## WAGE INDEXATION AND INTERNATIONAL COMPETITIVENESS IN BELGIUM: AN UNEASY COEXISTENCE

## Source details

**Canonical URL:** [WAGE INDEXATION AND INTERNATIONAL COMPETITIVENESS IN BELGIUM: AN UNEASY COEXISTENCE](https://www.imf.org/-/media/files/publications/cr/2023/english/1belea2023002.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2023/english/1belea2023002.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2023/english/1belea2023002.pdf.json)

---

### Inflation developments (Belgium-focused HICP measures)
- Recent episode:
  - HICP headline inflation reached 10.2 percent by December 2022, after peaking at 13.1 percent in October.
  - HICP core inflation accelerated to an annual rate of 7.1 percent (December 2022).
  - Since end-2020, Belgium's headline inflation rate has risen by 9.9 percentage points.
- Contributions to December 2022 headline inflation (10.2 percent):
  - Energy: around one third of the rise.
  - Processed food: 2.4 percentage points.
  - Services: 1.8 percentage points.
  - Non-energy industrial goods: 1.9 percentage points.
- Energy-specifics:
  - Energy prices increased at an annual rate of 33.0 percent by December 2022, after peaking at 69.2 percent in October.
  - Belgium’s taxation of energy and natural gas is lower than the euro area average; excise taxes on diesel and natural gas for use in buildings are much more modest than in other EU countries.
  - HICP places a relatively high weight on energy products (notably heating and powering of homes), amplifying pass-through to headline inflation.
  - Statbel measures energy inflation based on newly concluded contracts; fixed-price contracts typically last only a year in Belgium.
- Drivers and persistence:
  - Sequence of shocks: re-opening demand (pent-up demand for services), lingering pandemic-related supply chain bottlenecks, rapid labor market tightening, then steep energy and food price increases related to Russia’s war in Ukraine.
  - Since September 2021, contribution to headline inflation of HICP items affected by re-opening (15.4 percent of items in 2022) and by supply disruptions (13.9 percent of items in 2022) climbed from 0.5 to 2.0 percentage points.
  - Processed food contribution to core inflation rose from 0.6 percentage points in February to 2.0 percentage points in December 2022.
  - Aggregate NFC gross profit margins improved between Q4:2020 and Q2:2022; micro evidence shows many firms experienced margin declines between 2021 and 2022, with aggregate improvements driven by a few large corporations.
- Phillips-curve and expectations:
  - Food prices enter headline inflation at various lags with relatively small coefficients.
  - Energy prices are a statistically-significant driver of headline inflation with somewhat higher impact than the median euro area economy.
  - Persistence in headline inflation is the lowest among the euro area countries in the sample.
  - Forward-looking inflation expectations play a somewhat more prominent role for headline inflation in Belgium than for the euro area median.
  - For core inflation, Belgium’s distinctiveness relative to the euro area median declines and commodity-price significance vanishes.

### Features, benefits, and costs of Belgium’s wage indexation system
- Coverage and mechanics:
  - Indexation of base pay to price developments is nearly universal across firms, industries, and the public sector.
  - Wages are indexed to inflation by the “health index” (CPI excluding alcoholic beverages, tobacco products and motor fuels except LPG).
  - A 4-month moving average of the health index underpins indexation of public sector wages, most private sector wages, pensions and social security benefits, and some prices (rents, certain insurance premia, some doctors’ fees).
  - Smoothed health index transmits cumulative 2 percent increases into equivalent near-immediate rises in nearly half of private sector salaries and in public sector wages and social outlays.
- Benefits:
  - Cushions purchasing power losses for workers substantially during high inflation.
  - Reduces need for broad-based fiscal compensation and allows targeting of government support to the most vulnerable.
  - In a terms-of-trade shock, prevents the immediate loss from falling solely on households.
- Costs and trade-offs:
  - Raises labor compensation permanently; nominal wages rarely adjust downward even if terms-of-trade reverse.
  - Worsens corporate finances when firms cannot fully pass through costs, potentially lowering investment or threatening solvency.
  - Raises government expenditures through indexed public wages and social benefits; nominal revenues may increase (e.g., VAT, unindexed tax brackets) but indexation absorbs revenues that could be used for other priorities.
  - Risk of propagating a wage-price spiral, particularly harmful for a currency-union member like Belgium.
  - Uniform indexation across income brackets during high inflation may limit wage differentiation based on productivity and exacerbate labor market rigidities.

### Wage formation, Wage Law, and recent developments
- Legal framework and negotiation mechanics:
  - “Law on the Promotion of Employment and Maintaining Competitiveness” (Wage Law) codified in 1996.
  - Social partners obliged to negotiate salary increases over two-year periods within:
    - an upper limit set by anticipated hourly wage developments in France, Germany, the Netherlands, and
    - a floor determined by expected inflation in Belgium.
  - The Wage Law corrects for wage drift (seniority, promotions, employment-structure shifts).
- Reforms and enforcement history:
  - A 4 percent gap emerged by 2010 due to reluctance to fully enforce the Wage Law and prolonged wage restraint in Germany.
  - Federal actions: moderate benchmarks for 2011-12 and 2013-14; index suspension (“index jump”) April 2015 lowering the smoothed health index by 2 percent; suspension April 2015–April 2016.
  - 2017 reform: made CCE determination of the wage ceiling binding; introduced correction for past overshoots and a safety margin for forecast errors.
  - Current Wage Law effectively caps real wage rises by considering expected gaps between Belgium and comparator nominal hourly wage developments over two years.
- Recent wage outcomes:
  - Reformed Wage Law allowed two-year real wage improvements of 1.1 percent in 2017-18 and 0.8 percent in 2019-20.
  - For 2021-22, scope for real wage hikes was identified at 0.4 percent, leading to failed social-partner agreement and government mediation at fiscal cost.
  - For close to two-fifths of private sector pay, indexation takes place in January, implying an approximately 10 percent rise at the start of 2023.
  - CCE estimates a wage gap of 2.9 percentage points by end-2022, widening to 5.7 percent by end-2024; in line with the Wage Law, this implied no space for real wage growth in 2022-24, requiring government-brokered deals.
  - Government proposals for exceptionally profitable firms: €500 (€750) bonus payment for 2023 via consumption vouchers fully tax-deductible for companies and tax-free for employees.

### Structural characteristics, vulnerabilities, and competitiveness implications
- Openness and export structure:
  - Belgium is a highly-integrated small open economy; medium- and high-tech manufactures account for more than half of total exports of goods.
  - Commodities and natural resource-based manufactures have a 35 percent share of merchandise exports.
  - Belgium does not occupy a dominant supply position in main foreign markets for most manufactures, implying substitutes and the need to sustain price competitiveness.
- Transmission channels and rigidities:
  - The smoothed health index is not well insulated from volatile HICP components (energy, food), leading to rapid transmission of shocks to wages.
  - Wage Law mandates prolonged periods of low/no real compensation improvement if salaries abroad do not catch up, constraining union bargaining and employer leeway.
  - Wage-setting rigidity compounds a labor market with relatively low job-to-job transition rates, fosters confrontational industrial relations and frequent government intervention (index freeze 2015-16; brokering in 2021 and 2022).
  - Despite rigidities, salaries largely reflect productivity differences at the sectoral level, with more divergence at firm level or by education.

### Policy recommendations and reform options
- Review and redesign the indexation base:
  - Explore excluding highly volatile items (energy, food) from the smoothed health index to distribute losses more evenly and provide more predictable salary/wage cost developments.
  - If fuller compensation for purchasing-power losses is desired, implement well-targeted fiscal support for vulnerable groups rather than broad-based measures.
  - Redefining the health index could loosen rigidities in the Wage Law and give more opportunities for social partners to negotiate real salary increases differentiated across sectors or firms.
- Account for productivity and comparator selection:
  - Allow productivity improvements above comparator economies to be reflected in higher wages; let slower-than-comparator productivity gains be reflected in lower wages rather than increased capital intensity or offshoring.
  - Consider widening the comparator group beyond France, Germany and the Netherlands (they constitute less than half of Belgian merchandise exports).
- Temporary and contractual flexibility:
  - Consider allowing viable firms to pause or limit wage indexation where going concern is at risk to preserve investment and employment.
  - Assess reviving contracts with all-in clauses (compensation for expected rather than actual inflation) to complement re-casting of the health index and fit forward-looking inflation formation.
- Complementary fiscal and product-market measures:
  - Strengthen tax policy on energy used for housing: prefer excise duties (per-unit basis) over ad valorem taxes to dampen pass-through of wholesale energy price fluctuations to retail and wages.
  - Accelerate product market reform: increased competition would weaken firms’ ability to pass higher input costs to prices, help contain wage-price spiral risks, and foster a more dynamic economy.
- Analytical priorities:
  - Investigate how indexation interacts with firm-level heterogeneity in profitability and pricing power.
  - Assess trade-offs between protecting purchasing power and preserving international competitiveness within a currency union context.
  - Consider reforms/complementary policies that retain indexation benefits for vulnerable households while mitigating macroeconomic and fiscal costs.

### Risks to monitor
- Emergence of a wage-price spiral with persistent inflation and competitiveness losses.
- Structural absorption of fiscal space via indexed public wages and social benefits.
- Reduced ability to differentiate wages by productivity, increasing labor market rigidities and constraining employment adjustments.
- Heterogeneous corporate impacts where aggregate NFC margin improvements mask widespread firm-level margin deterioration.

