending responsibilities provide few incentives for pursuing spending efficiency. Better incentives could come from aligning spending and revenue powers as well as reorganising spending responsibilities to pursue efficiency.

Despite reforms in the 2000s, the tax system still relies too much on relatively growth-distorting taxes, such as labour and corporate taxes. The interaction of personal income tax, the social security and the benefit systems creates a range of labour market traps, mostly reflecting high marginal rates combined with numerous tax exemptions. Taxation of saving differs across vehicles, where particularly mortgage financed owner-occupied housing is tax favoured, hampering the optimal allocation of capital and thus growth. At the same time, there is scope for increasing less-distortive taxes, such as those on immovable property and consumption. Regarding the latter, the standard VAT rate is relatively high, but the effective rate is much lower because of the widespread use of reduced rates.

The competition framework was reformed in 2006 so as to be aligned with EU legislation and to boost the powers of the competition authority. The framework now looks like those in most other European countries. While the first results are encouraging, the authority’s staffing remains an issue to be dealt with. On the other hand, competition in retailing is hampered by strict sector regulation. Moreover, network regulation lags behind, raising the question of whether the relevant regulatory authorities are strong enough to deal with the main issue of the dominant position of the incumbents, who appear to be responsible for internationally high prices.