*Source: 1belea2023002 — IMF chapter.*

### References ____________________________________________________________________________ 17

### 1belea2023002 - References ____________________________________________________________________________ 17

### Overview and scope
- Document contains multiple chapters and sections, including:
  - "FISCAL FEDERALISM IN BELGIUM: CHALLENGES IN RESTORING FISCAL SUSTAINABILITY"
  - "FISCAL POLICY OPTIONS TO ACCELERATE EMISSIONS REDUCTIONS IN BELGIUM"
  - "WAGE INDEXATION AND INTERNATIONAL COMPETITIVENESS IN BELGIUM: AN UNEASY COEXISTENCE"
- Supplied extract focuses on the "WAGE INDEXATION AND INTERNATIONAL COMPETITIVENESS IN BELGIUM" chapter, covering:
  - A. Introduction
  - B. Inflation developments and drivers (Belgium-focused, HICP measures)
  - C. Initial discussion of wage formation and trade-offs of indexation

### Key findings on inflation developments (Belgium)
- Recent inflation episode is historically large:
  - HICP headline inflation in Belgium reached 10.2 percent by December 2022, following a peak of 13.1 percent in October.
  - HICP core inflation accelerated to an annual rate of 7.1 percent (December 2022).
  - Since end-2020, Belgium's headline inflation rate has risen by 9.9 percentage points.
- Contributions to headline inflation (December 2022):
  - Energy accounted for around one third of the 10.2 percent rise in headline inflation.
  - Processed food contributed 2.4 percentage points.
  - Services contributed 1.8 percentage points.
  - Non-energy industrial goods contributed 1.9 percentage points.
- Energy price inflation specifics:
  - By December 2022, energy prices increased at an annual rate of 33.0 percent, after peaking at 69.2 percent in October.
  - Belgium’s taxation of energy and natural gas is lower than the euro area average; OECD indicates Belgium maintains much more modest excise taxes on diesel and natural gas for use in buildings than other EU countries.
  - Belgium’s HICP places a relatively high weight on energy products (notably heating and powering of homes), amplifying the pass-through to headline inflation.
  - Statbel measures energy inflation based on newly concluded contracts; fixed-price contracts in Belgium typically last only a year, reducing but not eliminating measurement effects.
- Supply- and demand-side drivers:
  - A sequence of shocks: re-opening demand (pent-up demand for services), lingering pandemic-related supply chain bottlenecks, rapid labor market tightening, followed by steep energy and food price increases related to Russia’s war in Ukraine.
  - Since September 2021, contribution to headline inflation of HICP items affected by the re-opening of the economy (15.4 percent of items in 2022) and items affected by supply disruptions and bottlenecks (13.9 percent of items in 2022) climbed from 0.5 to 2.0 percentage points.
  - Processed food contribution to core inflation rose from 0.6 percentage points in February to 2.0 percentage points in December 2022.
- Corporate sector margins and heterogeneity:
  - Aggregate non-financial corporate (NFC) gross profit margins improved between Q4:2020 and Q2:2022, keeping them above levels seen in most other euro area countries and higher than before the pandemic.
  - Microeconomic evidence indicates a sizeable share of Belgian companies experienced a decline in gross profit margins between 2021 and 2022; positive aggregate outcomes driven mainly by a few large corporations.
- Phillips-curve and persistence findings:
  - Compared to the median euro area country, Belgium displays differences in the inflation-setting process:
    - Food prices enter headline inflation at various lags in Belgium (coefficients of relatively small magnitude).
    - Energy prices are a statistically-significant driver of headline inflation with somewhat higher impact than the median euro area economy.
    - Persistence in headline inflation is the lowest among the euro area countries in the sample.
    - Forward-looking inflation expectations play a somewhat more prominent role for headline inflation in Belgium than for the euro area median.
  - For core inflation, Belgium’s distinctiveness relative to the euro area median declines and the statistical significance of commodity prices vanishes.

### Features, benefits, and costs of Belgium’s wage indexation system
- Coverage and uniqueness:
  - Indexation of base pay to price developments is nearly universal in Belgium across firms, industries, and the public sector.
  - Other euro area countries with comparable private-sector wage indexation arrangements include Cyprus, Luxembourg, and Malta.
- Benefits of indexation:
  - Cushions purchasing power losses for workers substantially during high inflation episodes.
  - Reduces need for broad-based fiscal compensation; supports targeting of government support to the most vulnerable groups.
  - In a terms-of-trade shock, indexation helps prevent the immediate loss being borne solely by households.
- Costs and economic trade-offs:
  - Indexation raises labor compensation permanently, creating a cost that can persist even if terms-of-trade reverses (nominal wages rarely adjust downward).
  - Worsens corporate finances when firms cannot pass-through costs fully, potentially lowering investment or threatening solvency.
  - Raises government expenditures via public sector wage and social benefit indexation; nominal revenues may increase (e.g., VAT, unindexed tax brackets) partially softening the budgetary impact, but indexation has an opportunity cost by absorbing revenues that could be used for other priorities.
  - Risk of propagating a wage-price spiral, especially harmful for a currency-union member like Belgium.
  - Uniform indexation across income brackets during high inflation may limit wage differentiation based on productivity and exacerbate labor market rigidities.
- Sectoral and policy context relevant to inflation transmission:
  - Belgium’s relatively low excise taxes on some energy uses foster stronger pass-through from wholesale to retail energy prices.
  - Variable-rate energy contracts and a liberalized energy market with short adjustment intervals have amplified retail price movements.
  - The combination of high energy weight in the HICP and lower energy taxation contributes to higher HICP energy inflation impact relative to many euro area peers.

### Policy implications and considerations (from analysis)
- Indexation supports household purchasing power and reduces immediate fiscal broad-based compensation needs, enabling targeted fiscal support.
- Indexation imposes structural cost pressures on firms and the government that can:
  - Weigh on corporate profitability, investment, and solvency in the presence of large input-cost shocks.
  - Absorb fiscal space and complicate public finances through indexed public wages and social benefits.
- Potential risks to monitor:
  - Emergence of a wage-price spiral with persistent inflation and competitiveness losses.
  - Reduced ability to differentiate wages across sectors and by productivity, increasing labor market rigidities.
- Analytical priorities suggested by the chapter:
  - Investigate how indexation interacts with firm-level heterogeneity in profitability and pricing power.
  - Assess trade-offs between protecting purchasing power and preserving international competitiveness within a currency union context.
  - Consider reforms or complementary policies that retain the benefits of indexation for vulnerable households while mitigating its macroeconomic and fiscal costs.

*IMF staff compilation, chapter: "WAGE INDEXATION AND INTERNATIONAL COMPETITIVENESS IN BELGIUM: AN UNEASY COEXISTENCE" (extract).*

### 9.      Wage formation in Belgium is characterized by the desire to shield households from

### 9.      Wage formation in Belgium is characterized by the desire to shield households from purchasing-power losses while protecting the competitiveness of a highly-open economy

### Wage-setting framework and mechanics
- The wage-setting process was codified into law in 1996 by the “Law on the Promotion of Employment and Maintaining Competitiveness” (the Wage Law).
- The Wage Law obliged social partners to negotiate salary increases over a two-year period within:
  - an upper limit set by anticipated hourly wage developments in key export markets (France, Germany, the Netherlands), and
  - a floor determined by expected inflation in Belgium.
- Wages in Belgium are indexed to inflation by means of the “health index”.
  - The “health index” removes alcoholic beverages, tobacco products and motor fuels (except LPG) from the CPI.
  - Its smoothed version, a 4-month moving average, underpins the indexation of public sector wages, most private sector wages, pensions and social security benefits as well as some prices (rents, certain insurance premia, some doctors’ fees).
- The Wage Law also makes amends for wage drift to account for changes in pay due to, e.g., seniority, promotions or shifts in the employment structure.

### Evolution, enforcement, and reforms of the Wage Law
- During the first decade after 1996 the Wage Law broadly kept salary developments in line with the three comparator countries, but:
  - a 4 percent gap emerged by 2010, reflecting reluctance to fully enforce the provisions of the Wage Law and an episode of prolonged wage restraint in Germany that contributed to overestimation of comparator compensation.
- The federal government used the prerogative in the Wage Law to set a comparatively moderate benchmark for wage rises for the 2011-12 and 2013-14 rounds, followed by suspension of indexation between April 2015 to April 2016 (an “index jump” lowering the smoothed health index by 2 percent in April 2015).
- A wider reform in 2017:
  - made the determination of the maximally-permissible wage increase by the Conseil Centrale de l’Economie (CCE) a binding factor in salary negotiations;
  - revised the approach for deriving the ceiling by introducing a correction term for past overshoots of wage developments between Belgium and its three neighbors and a safety margin to account for potential forecasting errors.
- In its current form, the Wage Law effectively caps real wage rises by considering expected gaps between nominal hourly wage developments in Belgium and abroad over the coming two years, correcting for past deviations and incorporating a safety margin.

### Recent developments, inflation, and wage outcomes
- The reformed Wage Law allowed for two-year real wage improvements of:
  - 1.1 percent in 2017-18, and
  - 0.8 percent in 2019-20.
- For 2021-22, the available scope for real wage hikes was identified at 0.4 percent, leading to failed agreement among social partners and government mediation at non-negligible fiscal costs.
- Since end-2020 the pace and degree of wage indexation accelerated with rising inflationary pressures:
  - Each cumulative 2 percent increase in the smoothed health index implies an equivalent, near-immediate rise in nearly half of private sector salaries and in public sector wages as well as in pension and social security outlays.
  - For close to two-fifths of private sector pay, indexation takes place in January of each subsequent year, which implied an approximately 10 percent rise at the start of 2023.
- CCE estimates:
  - a wage gap of 2.9 percentage points by the end of 2022, widening to 5.7 percent by the end of 2024.
- In line with the Wage Law, the extent of this overshoot implied no space for real wage growth in 2022-24, requiring another costly government-brokered deal between social partners.
  - For firms that were (exceptionally) profitable in 2022 the government proposed a €500 (€750) bonus payment for 2023 in the form of consumption vouchers that are fully tax-deductible for companies and tax-free for employees.

### Structural characteristics and vulnerabilities
- Belgium is a highly-integrated small open economy:
  - medium- and high-tech manufactures account for more than half of total exports of goods.
  - commodities and natural resource-based manufactures have a 35 percent share of merchandise exports.
- Belgium does not occupy a dominant supply position in its three main foreign markets for the vast majority of its manufactures, implying substitutes and the need to sustain price competitiveness.
- The smoothed health index is not well insulated from volatile HICP components (energy, food), leading to rapid transmission of global or idiosyncratic price shocks to Belgian wages.
- The Wage Law mandates prolonged periods of low or no real compensation improvement if salaries abroad do not catch up with near-universal indexation in Belgium, constraining bargaining space for unions and reducing employers’ leeway to adjust real base pay at firm or sectoral level.
- The wage-setting rigidity compounds a labor market with relatively low job-to-job transition rates, and fosters confrontational industrial relations and frequent government intervention in collective bargaining (index freeze 2015-16; government brokering in 2021 and 2022) at additional budgetary cost.
- Despite rigidities, evidence indicates salaries in Belgium largely reflect productivity differences at the sectoral level, with more divergence at firm level or between educational attainments.

### Policy recommendations and reform options
- Review the basis for indexation (the smoothed health index):
  - Explore excluding highly volatile items (energy, food) from the smoothed health index to distribute losses more evenly and provide more predictable salary and wage cost developments.
  - If fuller compensation for purchasing-power losses is desired, implement well-targeted fiscal support for vulnerable groups rather than broad-based measures.
  - Redefining the health index could loosen rigidities in the Wage Law and give more frequent opportunities for social partners to negotiate real salary increases differentiated across sectors or firms, reducing reliance on government intervention or in-kind benefits.
- Account for productivity trends when assessing labor cost deviations vis-à-vis key export markets:
  - Allow productivity improvements above comparator economies to be reflected in higher wages; let slower-than-comparator productivity gains be reflected in lower wages rather than in increased capital intensity or offshoring.
  - Consider widening the comparator group beyond France, Germany and the Netherlands, as they constitute less than half of Belgian merchandise exports.
- Provide temporary flexibility in the indexation regime:
  - Consider allowing affected viable firms to pause or limit wage indexation where the going concern is at risk, to preserve investment and employment.
  - Assess reviving contracts with all-in clauses (compensation for expected rather than actual inflation) to complement re-casting of the health index and fit forward-looking inflation formation.
- Strengthen tax policy on energy used for housing:
  - Prefer excise duties (per-unit basis) over ad valorem taxes to dampen pass-through of energy price fluctuations from wholesale to retail and on to consumer price inflation and wages.
- Accelerate product market reform:
  - Elevated corporate profit margins suggest limited competitive pressure; product market reforms to increase competition would weaken firms’ ability to pass higher input costs to prices and help contain wage-price spiral risks while fostering a more dynamic economy.

*International Monetary Fund — Country Report excerpt*

### 1.      Belgium is one of the most fiscally-decentralized advanced economies. Fiscal

### 1belea2023002 - 1.      Belgium is one of the most fiscally-decentralized advanced economies. Fiscal

### Overview and key findings
- Belgium has the most decentralized spending autonomy among euro area economies and ranks fourth globally among advanced economies after Canada, Switzerland, and the U.K.
- Subnational governments in Belgium are responsible for 46 percent of total spending, while own tax revenues are equivalent to 16 percent of total tax revenues.
- Belgium’s vertical fiscal imbalance—the share of sub-national own spending not financed through own revenues—was high at 50 percent in 2019.
- Grant transfers increased to 4.4 percent of GDP in 2015-21 from 1-1.7 percent of GDP during 1990-2014.
- By 2019, subnational government own spending increased to 24 percent of GDP against their own revenue of 12 percent of GDP.
- Consolidated public debt to GDP ratio is expected to decline to 107 percent in 2022 from a recent peak of 112 percent in 2020, but is projected to rise to 120 percent in the medium term under unchanged policies.
- Regions and communities deficits reached 2.4 percent and 1.6 percent of GDP in 2020 and 2021, respectively; NBB estimates suggest deficits narrowed to 1.3 percent of GDP in 2022 and will remain around this level in 2023-25.
- Debts of regional and community governments increased from an average of 12 percent of Belgium’s GDP in 2010-2015 to 17 percent of GDP in 2021.
- Debt outstanding held by communities and regions increased by 1.9 ppt of GDP in the Flemish region, 1.4 ppt of GDP in the Walloon region, and 0.6 ppt of GDP in the Brussels-Capital region over 2019-21.
- Dependency on debt financing in 2021: about 22 percent for the Brussels Capital region, 17 percent for the Walloon region, and less than 5 percent for the Flemish region.

### Evolution of fiscal decentralization
- Decentralization progressed in stages under six state reforms implemented over five decades.
- The most recent push of decentralization took place during 2015-19 following Belgium’s sixth state reform in 2014.
- Spending share increases (2014 to 2019):
  - Subnational (state and local): from 38 percent to 46 percent of general government total expenditure.
  - Regional and community (excluding municipalities): from 25 percent to 33 percent of general government total expenditure.
- Revenue-side increases (2014 to 2019):
  - Subnational own tax collections: from 10 percent to 16 percent of general government tax revenue.
  - Regional and community own tax collections (excluding municipalities): from 5 percent to 11 percent of general government tax revenue.
- Combined effect reduced the vertical financing gap by 5 percentage points between 2015 and 2019, but VFI remained elevated at 50 percent in 2019.

### Strengths and weaknesses of decentralization
- Strengths:
  - Potential improved effectiveness and tailoring of public services to local needs given economic and social heterogeneity among Flanders, Wallonia, and Brussels-Capital and among Flemish-, French-, and German-speaking communities.
- Weaknesses:
  - Fiscal discipline challenges arise from high reliance on grant-based transfers, creating soft-budget constraints and weaker incentives to rationalize expenditures.
  - “Common pool” problem: subnational governments may have little incentive to save shared revenues.
  - Heterogeneity among regions and constitutionally-established privileges complicate intergovernmental fiscal relations and may create moral hazard.

### Vertical fiscal imbalance, transfers, and financing structure
- Definition used: VFI = 1 - [(SNG own revenue)/(SNG own spending)] where SNG is sum of state and local governments.
- Financing sources for regions and communities:
  - Own revenues: about twelve own-sourced taxes (e.g., registration duties on sales of real estate, tax on vehicles, taxes on goods and services).
  - Tax revenue transfers: shared personal income tax (PIT) revenues collected on their territory; since 2014 regions may levy an additional regional tax on federal PIT.
  - Communities: do not have own taxes; mainly financed by shared PIT and VAT revenues.
  - Specific federal grants provided to implement spending policies corresponding to respective powers; grants are formula-based with limited flexibility for ad hoc adjustments.
- Interregional implicit transfers (2019, NBB estimates):
  - Flanders: net implicit contribution of €6.2 billion (€900 per resident).
  - Brussels: net contributor of €900 million (€800 per capita).
  - Wallonia: net recipient of €7.1 billion (€1,900 per capita).
- Overall financing dynamics:
  - Grant transfers rose and now play a larger role in covering subnational spending; increases in own revenues were offset by reductions in transferred taxes.
  - Combined financing from tax revenue rose from 13 percent of GDP in 1990-2014 to 15 percent in 2015-21.

### Recent shocks, fiscal positions, and sustainability pressures
- Major shocks: global financial crisis, Covid-19 pandemic, and spillovers from Russia’s war in Ukraine.
- Fiscal outcomes and projections:
  - Overall fiscal deficit widened to 9 percent of GDP in 2020 before narrowing to 5.6 percent of GDP in 2021.
  - Projected fiscal deficit remained elevated at 5½ percent of GDP in 2023 due to energy crisis measures and war spillovers.
  - Without policy action, fiscal deficits will remain elevated over the medium term as temporary measures expire while aging-related and interest payment costs increase.
  - Public expenditures were over 50 percent of GDP in 2019, the third highest among euro area countries; with unchanged policies, public expenditures would rank highest in percent of GDP in the euro area by 2027.
  - Four major functions—general public services, economic affairs, education, and health—account for half of general government spending and are higher than neighboring countries by 0.3-2.1 percentage points of GDP in 2020.
  - Social protection accounts for close to 40 percent of general government expenditures; old age and sickness and disability outlays account for one half of social protection spending.
- Regional fiscal deterioration:
  - Regions and communities combined deficits accounted for about 30 percent of general government deficits in 2020-21.
  - Rapid increase in regional borrowing and deficits during the pandemic translated into sizable increases in regional debt shares of GDP.

### Regional debt dynamics and market perceptions
- Regional and community debt increased from 12 percent of GDP in 2010-2015 to 17 percent of GDP in 2021.
- Debt increases over 2019-21:
  - Flemish region: +1.9 ppt of GDP.
  - Walloon region: +1.4 ppt of GDP.
  - Brussels-Capital region: +0.6 ppt of GDP.
- Market discipline limitations:
  - Reliance on market-based risk assessment to discipline regional borrowing may be ineffective if federal authorities are perceived as responsible for supporting subnational borrowers.
- Rating action:
  - In December 2021, Moody’s downgraded the long-term debt rating of the Walloon region by one notch to A3, citing long-lasting Covid-19 impacts, expectation of substantial deficits elevating debt for an extended period, and less favorable regional economic prospects.

### Policy implications and recommendations emphasized in the chapter
- Strengthen policy efforts to improve public debt sustainability and restore fiscal space to safeguard the economy from future shocks.
- Significant fiscal adjustment is needed, and its implementation will be more difficult if federal and regional/subnational policies are not well aligned and pulling in different directions.
- Improve the fiscal framework and budgetary processes to support medium-term fiscal consolidation and robust policies, with focus on the role of fiscal decentralization in supporting consolidation and ensuring debt sustainability.
- Consider the effects of greater revenue devolution on lowering vertical fiscal imbalance; revenue devolution on its own would lower VFI, while spending decentralization raises it.
- Recognize that heavy reliance on grant-based transfers undermines incentives for expenditure rationalization and fiscal discipline at subnational levels; moving to a more balanced mix of expenditure and tax autonomy could strengthen budgetary incentives.

*International Monetary Fund — chapter content as provided in the source PDF.*

### 13.      The outlook for regional public finances is challenging. The economic performance of

### 1belea2023002 - 13.      The outlook for regional public finances is challenging. The economic performance of

### Regional economic and fiscal outlook — findings
- The economy of Flanders recovered relatively quickly from Covid-19, surpassing its pre-pandemic GDP level in 2021.
- The Walloon economy recovered to pre-Covid-19 levels but experienced devastating flooding in 2021 and faces structurally higher unemployment.
- The Brussels-Capital Region’s post-pandemic catch-up has been slower; activity was expected to reach its pre-Covid-19 levels in 2022 (FPB July 2022).
- Regions and communities are relatively well protected against the effects of inflation due to the indexing of federal grants, but still faced additional costs for responses to recent shocks.
- Fiscal deficits of the regions and communities are expected to remain higher than before the pandemic.
- Local authorities are expected to continue to be in balance or record small deficits—in line with balanced budget requirements—while relying on revenue transfers from regional governments.

### Key regional fiscal projections and figures
- Walloon Region: overall deficit expected to decrease to -0.45 percent of GDP (€2.58 billion) in 2023 and -0.35 percent of GDP in 2025.
- Brussels-Capital Region: deficit expected to be broadly unchanged from 2023 (-0.2% of GDP) to 2027 (-0.3 % of GDP).
- French Community: overall deficits expected to increase to -0.2 percent of GDP (€1.1 billion) in 2023 and to -0.3 percent of GDP in 2025.
- Flanders: budget expected to reach a balance by 2027; interest costs expected to triple by 2027 to €1.2 billion (0.2% of GDP) (FPB July 2022, HCF and NBB December 2022; all figures are in percent of national GDP).

### Table 2: Summary of Fiscal Positions: Net Lending (+)/Borrowing (-) (Percent of GDP)
- General government: 2019 -1.9, 2020 -9.0, 2021 -5.6, 2022 1/ -5.2, 2023 1/ -5.8
- Entity I: 2019 -1.6, 2020 -6.7, 2021 -4.0, 2022 1/ -3.4, 2023 1/ -4.1
- Federal government: 2019 -1.9, 2020 -6.9, 2021 -4.2, 2022 1/ -3.0, 2023 1/ -4.1
- Social Security Funds: 2019 0.2, 2020 0.2, 2021 0.3, 2022 1/ -0.4, 2023 1/ 0.0
- Entity II: 2019 -0.3, 2020 -2.3, 2021 -1.6, 2022 1/ -1.8, 2023 1/ -1.6
- Regions and Communities: 2019 -0.3, 2020 -2.4, 2021 -1.6, 2022 1/ -1.7, 2023 1/ -1.4
- Local government: 2019 0.0, 2020 0.1, 2021 0.0, 2022 1/ -0.1, 2023 1/ -0.2
- Sources: FOD BOSA; and NBB.
- 1/ 2022 and 2023 are based on 2023 Draft Budgetary Plan.

### Debt sustainability assessment and required adjustment
- Belgium’s public debt sustainability risks remain elevated due to the high and rising level of outstanding debt, high continuing primary deficits, higher interest cost from rising interest rates over the medium term, aging costs, and other expenditure requirements (green transition, energy, national security).
- Staff recommends:
  - Adjustment of at least 0.6 percent of GDP to restrain the rise of overall deficit in 2023.
  - Adjustment of 0.8 percent of GDP or more annually during 2024-30 to reach structural balance (see Belgium 2022 Article IV Consultation Staff Report).
- The recommended size and duration of adjustment are demanding and require a comprehensive approach involving both the federal and subnational governments: reduce non-essential expenditures and accommodate new spending in a reduced envelope.

### Policy recommendations related to fiscal federalism (Recommendations 1–7)
- Recommendation 1: Fiscal adjustment at the subnational levels should be part of an overall general-government consolidation plan, with strict spending limits applying.
  - Consider a federal-regional/community split of 67-33 to share the burden of adjustment.
  - This split would imply annual reduction of spending of about 0.3 percent of GDP over the medium term at the level of the regions and communities under staff’s proposed adjustment path.
  - Introduce expenditure rules for all levels of government to improve transparency and accountability.
- Recommendation 2: Integrate systematic spending reviews in the budgetary process.
  - Expand and systematically integrate spending reviews at federal and subnational levels, with clear macroeconomic objectives including reining in rapid growth of public expenditure.
  - Reviews should be resource-intensive, focus on results, deliver efficiency gains, and form a strategic medium-term view for managing scarce public resources.
- Recommendation 3: Adopt a more strategic, multi-annual approach to fiscal policy making.
  - Fully develop medium-term budgetary frameworks for all levels of government to facilitate a rules-based approach and raise accountability.
  - Multi-year trajectories should correct overspending in subsequent 2-3 years rather than allowing deficits to persist unaddressed.
- Recommendation 4: Implement the 2013 Cooperation Arrangement to strengthen budgetary coordination between different levels of government.
  - The Cooperation Agreement (December 2013) aims to ensure budgetary coordination but has yet to be implemented in practice.
  - Advancing cooperation among federated entities would help adhere to medium-term budgetary objectives, restore buffers, and ensure fiscal sustainability.
- Recommendation 5: Fully internalize the cost of overborrowing and recalibrate grant transfers.
  - Introduce debt sustainability guidelines for subnational governments.
  - Recalibrate grant transfers to incorporate incentives and link transfers to demonstrated spending efficiency gains.
- Recommendation 6: Retain some flexibility in the pace and scope of fiscal decentralization.
  - Review whether the federal government has retained sufficient expenditures and revenues to conduct counter-cyclical policies.
  - Align the pace of expenditure and revenue decentralization to address vertical fiscal imbalances.
- Recommendation 7: Improve integration of fiscal sustainability objectives in structural reforms.
  - Ensure structural reforms (including pension and labor-market reforms) have clear fiscal consolidation objectives, cost-benefit assessments, and budgetary cost estimates at federal and subnational levels.
  - Enhance coordination where federal and regional competencies are closely associated (e.g., labor market interventions and social protection spending).

### Conclusions and strategic priorities
- Fiscal decentralization progressed during 2015-19 but vertical imbalances remained high as devolution of spending outpaced revenue decentralization.
- Reliance on grant-based transfers appears to have reduced spending discipline and contributed to rapid expenditure growth during 2020-22.
- Urgent and concerted efforts are needed to implement fiscal consolidation: rationalize spending (incl. spending reviews), apply strict spending limits, increase revenues via tax and revenue administration reforms, and enhance growth and employment through decisive structural reforms.
- Improve fiscal policy coordination across all levels of government via clear communication, strong fiscal institutions (fiscal rules and fiscal councils), a good track record on past fiscal performance, and political will for all levels of government.
- Implement cooperation and burden sharing among federal, regional, and community governments to support consolidation.

*Source: 1belea2023002 — IMF chapter.*

### Box 1. Belgium: Evolution of Fiscal Federalism in Belgium (Concluded)

### Box 1. Belgium: Evolution of Fiscal Federalism in Belgium (Concluded)

### Reforms and Key Institutional Changes
- 2001
  - The Flemish Parliament became directly elected under the Lombard Agreement.
  - Established the Lambermont Agreement:
    - Regions were granted an extension of their fiscal powers and the communities provided with financial measures.
    - More tax autonomy for the regions: to levy positive or negative surcharges on PIT within a limit of 6.75 percent of the PIT.
    - Refinancing of communities: additional grant and increased VAT claim for education; PIT adopted for the future.
  - Strong push on revenue decentralization.
- 2011 (Substantial state reform will take place in several stages)
  - More competences were shifted from the federal level.
  - Regions made responsible for territorial matters (e.g., infrastructure) in economy, employment and tax matters; communities become responsible for people-related matters (e.g., culture, education), and family policy (e.g., healthcare, family allowance).
  - The reform in 2011-13 included:
    - A first partial decentralization of Social Security (a transfer of 61 million euros).
    - Decentralized competences of 20 billion euros, including child allowances (6 billion euros), employment policy (4 billion euros) and health policies (4 billion euros).
    - Increased decentralized financing (e.g., increased tax autonomy of 12 billion euros and expanding regional PIT competences).

### Fiscal Decentralization and Changes in Financing
- Sixth state reform increase in budgetary autonomy:
  - Regions and communities granted the right to run fiscal deficits and to finance by borrowing.
  - Regions and communities authorized to issue debt on financial markets to fund current and capital expenditures.
  - Local governments (municipalities and provinces) can only borrow to fund investment projects.
- Oversight and potential federal intervention:
  - Federal authorities, based on recommendation of the High Council of Finance, could impose borrowing limits on regions if they have not respected their budgetary targets, to prevent endangering economic stability or the external balance, while in practice implementation is likely far more complex.
- High Council of Finance (footnote summary):
  - Composed of members nominated by the federal, regional, and community levels, and the National Bank of Belgium.
  - Monitors and analyzes borrowing requirements of all levels of government at regular intervals, and based on fiscal/debt sustainability, formulates recommendations about medium- and long-term budgetary targets for the different government levels.

### Fiscal Policy Options to Accelerate Emissions Reductions (Summary of Recommendations)
- Economy-wide carbon pricing reinforced by sectoral policies:
  - A carbon tax that progressively increases to around €100 per tonne by 2030 for sectors not covered by the existing EU Emissions Trade Scheme (ETS)—namely, transportation, buildings, agriculture, and excluded industrial emissions.
    - The tax should be phased in as international energy prices fall and ahead of the EU-wide ETS for buildings and transportation.
    - Revenues should be used to compensate vulnerable households and trade-exposed firms and increase productivity, with direct support for firms phased out as the Carbon Border Adjustment Mechanism (CBAM) is phased-in.
    - The tax should be extended to non-carbon greenhouse gases (e.g., methane) if administrative and political costs are manageable.
  - A domestic price floor for sectors covered by the existing EU ETS—namely, industry and power—with the floor equal to the non-ETS sector carbon tax to increase investor certainty and equalize emissions prices across the economy.
- Sectoral and regulatory measures:
  - A feebate for the power and transportation sectors to promote decarbonization as nuclear power is planned to be phased out and to speed up electrification of the vehicle fleet.
    - Transportation sector feebates should be coupled with the removal of the company car regime.
    - Feebates for industry, building heating, and appliances could also be considered to promote cost-efficient, deeper decarbonization and needed renovation of the housing stock.
  - Reduced fees and levies on electricity consumption for charges not directly related to delivering electricity to the end-user to allow for more cost-reflective pricing and promote switching from fossil fuel-based to electricity-powered activities.
  - Transitioning from the current social tariff to a fiscally-sustainable, income-based social protection system with benefit levels that phase out as total income or wealth increases to improve employment incentives and decarbonization.
- EU-level engagement:
  - Promoting dialogue at the EU-level to harmonize ETS prices and include all sectors under a single trading scheme.

### Background: Emissions Context and Risks
- Global and Belgian context:
  - Limiting global warming to 1.5 to 2°C requires cutting CO2 and other GHGs by 50 and 25 percent, respectively, by 2030 compared to 2019 levels, followed by a rapid decline to net zero emissions near the middle of the century.
  - Over 85 countries, representing around 80 percent of current emissions, have communicated ‘net-zero’ targets by mid-century but intermediate mitigation targets and policies remain insufficient.
  - Under current policies, global emissions are expected to increase significantly to 2030.
  - Belgium’s primary climate-related economic risks are heat-related productivity and health losses and flooding, with annual economic costs projected to be up to one percent of GDP by 2050.
- Sectoral shares and historical changes (2019 vs. 2005):
  - Industrial sector: 34 percent of emissions in 2019.
  - Transportation: 21 percent.
  - Buildings: 20 percent.
  - Power generation: 13 percent.
  - Agriculture: 8 percent.
  - Emissions reductions realized by sector since 2005:
    - Power generation: down by 38 percent.
    - Industry: down by 21 percent.
    - Buildings: down by 21 percent.
  - Emissions in transportation and agriculture have remained relatively constant.

### Projections and Targets: Current Policy Gaps
- Projected trajectory under current policies:
  - By 2030, total emissions are estimated to increase to four percent above 2019 levels under current policies.
  - Drivers include higher power sector emissions-intensity due to the phase out of much of Belgium’s nuclear generation capacity:
    - Nuclear power generated 45 percent of electricity in 2019 (compared to 27 and 10 percent from natural gas and wind, respectively).
  - Natural gas power generation will rise; increase in wind power generation partly offsets the switch from nuclear to natural gas.
- Comparison to targets and expected shortfalls:
  - Under the EU Effort Sharing Regulation (ESR), Belgium is required to reduce emissions to 47 percent below 2005 levels by 2030 for activities not included in the existing EU ETS.
  - Projected decline by 2030 under current policies: 11 percent.
  - Additional policies in Belgium’s National Energy and Climate Plan (NECP) yield overall emissions falling by 28 percent (split between a decline of 35 and 22 percent for non-ETS and ETS sectors, respectively), but do not close the gap to ESR requirements.
  - Failing to meet ESR and other targets may result in financial costs, potentially through purchasing ‘statistical transfers’ from member states that overachieve or using additional flexibilities.

### Table of Targets and Assessments (Selected Entries)
- ETS sectors, emissions
  - 2019: -27%
  - CPAT: -20% (WEM)
  - EEA: -14% (WEM), -19% (WAM)
- Power, emissions
  - NECP: -100% by 2050, no 2030 target
  - 2019: 38%
  - CPAT: -10% (WEM)
  - EEA: 4% (WEM), -4% (WAM)
- Industry, emissions
  - NECP: -33% in 2030, -79% in 2050 for non-ETS industry
  - 2019: -21%
  - CPAT: -24% (WEM)
  - EEA: -25% (WEM), -29% (WAM)
- Non-ETS sectors, emissions
  - ESR: -47% in 2030
  - NECP: -35% in 2030, -85 to 87% in 2050; Flanders (-40% in 2030, -85% in 2050); Wallonia (-35% in 2030); Brussels (-40% in 2030)
  - 2019: 11%
  - CPAT: -10% (WEM)
  - EEA: -10% (WEM), -35% (WAM)
- Transport, emissions
  - EU: -55% reduction by 2030 relative to 2021 (reflects proposals in the Fit for 55 package)
  - NECP: -27% in 2030, -100% in 2050; Wallonia (-24% by 2030)
  - 2019: 3%
  - CPAT: -6% (WEM)
  - EEA: 4% (WEM), -32% (WAM)
- Buildings, emissions
  - NECP: no explicit federal target; Wallonia (-29% by 2030)
  - 2019: -21%
  - CPAT: -18% (WEM)
  - EEA: -24% (WEM), -44% (WAM)
- Agriculture, emissions
  - NECP: -23% in 2030, -47% in 2050
  - 2019: -4%
  - CPAT: 1% (WEM)
  - EEA: -8% (WEM), -18% (WAM)
- Economy-wide, emissions
  - NECP: no explicit federal target, Wallonia (-30% by 2020 and -95% by 2050, compared to 1990), Brussels (-40% in 2030, ‘approach net zero’ by 2050), Flanders (no explicit target)
  - 2019: -19%
  - CPAT: -16% (WEM)
  - EEA: -13% (WEM), -28% (WAM)
- Power, renewable share
  - EU: 25% of gross final energy consumption by 2030
  - NECP: 17.5% of energy consumption by 2030
  - 2019: 9.9%
  - CPAT: 16.7% (WEM)

### EU and Belgian Policy Interaction
- EU Emissions Trading Scheme (ETS) overview:
  - ETS covers large emissions sources from energy, industry, and within-EU aviation.
  - The ETS currently covers about 41 percent of total EU GHGs.
  - Presently the cap declines by 2.2 percent each year; expected to increase to 4.3–4.4 percent annually to comply with the new ‘Fit-for-55’ target.
  - EU allowance prices rose to around €80 per tonne in September 2021 and have since hovered around this level.
  - Drawbacks of the ETS:
    - Volatile emissions prices create investor uncertainty.
    - With a fixed cap at the EU level, emissions reductions from overlapping policies for ETS sectors in Belgium are offset by extra emissions in other EU countries via a decline in the ETS allowance price (i.e., full leakage).
    - The Market Stability Reserve (MSR) withdraws emissions allowances from the system (sometimes permanently) when the amount of banked allowances exceeds a threshold level.
  - Energy intensive, trade exposed (EITE) industries have historically been granted free allowance allocations to address competitiveness and leakage concerns; these are expected to be phased out as the EU Carbon Border Adjustment Mechanism (CBAM) is introduced.

*Source: Box 1. Belgium: Evolution of Fiscal Federalism in Belgium (Concluded), 1belea2023002*

### 7.      In December 2022, the European Commission and the European Parliament

### 7.      In December 2022, the European Commission and the European Parliament 

### EU ETS reform and new ETS for road, buildings, and other sectors
- Provisional agreement to introduce a separate ETS for road transportation, buildings, and other sectors.
- Timing: introduced in 2027 (or 2028 if energy prices are ‘exceptionally high’).
- Allowance price cap: not exceeding €45 per tonne.
- Allowance cap trajectory: annual, linear decline of 5 percent per year from 2024 emission levels.
- Exemption: member states with a national-level carbon tax equal to or above the ETS allowance price.
- Revenue use: a portion of revenues will support vulnerable households and small businesses through the Social Climate Fund.

### Key EU directives and sectoral standards
- Principal directives and regulations cited:
  - Energy Taxation Directive (ETD): provides minimum excise duties on energy products and electricity.
  - Renewable Energy Directive: sets renewable energy targets for electricity, heating, cooling and transportation; legally binding as of 2021.
  - Energy Efficiency Directive: provides binding energy consumption reductions relative to a baseline level.
  - Energy Performance of Buildings Directive: requires each member to provide a long-term renovation strategy for buildings and phases in minimum energy performance standards for buildings.
  - CO2 emissions performance standards for road transportation: progressively more stringent; will require all new passenger vehicles and vans to be zero-carbon by 2035.

### Belgium: governance and competencies
- Regions control: electricity and natural gas distribution (including tariffs), district heating networks, onshore renewable energy, waste management, public transportation, urban and rural planning, agriculture, building and vehicle efficiency requirements (except for federal buildings), and vehicle registration.
- Federal government controls: tax policy, offshore renewable energy, nuclear energy, energy R&D, energy pricing policy, and the national rail system.
- Coordination: forums exist (e.g., the National Climate Commission) but do not ensure binding coordination.

### Current fiscal instruments and excise structure (exact rates and impacts)
- Excises as main instruments to (indirectly) price carbon; rates imply substantially different carbon prices across fuels and activities.
- Road fuels:
  - Excise on unleaded petrol: €193 per tonne of CO2 (equivalently €0.45 per liter of fuel when used for transportation).
  - Excise on diesel (transportation): €160 per tonne of CO2 (equivalently €0.45 per liter of fuel when used for transportation).
  - Reduced diesel excise for non-transportation uses: around €0.02 per liter.
  - Refund: portion of excise charged on transportation diesel for professional use refunded; the refund was €0.08 per liter most recently.
- Other fuels:
  - Natural gas excise maximum: €0.31 per GJ (equivalent to around €4.3 per tonne of CO2).
  - Coal excise maximum: €0.37 per GJ (equivalent to around €4.3 per tonne of CO2).
  - Electricity excise: €0.50 per MWh (commercial) and €2.93 per MWh (residential).
  - Biofuel content of blended fuels taxed at the rate of the fossil fuel (e.g., diesel with biofuel fully taxed at the diesel rate).
- Value-added tax (VAT):
  - Standard VAT rate: 21 percent.
  - Reduced VAT rate (temporary, but likely to be made permanent for some items): 6 percent for natural gas, district heating, and electricity.

### Fossil fuel subsidies, fiscal cost, and distribution
- Reduced excise duties (bulk of subsidies): €10.5 billion in 2019 (around 2.2 percent of GDP).
- Preferential tax treatment for company cars and road fuel subsidies: around €2.5 billion and growing.
- Social tariff: coverage expanded during recent energy crisis; now around 20 percent of households.
- Subsidy distribution by end use:
  - Heating and electricity: around 40 percent of subsidies.
  - Transportation: around 30 percent of subsidies.
  - Industry: around 25 percent of subsidies.
- Trend note: total subsidies decreased from 2015 to 2019, but recent policy decisions and international price developments are likely to reverse the recent trend.

### Effective carbon tax rates and sectoral gaps
- Combined effect of excise, VAT, and social protection systems results in effective carbon tax rates particularly low for buildings and agriculture.
- Road transportation and power sector carbon taxes: broadly in line with the EU average and slightly above the OECD average, but below neighboring countries and levels needed to meet emissions-reductions targets.
- Industrial sector: low effective carbon prices due to low natural gas and coal excise rates and a significant portion of emissions not covered by the ETS (around 20 percent of industrial sector emissions).
- Buildings and agricultural, fish, and forestry sectors: low carbon price levels driven by reduced excise rates for diesel (when used for heating) and natural gas.

### Response to the 2022 energy crisis (Box 1) — measures, costs, and targeting
- Impact on low-income households: electricity, natural gas, and oil products make up 3.9, 2.1, and 3.5 percent of total household consumption, respectively, for the lowest 20 percent of the income distribution.
- Government measures: federal and regional measures cost about 1.7 percent of GDP and include reduced VAT for natural gas, electricity, and district heating; reduced excises on petrol and diesel; additional cash transfers; and expanded eligibility for the social tariff.
- Targeting of measures: roughly 1/3 of measures are targeted and distort price signals, while 2/3 are untargeted and not price distortionary.
- Policy design recommendation highlighted: household assistance should be targeted (to limit fiscal costs) and unrelated to energy consumption (to preserve incentives for energy conservation).
- Planned design: government plans to introduce a flexible excise rate that declines for base levels of consumption as natural gas and electricity prices rise; improving targeting mechanisms through matching tax, household size, and third-party data is a medium-term exercise.

### Policy thinking and reform proposals at federal level
- Authorities considering reforms including possibly increasing carbon prices on non-ETS sectors.
- Tax Reform Blueprint (presented July 2022) notes importance of more extensive carbon pricing in non-ETS sectors.
- Recent reduced VAT rates for natural gas and district heating likely to be made permanent; government plans to raise excises to allow 2021 post-tax prices to be reached and to make the portion of the excise applicable to base electricity and natural gas consumption vary with energy price spikes.
- Directional shift: energy taxation needs to shift from electricity to fossil fuels — could entail progressively rising excise rate on natural gas (and other fossil fuels), potentially through carbon pricing.

### Rationale for economy-wide carbon pricing (advantages and strategic design)
- Advantages of carbon pricing:
  - Across-the-board incentives to reduce energy consumption and shift to cleaner fuels.
  - Equalizes marginal abatement costs across fuels and sectors.
  - Mobilizes revenues that can support vulnerable households and firms and be used to improve productivity.
  - Generates domestic environmental benefits (e.g., reductions in local air pollution mortality).
  - Administratively straightforward and can build on existing excise tax system.
- Good carbon pricing strategy elements:
  - Covers emissions comprehensively.
  - Establishes predictable prices and aligns stringency with mitigation goals.
  - Exploits fiscal opportunities (revenue use for support and productivity-enhancing tax shifts).
  - Coupling a non-ETS carbon price with a price floor for ETS sectors achieves economy-wide equalization of marginal abatement costs.
  - Progressively increasing the policy’s stringency with an announced price path allows households and firms to adjust and promotes investment in clean technologies.

### Carbon tax vs. ETS — comparative points (Box 2 and discussion)
- Carbon tax: greater price certainty (supports long-payback investments), easier administration (builds on fuel tax regime), generates government revenues.
- ETS: provides certainty over emissions level but has historically shown price volatility; revenues only if allowances are auctioned and free allowances can create windfalls.
- Mitigation of ETS volatility: include a price floor or market stability reserve (MSR acts as a weak version of a price floor).
- Overlapping policies: carbon tax is more compatible with complementary policies (feebates, emission regulations, subsidies) than an ETS without a price floor.

### International practice in non-ETS carbon pricing (excerpt from Table 2)
- Current non-ETS carbon prices vary from €35 to €110 per tonne in selected countries:
  - Austria: Tax to ETS; €35 (2023) to €55 (2025); sectors: Heat, Tran.
  - Denmark: Tax since 1992; €47 (2022) to €101 (2030); sectors: All (lower rate for ETS sectors).
  - Finland: Tax since 1990; €77 (2022, Tran.), €53 (2022, other); sectors: Heat, Tran., Ind.
  - France: Tax since 2014; €45 (2022); sectors: Heat, Tran., Ind. (ETS sectors are exempt).
  - Germany: Tax to ETS since 1/2021; €30 (2022) to €55 (2025); sectors: Heat, Tran. (price fixed until 2026).
  - Ireland: Tax since 2010; €34-41 (2022) to €100 (2030); sectors: Heat, Tran., Ind. (other sectors covered with exemptions).
  - Portugal: Tax since 2015; price: Previous years’ avg. ETS price; sectors: Heat, Tran., Ind.
  - Sweden: Tax since 1991; €110; sectors: Heat, Tran.
- Note: Some countries apply lower rates for ETS sectors or exempt ETS sectors; Germany and Austria plan market transition after fixed-price periods.

### Quantified modelling outcomes of introducing a carbon price for non-ETS sectors (selected scenarios and impacts)
- Illustration: a tax progressively reaching €75 per tonne combined with a price floor for industry and power yields:
  - Overall emissions: 25 percent below 2005 levels in 2030 (or 12 percent below a Business-as-Usual (BAU) scenario).
  - Revenue: raises 0.6 percent of GDP.
  - Economic efficiency cost: 0.2 percent of GDP (offset by improved health, reduced congestion, among others).
  - Sectoral emissions changes relative to BAU:
    - Power: emissions decline by 1 percent.
    - Industry: emissions decline by 19 percent.
    - Transportation: emissions decline by 6 percent.
    - Buildings: emissions decline by 13 percent.
- Agricultural emissions: modest price responsiveness at low carbon price levels because majority are methane and nitrous oxide; deeper abatement is more costly.
- Even high carbon prices (e.g., €125 per tonne) do not achieve mitigation targets alone; reinforcing sectoral policies are required.

*Source: 1belea2023002 - 7.      In December 2022, the European Commission and the European Parliament*

### 19.      A practical and effective reform for Belgium would be to phase in a carbon price on

### 1belea2023002 - 19. A practical and effective reform for Belgium would be to phase in a carbon price on

### Major findings: emissions outcomes and macro impacts
- Table 3 sectoral outcomes (Relative to 2005 Levels; Carbon price (€ per tonne of CO2 eq)):
  - Scope Target 2019: Non-ETS -47, ETS -21, All -19, Ren. share 17.5, Revenue raised (% GDP) 0.2, Efficiency costs (% of GDP) -0.1, Welfare benefits (% GDP) 0.0, Deaths averted 50.
  - At €0: Non-ETS -11; Transport -3; Buildings -18; Agriculture -4; ETS -18; Power -10; Industry -24; All -15; Ren. share 9.6; Revenue raised (% GDP) 0.3; Efficiency costs (% of GDP) -0.2; Welfare benefits (% GDP) 0.0; Deaths averted 72.
  - At €25: Non-ETS -10; Transport -6; Buildings -21; Agriculture 1; ETS -23; Power -11; Industry -30; All -20; Ren. share 17; Revenue raised (% GDP) 0.6; Efficiency costs (% of GDP) -0.3; Welfare benefits (% GDP) 0.0; Deaths averted 93.
  - At €50: Non-ETS -14; Transport -8; Buildings -25; Agriculture -8; ETS -27; Power -11; Industry -34; All -22; Ren. share 18; Revenue raised (% GDP) 0.8; Efficiency costs (% of GDP) -0.4; Welfare benefits (% GDP) -0.1; Deaths averted 114.
  - At €75: Non-ETS -17; Transport -10; Buildings -28; Agriculture -9; ETS -30; Power -11; Industry -39; All -25; Ren. share 18; Revenue raised (% GDP) 1.1; Efficiency costs (% of GDP) -0.6; Welfare benefits (% GDP) -0.2; Deaths averted 132.
  - At €100: Non-ETS -19; Transport -12; Buildings -31; Agriculture -10; ETS -33; Power -11; Industry -44; All -28; Ren. share 19.
  - At €125: Non-ETS -21; Transport -13; Buildings -34; Agriculture -12; ETS -38; Power -17; Industry -48; All -32; Ren. share 19.
  - At €150: Non-ETS -23; Transport -15; Buildings -37; Agriculture -13; ETS -?; Power -?; Industry -?; All -?; Ren. share 20. (Table shows up to €125 explicitly; ren. share 20 appears in rightmost column.)
- Revenues and costs:
  - Revenue raised (% GDP) entries reported: 0.2, 0.3, 0.6, 0.8, 1.1 (aligned with increasing carbon price levels in table).
  - Efficiency costs (% of GDP) reported: -0.1, -0.2, -0.3, -0.4, -0.6.
  - Welfare benefits (% GDP) reported: 0.0, 0.0, 0.0, -0.1, -0.2.
- Air-pollution co-benefits: Deaths averted reported as 50, 72, 93, 114, 132 across increasing price points.
- Renewable share (Ren. share) values: 17.5 (2019), then 9.6, 17, 18, 18, 19, 19, 20 across price columns.

### Distributional impacts and acceptability
- Indexation: Belgium’s extensive wage and social benefit indexation automatically protects the average household that uses electricity and/or natural gas for heating because higher energy taxes increase inflation.
- Without indexation:
  - Loss in purchasing power under a €100 per ton carbon tax: poorer households 1.8 percent of total consumption; wealthier households 1.5 percent of total consumption.
  - Rural households experience higher losses than urban households across all income deciles.
- Revenue recycling and compensation:
  - Around 25 percent of carbon pricing revenue is needed to fully compensate households in the lower four income deciles, leaving around 0.6 percent of GDP in revenue for other objectives (e.g., reducing income taxes).
  - Energy-intensive firms: estimated 1–2 percent increase in input costs due to higher electricity prices; suggested support via reductions in the corporate income tax, investments in productive public infrastructure and R&D, and/or rebates based on output rather than energy inputs.
  - Recommended compensation delivery: income-based measures (e.g., cash transfers) phased out as total income or wealth increases; support should not be conditional on household or firm energy expenditure.

### Policy recommendations: design and sequencing of carbon pricing
- Core recommendation:
  - Phase in a carbon tax for non-ETS sectors through the excise regime, reaching €100 per tonne by 2030.
  - Introduce a domestic price floor for ETS sectors aligned with the carbon tax for non-ETS sectors.
- Rationale for early domestic non-ETS pricing (prior to EU-wide ETS planned introduction in 2027):
  - (i) Non-ETS emissions reductions are needed immediately to meet Belgium’s ESR and to avoid rapid and costly decarbonization later.
  - (ii) Pending final design of the EU-wide ETS increases investment uncertainty; a domestic price path announced in advance can act as a price floor and reduce investment risk.
  - (iii) Competitiveness and leakage concerns are less pronounced for transport and buildings.
  - (iv) Expected decline in international energy prices provides an opportunity to phase in carbon pricing without increasing post-tax prices.
- Operational design choices:
  - Price path: progressively increase to around €100 per tonne by 2030, announce in advance, small annual increases (example: €10 per tonne each year), adjust for inflation to maintain real value.
  - Use excise regime for phasing in a carbon tax:
    - Benefits: avoids volatility, minimal administrative burden, within federal competencies, compatible with future EU ETS (acts as domestic price floor), avoids leakage from regional mitigation policies and a national ETS.
  - Extend tax to non-carbon GHGs (e.g., methane) if administrative, compliance and political costs can be managed; consider proxy taxes in the medium-term.
  - Revenue use:
    - Compensate vulnerable households via income-based support.
    - Recycle revenues to reduce labor and/or corporate income taxes to increase productivity.
  - ETS price floor mechanics:
    - Consider an ETS price floor applied as a surcharge (resembles U.K. Carbon Price Floor), with industry-generated revenues recycled to protect competitiveness; Netherlands example noted (price floor levels likely below EU ETS and may not be binding).

### EU-level policy actions and coordination
- Suggested EU-level reforms to strengthen decarbonization framework and achieve synergies:
  - Extend the EU ETS so aggregate emissions from power, industry, transport, and buildings are subject to one aggregate cap with a common emissions price across sectors (would require compensation for lower-income member states).
  - Consider including agriculture for greater efficiency (administrative feasibility caveat).
  - Allow member states to re-allocate a greater share of emissions reductions from transport/buildings to power/industry to lower national mitigation costs.
  - Extend ability to trade ESR quotas between states to promote cost-efficiencies (political agreement reached in late November; details not clear).
  - Establish an exogenous and escalating price floor for both EU ETSs to provide investment signals and allow overlapping member-state measures to lower emissions rather than only lowering allowance prices.

### Sectoral reinforcement and complementary instruments
- Need for reinforcement:
  - Carbon pricing likely needs to be high to achieve targets, especially in transport and buildings; sectoral instruments can complement pricing while avoiding large energy price increases.
  - Sectoral instruments should be flexible and ideally technology neutral.
- Feebates:
  - Feebates (revenue-neutral tax-subsidy schemes) are presented as a relatively efficient reinforcing policy across transport, power, buildings, industry, and agriculture.
  - Advantages: more flexible and potentially more cost-effective than emissions-rate regulations; do not raise average consumer prices or firm costs; can reward going beyond standards.
- Power sector specifics:
  - Decarbonizing electricity production is key to overall decarbonization because electrification of industry, transport, and buildings must be supported by low emissions-intensity electricity.
  - Renewable potential: onshore wind and rooftop solar capacity potentially able to more than double existing electricity demand (EnergyVille 2021).
  - Current baseload and nuclear phase-out:
    - Nuclear power currently makes up 45 percent of generation.
    - Nuclear phase-out legislated in 2003 and expected to be complete by 2035.
    - First reactor (17 percent of nuclear capacity) decommissioned in 2022; others planned for 2023, 2025, and 2035.
  - Capacity Remuneration Mechanism (CRM):
    - First CRM auction (2021) awarded 4.4 GW for delivery in 2025, with 3.6 GW from natural gas and the rest primarily from co-generation and demand-side response.
    - Annual CRM auctions planned to ensure capacity one and four years ahead.
    - Federal auction planned to develop 3.15 to 3.5 GW in new offshore wind generation in Princess Elisabeth Island.
    - Increasing interconnections to import clean electricity from Norway and Denmark.
  - Note: Price responsiveness of power sector is relatively low; capacity committed to natural gas through the CRM and tax application only above EU ETS prices limit reductions.

*Source: IMF Staff estimates using CPAT and IMF staff analysis from the provided content.*

### 28.      A feebate reinforces incentives for shifting to a cleaner power generation mix without

### A feebate reinforces incentives for shifting to a cleaner power generation mix without a first-order tax burden—that is, a tax on remaining emissions—for the average electricity producer and consumer.

### Feebate design and implementation for power sector
- Under a feebate scheme, generators could be subject to a fee given by:
  - {CO2 price} × {CO2/kWh – industry-wide average CO2/kWh} × {electricity generation}
- Illustration: a feebate with price €100 per tonne would have applied a fee equivalent to 3 cents/kWh for natural gas and a subsidy of 1.5 cents/kWh for renewables in 2022.
- Practical implementation notes for Belgium:
  - Could build off existing monitoring procedures under the EU ETS.
  - Nuclear would be exempt given the planned phase-out.
  - Use a smoothing mechanism (e.g., a five-year average) to determine the industry-wide average emissions-intensity to promote certainty and avoid jumps in subsidies as nuclear is decommissioned.
  - To be within federal competencies, could be applied via refundable credits and taxes in the corporate or personal income (PIT) tax regime (may require data sharing), or ideally as a direct excise/subsidy scheme.
- Interaction with existing mechanisms:
  - A feebate interacts well with the CRM: CRM maintains capacity incentives through auctions and derating factors; the feebate promotes low-carbon electricity within that framework.
- Design choices to preserve incentives:
  - Pivot point (emissions-intensity that results in no subsidy or fee) could be set exogenously to decline at a rate aligned with renewable targets to avoid declining fees on fossil-fuel generation as nuclear phases out.
- Broader technology incentives:
  - Promotes more energy efficient natural gas technologies, hydrogen blending with natural gas, and carbon capture; strongly disincentivizes coal power generation.
- Applicability:
  - Can be applied to residential renewable energy production connected to the grid; separate policy would be needed for renewable heating (e.g., rooftop solar PV to heat water).

### Illustrative impacts and scenarios (power sector)
- Feebates shown to significantly reduce electricity emissions-intensity compared with business-as-usual (scenarios illustrated using CPAT).
- Scenarios presented include:
  - Business as Usual
  - Feebate of USD 100
  - Feebate of USD 200
- Important complementarities:
  - Switching to renewables needs to be combined with electricity grid management, demand-side response, and energy storage to reduce intermittency concerns.
- Limitation regarding EU ETS dynamics:
  - National feebates reduce national emissions but will not (fully) reduce EU-wide emissions if the MSR is not operating, because falling Belgian emissions reduce the ETS price and result in leakage to other countries and to Belgium’s industrial sector.

### Existing clean energy promotion (Green Certificate Scheme) and fiscal charges on electricity
- The primary existing scheme ('Green Certificate Scheme') should be reconsidered:
  - The scheme resulted in a cost of €2.4 billion in 2020.
  - Contributed to growing debt levels for Elia, Belgium’s transmission system operator.
  - Is regressive: wealthier households have larger shares of rooftop solar and residential renewable production.
  - Includes arbitrary design parameters (e.g., minimum level of support) and is partly financed through surcharges on electricity bills, contributing to higher electricity prices relative to fossil fuels.
- Feebates could replace the Green Certificate Scheme to improve incentive efficiency while not increasing prices.
- Recommendation on charges and levies:
  - Reduce fees and levies on electricity to promote electrification by lowering the price of electricity relative to heating oil, natural gas, diesel and gasoline.
  - The energy portion of electricity costs (excluding fees, levies, taxes) is on par with France, Germany, and the Netherlands; differences arise from charges to recover network costs, fees, levies, taxes, and possibly market power.
  - Suggestion: gradually remove charges that do not directly relate to delivery of electricity to end-users and instead finance those measures through the general budget to promote climate objectives and align electricity prices with generation costs.

### Industry: emissions profile and feebate application
- Industrial emissions account for 35 percent of Belgium’s total emissions.
- Main emitting sub-sectors: chemicals; refining of oil and coke; manufacture of non-metallic minerals and metals.
- Emissions split roughly between direct fuel combustion and industrial processes.
- About 20 percent of industrial emissions are outside the ETS due to:
  - Installations below the ETS threshold of 25,000 tonnes of CO2 per year.
  - Emissions from biomass being excluded from the ETS.
  - Most excluded emissions occur in chemical and food sectors and are not covered by domestic mitigation policies (except voluntary regional agreements).
- Feebate design for industry:
  - Firms within an industry could be subject to a fee given by:
    - {CO2 price} × {CO2/output – industry-wide average CO2/output} × {firm output}
  - Applied to emissions from fuel combustion and direct and process emissions.
  - Avoids a first-order burden on the average producer (they pay no charge on remaining emissions), alleviating competitiveness and leakage concerns versus charging remaining emissions.
  - Less efficient at reducing emissions than a scheme that reduces output because it does not decrease output directly.
  - Could build on EU ETS monitoring of direct emissions and operate alongside voluntary agreements.
  - Pivot-point could be set exogenously based on projected emissions-intensity where market power concerns exist; pivot-points could be unique to sub-sectors with cross sub-sector permit trading to avoid leakage and promote cost-effectiveness.

### Buildings: emissions, heating, and feebates
- Buildings constitute 21 percent of total emissions.
- Residential buildings are 75 percent of building emissions and largely use natural gas and oil.
- Energy share comparisons:
  - Oil: 32 percent of total energy consumption in Belgium vs. 21 percent in the EU.
  - Renewables: 8 percent in Belgium vs. 20 percent in the EU.
  - Electricity: 20 percent in Belgium vs. 25 percent in the EU.
- Energy use in buildings:
  - 83 percent of building energy is used for space and water heating; remainder for lighting and appliances.
- Local health pollutants:
  - Biomass burned for heating represented 7 percent of total household heating in 2020.
- Heterogeneity and equity considerations:
  - 80 percent of constructions occurred prior to energy standards across Belgium and 94 percent in Brussels.
  - Poorer households have worse insulation; apartments have better energy performance, contributing to Brussels’ relatively more efficient housing stock.
  - Heating source variation: oil boilers in Brussels, Flanders, Wallonia are 16 percent, 24 percent, and 50 percent respectively.
  - 45 percent of households are not connected to the natural gas grid and generally choose between heat pumps and oil boilers.
  - Household expenditure: lowest income quartile spent roughly eight percent of total consumption on natural gas, heating oil, and electricity vs. 3.6 percent for the highest quartile in 2018.
- Heating cost illustration (assumptions preserved):
  - Heat pump cost competitiveness depends on pre-crisis price levels.
  - Fuel price assumptions used: natural gas EUR 0.054 and 0.034 per kWh (without and with social tariff), heating oil EUR 0.060 and 0.045 per kWh, electricity EUR 0.290 and 0.189 per kWh.
  - Discount rate 7 percent; interest rate 4.5 percent; grant assumed to cover 70 percent of equipment and installation costs; 20-year lifetime assumption.
  - Removing fees and levies on electricity reduces heat pump costs by 20 percent in the illustrative calculation.
  - Carbon tax raises all-in natural gas heating costs by about 28 percent, 38 percent for oil, and 4 percent for a heat pump.
  - Social tariff significantly reduces costs for electricity, natural gas, and oil; it makes natural gas heating significantly cheaper than heat pumps even if government pays the entire capital cost of a heat pump.
- Renovation needs:
  - Current renovation rate is 1 percent annually and needs to increase to 2.5 to 3 percent to meet emissions targets.
  - Deep renovations are needed; barriers include liquidity constraints, cost-benefit mismatches between owners and renters, unawareness/uncertainty about energy savings, inconsistent EPC criteria across regions, and supply constraints in construction/labor.
- Feebate and tax options for buildings:
  - Feebates could encourage phase-out of fossil fuel space heating, energy-efficient appliances, and renovations.
  - Example appliance feebate formula:
    - {CO2 price} × {CO2 per unit of energy} × {energy consumption per unit – industry-wide energy consumption per unit} × {number of units}
    - For refrigerators: energy consumption per unit would be kWh/cubic foot cooled and number of units would be cubic feet.
  - Property taxes linked to energy use per square meter or EPC scores could mimic a feebate but require detailed study:
    - Increased administrative cost for auditing reported energy performance/EPCs.
    - Effectiveness depends on correlation between EPC scores and CO2 emissions.
    - Could be regressive since poorer households live in less insulated dwellings.
  - Federal policy options are limited by information and competency constraints.

### Transportation: profile and implications
- Road transport emissions mainly from passenger vehicles (75 percent); road freight makes up most of the remainder.
- Car ownership around one car for every two people (similar to EU average and neighbors).
- EV and plug-in hybrid share in new car sales: 5 percent in 2021.
- Fuel efficiency of new cars is below the EU average nationally and regionally.
- EV charging infrastructure:
  - 8.8 charging points per 100 km of road in Belgium.
  - Germany: 26 per 100 km; Netherlands: 64 per 100 km.
  - Less than 10 percent of charging stations in Belgium are ‘fast’ compared to much higher rates in other countries.

*Source: IMF staff estimates and analysis in the provided content unit.*

### 44.      There are registration and annual circulation taxes applied at the regional level, as well

### 44.      There are registration and annual circulation taxes applied at the regional level, as well 

### Regional taxes, incentives, and complementary policies
- Registration and annual circulation taxes vary by region; Flanders and Walloon registration taxes vary based on the vehicle’s CO2 emissions-rate and Brussels is considering such a policy (IEA 2022).
- Federal income tax credit: 15 percent of the purchase price up to €5,150 for electric vehicles purchased by individuals — available until 2024.
- Nationwide scheme charging heavy commercial vehicles per kilometer travelled.
- Each region maintains its own incentive regime for low-emitting vehicles (e.g., Low Emissions Zones), and requirements to green public transport and government vehicle stock.
- Notes on vehicle tax calculation assumptions: assumes an engine strength of 1,500 cc (average for new Belgian vehicles in 2018, ICCT 2019) and vehicles meet Euronorm 6 standards. Annual Circulation Fees are discounted at 7 percent over 13 years.

### Limitations of the existing transportation tax system
- Two main limitations:
  - When expressed on a lifetime basis, Flanders, Brussels, and Wallonia apply only modest taxes on high emission vehicles; the relative price of low-emitting, non-electric vehicles is not decreased relative to vehicles with average levels of emissions in Brussels or Wallonia.
  - EU emission rate standards apply to fleetwide average emissions; any demand shift to low-emission vehicles through taxes could be offset by reduced effort to reduce emissions of other vehicles in the fleet.
- Company car regime effects:
  - Company cars create incentives for compensation in kind rather than cash and are effectively not subject to VAT for employees, costs are tax deductible for companies, and provide income tax advantages since in-kind benefits are not subject to social security contributions.
  - The portion of company car value subject to personal income taxation depends on carbon-intensity and will progressively shift towards limiting tax deductibility to only electric vehicles.
  - Company cars constitute around 12 percent of the total vehicle fleet.
  - The company car regime is estimated to be fiscally costly at around 1 percent of GDP.
- Recent reforms: restricting company car eligibility to EVs by 2026 and introduction of the mobility budget; reported low take-up of the mobility budget.
  - Mobility budget parameters: minimum of € 3,000 per year and maximum of the lesser of one fifth of gross remuneration and €16,000 per year.

### Feebate proposal (design and effects)
- Feebate structure: sliding fees for vehicles above average emission rates and sliding rebates for vehicles below average emission rates.
- Feebate annual fee formula (preserved exactly):
  {CO2 price} × {the vehicle’s CO2/km – the industry average CO2/km} × {the average lifetime km driven per vehicle}
- Illustration:
  - A feebate with price of €400 per tonne of CO2 would:
    - Provide the same EV subsidy as at present.
    - Apply a tax of €3,000 to a vehicle with 200 g CO2/km (an increase of around €1,000 for Brussels and Wallonia).
- Advantages and mechanisms:
  - Would incentivize purchase of low emissions vehicles that are not electric (currently not subsidized in Belgium).
  - Could replace the company car regime; federal government could introduce it unilaterally through personal income tax credits, but ideally regions would harmonize vehicle taxes/subsidy systems and provide any necessary financing.
  - Subsidies for EVs would decline over time as the average fleet emission rate declines.
  - Manufacturers would be penalized for any increase in emissions for the rest of their fleet in response to higher sales shares for EVs.
  - Other attractions:
    - Feebates automatically maintain revenue neutrality despite progressive decarbonization because the average fleet emission rate in the feebate formula updates.
    - Feebates do not require new data or administrative capacity relative to the existing emission rate program.

### Broader fiscal instruments and future reforms
- Other transportation externalities (congestion, road damage, accidents) are best addressed through distance-, location- and time-based (i.e., congestion) charges rather than fuel taxes.
- Existing heavy duty truck distance-based charge is an example of pricing road damage through distance-based mechanism.
- Rationale for distance/time-based pricing:
  - Importance increases with EV penetration because EVs contribute to external costs while road fuel taxes decline as EVs replace fossil-fuel vehicles.
  - Administrative feasibility is improving with technological improvements (e.g., improved and lower cost global positioning system (GPS) tools).
  - Congestion pricing would be within regional competencies and should be coupled with reductions in road fuel taxes (and potentially vehicle registration and annual circulation fees).
  - Moving towards distance and time-based pricing would shift revenue from federal to regional governments but still provide the general government with a robust source of revenue as traditional fuel tax bases erode.
- Pay-as-you-drive (PAYD) vehicle insurance could more accurately price accident-related externalities; PAYD charges a premium per kilometer travelled.

### Conclusion and summary of policy recommendations
- Carbon pricing coupled with reinforcing sectoral policies would promote emissions reductions at limited economic and administrative costs.
- Carbon pricing should be the centrepiece of Belgium’s decarbonization policy and can be implemented through the existing excise regime.
- Price-based, sectoral policies (such as feebates) complement carbon pricing where exceedingly high carbon prices are needed or significant non-climate considerations exist (e.g., nuclear phase-out, industrial competitiveness).
- Recommended priorities:
  - Carbon pricing in non-ETS sectors and a price floor for the existing EU ETS ideally prioritized.
- Expected impacts of the full recommendation package:
  - Reduce emissions to at least 20 percent below business-as-usual levels by 2030 (33 percent below 2005 levels).
  - Raise substantial revenue (at least 0.6 percent of GDP) to support vulnerable households and firms and increase economic productivity.

### Appendix — Selected relevant findings from recent studies
- Leuven (Leuven 2022):
  - Carbon pricing focused on transportation and buildings would reduce transportation emissions by 11.3 percent and building emissions by 14.1 percent by 2030 in the context of a reference scenario for a €100 per tonne carbon tax.
  - The tax would raise significant revenues: €2.7 billion by 2030.
  - Recommends revenue recycling to improve equity, maintain reduced VAT on electricity, and/or promote economic efficiency (e.g., reducing labor taxes).
  - Recommends sectoral measures including removing preferential VAT treatment for fertilizer, pesticides, meat, and aviation; a tax on pesticides and fertilizers; phasing out or reducing reimbursement for commercial diesel; phasing out preferential tax treatment of company cars and fuel cards; increasing the aviation departure tax; and introducing excises on LPG, CNG, and kerosene.
- National Bank of Belgium (Cornille et al 2021):
  - Finds effective carbon tax rates are currently relatively low for industry and buildings in Belgium; suggests linking tax rates partly to carbon content of fuel consumption.
  - Green Certificate Scheme likely not cost-effective; promoting renewables should be done through carbon pricing and subsidies on capital costs of low-carbon residential technology.
  - Reducing the price of electricity relative to natural gas would support investment in heat pumps; current support for heat pumps is relatively low, with subsidies for condensing boilers that use natural gas or oil.

*Source: 1belea2023002 - 44.      There are registration and annual circulation taxes applied at the regional level, as well*

### 5.      Extensive incidence analysis is provided in the NBB study. The share of spending on

### 1belea2023002 - 5.      Extensive incidence analysis is provided in the NBB study. The share of spending on

### Incidence analysis and distributional findings
- The share of spending on transportation varies by region and income groups, with more spending on transportation in Flanders and Wallonia and by high-income households.
- Electricity spending is skewed towards low-income households, but there is significant heterogeneity within income groups and across regions (lower consumption and similar shares across income groups in Brussels).
- Natural gas and heating oil spending is higher for low-income groups across all regions.
- High-income households have houses with better insulation; one study found that this could be due to financial constraints for low-income households (Heylen and Vanderstaeten, 2019).
- Conclusion of the incidence analysis:
  - Low-income households would benefit from general income support as carbon prices are introduced.
  - Subsidies for clean technology, including concessionary access to financing, are recommended for low-income households.
  - Environmental tax revenues should not be earmarked but rather spent considering the full set of government objectives.

### National Carbon Pricing Debate (Climact 2018) — principles and sectoral recommendations
- Three principles recommended when introducing carbon pricing:
  1. Carbon pricing should be revenue neutral, potentially through reducing labor taxes or electricity charges and levies, or with lump-sum transfers.
  2. The pricing policy should send a credible, long-term signal to direct investments and other input choices towards greener options.
  3. Complementary policies are needed to maximize the benefits of carbon pricing and promote further emissions reductions, as well as address barriers (such as information gaps and principle/agent problems).
- Buildings:
  - Carbon pricing is an efficient way to green residential and commercial buildings.
  - Concern: raising taxes on buildings will disproportionately hurt the vulnerable.
  - Taxes are regressive without compensating measures; suggested compensating measures include lump-sum transfers or energy vouchers to vulnerable citizens.
  - A secondary option: renovation programs for households, support to SMEs, or lump-sum transfers to every citizen.
- Transport:
  - The carbon price should cover all fossil fuels (with the biomass component of fuels subject to taxation using the emission factor equivalent to the associated fuel).
  - Special care for diesel used for commercial purposes since freight activity is mobile (i.e., subject to leakage and lost economic activity).
  - Two options provided:
    1. Include a carbon price on top of the existing excise and limit the final price of diesel for commercial purposes to that of neighboring countries.
    2. Introduce carbon pricing using a ‘smart’ road pricing system (would require time to implement).
  - Other transportation policies (e.g., company cars) should be made consistent with emissions reduction goals.
- Industry:
  - Non-ETS emissions are 17 percent of total industrial sector emissions—35 and 65 percent are from processes and energy, respectively.
  - Two options proposed:
    1. Price all fossil fuel emissions except for those at risk of carbon leakage, for which carbon prices would be limited to the current price difference with neighboring countries; price process emissions conservatively due to leakage concerns and high abatement costs.
    2. Reform the voluntary agreements of the Walloon and Flemish region to incorporate an explicit carbon price and impose a carbon price on those that do not use the voluntary agreement.
- Agriculture:
  - Belgium-specific aspects: a relatively large portion of products are trade exposed.
  - Carbon pricing should cover energy-related emissions from non-stationary sources (offroad vehicles and machinery).
  - For stationary sources (mostly agricultural greenhouses), use a similar approach to the non-ETS industry (cap post-tax price levels or implement voluntary agreements).
  - Pricing non-CO2 emissions is complicated by the difficulty in measuring emissions.

### Key modelling parameters (CPAT model assumptions and data sources)
- Modelling emissions trajectory with and without fiscal policies depends primarily on:
  - Energy price projections (and relative prices across different energy sources), driven by international prices and domestic policies.
  - The responsiveness of energy use to prices and income (i.e., elasticities).
  - Energy efficiency improvements from the autonomous technological change.
- Calibration notes:
  - A subset of key assumptions is provided in Table 4 and have been calibrated based on the existing literature and to align model results with that of more complex climate models.
  - Forecasted international energy prices use the average of the IMF’s World Economic Outlook and the International Energy Agency’s World Energy Outlook (Stated Policies Scenario).
  - Forecasted GDP is sourced from the IMF’s WEO.
- Footnote on industry emissions:
  - Specifically, these emissions are from chemicals, food and drinks, textiles, off-road emissions from industry and construction, manufacture of wood products, glass, ceramics, cement, lime, and plaster.

### Table 1. Belgium: Key Modelling Parameters — elasticities (as presented)
- Note: 1/ elasticities are interpreted as the percent change in fuel use that corresponds with a percent change in prices or income. 2/ there are separate cross-price elasticities.

- Coal
  - Elasticity with respect to income: Transport: NA; Residential: NA; Industry: 0.5
  - Elasticity with respect to price: Transport: NA; Residential: NA; Industry: -0.2

- Natural gas
  - Elasticity with respect to income: Transport: 0.5; Residential: 0.3; Industry: 1.0
  - Elasticity with respect to price: Transport: -0.4; Residential: -0.3; Industry: -0.4

- Gasoline
  - Elasticity with respect to income: Transport: 0.7; Residential: NA; Industry: 0.5
  - Elasticity with respect to price: Transport: -0.3; Residential: -0.4; Industry: -0.3

- Diesel
  - Elasticity with respect to income: Transport: 0.6; Residential: 0.5; Industry: 0.5
  - Elasticity with respect to price: Transport: -0.2; Residential: -0.2; Industry: -0.6

- Electricity
  - Elasticity with respect to income: Transport: 1.2; Residential: 0.8; Industry: 0.8
  - Elasticity with respect to price: Transport: -0.1; Residential: -0.2; Industry: -0.2

*Source: Excerpt from the provided IMF chapter/section content.*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1belea2023002.pdf_