3. Towards green growth

Luxembourg is one of the most prosperous economies in the OECD, and the population enjoys high income levels and well-being. The economy grew rapidly for most of the past decade, outpacing the euro area average (OECD, 2019a). Growth contracted as a consequence of the COVID-19 pandemic and the measures put in place to contain its spread, but could recover in 2021. New virus outbreaks would make the economy shrink further and hamper recovery prospects (OECD, 2020).

Progress was made in decoupling emissions of greenhouse gases (GHGs) and air pollutants, as well as waste generation, from economic growth in the 2010-19 period. The energy intensity of the economy fell and the share of renewable energy increased (Chapter 1). However, progress remains insufficient to mitigate mounting pressures from population growth and urbanisation. Over the last few decades, the expansion of the road network and low-density housing has contributed to high land fragmentation, urban sprawl and car-based mobility. The growing financial and skilled service sectors have attracted increasing numbers of workers from neighbouring countries. Urban sprawl and massive cross-border commuting by car entail major social costs in terms of GHG emissions, air and noise pollution, traffic congestion and ecosystem degradation. Luxembourg needs to accelerate its efforts to diversify its economy towards a greener and more inclusive model that has a stronger focus on well-being.

Luxembourg has a sound legal and institutional framework for sustainable development. The 2004 law on the co-ordination of the national sustainable development policy established the Higher Council for Sustainable Development, representing civil society, and the Interagency Commission for Sustainable Development, as a government working body (Chapter 2). The law requires the adoption of national sustainable development plans, which must be periodically monitored through a set of sustainable development indicators (OECD, 2010).

In December 2019, the government adopted the third National Plan for Sustainable Development (PNDD), which was developed through a broad participatory process. The plan is inspired by the United Nations (UN) Agenda 2030, encompasses the Sustainable Development Goals (SDGs) and sets ten priority fields of action.1 In 2017, prior to approval of the plan and as part of its development, Luxembourg presented the voluntary review of the implementation of the SDGs to the UN High-level Political Forum on Sustainable Development. Despite Luxembourg’s progress in implementing the SDGs (OECD, 2019c), ensuring policy coherence and effective integration of environmental considerations into sectoral policies remains a challenge. Insufficient policy co-ordination is more evident in sectors such as transport, housing, agriculture and fiscal policy. Systematic and thorough implementation of the “sustainability check” of proposed legislation and regulations (Chapter 2), as foreseen by the PNDD could help improve policy coherence.

Luxembourg does not have a green growth strategy, but authorities have made considerable efforts to diversify the economy towards a greener and more inclusive growth model over the past years. Economic diversification is one of the third PNDD priorities and the ultimate goal of the 2016 “Third Industrial Revolution” study (TIR). The TIR focuses on six sectors (energy, mobility, buildings, food, industry and finance) and three horizontal axes (smart economy, circular economy, and the prosumers and social model). The TIR outlines a comprehensive set of measures to transition each sector into a smart, circular economy. A monitoring committee oversees the implementation of these measures. The TIR study provides a good basis to continue on the economy diversification path and exploiting the synergies between environment and innovation, digitalisation, circular economy, renewables and energy efficiency, as recommended by the 2010 OECD Environmental Performance Review (EPR).

This is all the more important to ensure an environmentally and socially sustainable recovery from the heavy economic impact of the COVID-19 pandemic. In the first half of 2020, the government put in place several tax, expenditure and financial measures to preserve jobs and support households income and business liquidity. The fiscal stimulus under the government programme “Neistart Lëtzebuerg” (New Start Luxemburg) totalled about EUR 3 billion or 5% of GDP. Part of the support measures target investment in energy renovation of building, renewables, sustainable mobility, eco-innovation and circular economy (Box 3.1).

Since 2016, Luxembourg has made substantial progress in improving tax transparency and tackling tax avoidance. As part of its engagement in international efforts towards tax transparency, it has been gradually phasing out favourable tax arrangements that once attracted multinationals to the country and helped increase corporate tax revenue (OECD, 2019a). Luxembourg obtains more revenue from corporate income tax than the average of European countries. The tax/GDP ratio was 40% in 2018, among the highest in the OECD.

Luxembourg has made little use of its tax system to put a price on environmental externalities and encourage efficient use of natural resources. Like all OECD member countries, Luxembourg collects most revenue from environmentally related taxes through taxes on energy products and, to a lesser extent, on vehicles. Taxes on pollution and resource use are limited to water abstractions and polluting discharges, and generate a negligible revenue. Taxes on energy products, mostly on road transport fuels, account for about 93% of environmentally related tax revenue, the highest share in the OECD.

Taxes on transport fuels have traditionally represented an important source of revenue in Luxembourg. This reflects the large amounts of fuel sales to non-residents induced by lower taxes on petrol and diesel than in neighbouring countries, which result in lower fuel prices (Figure 3.1). This tax (and price) differential encourages heavy-duty vehicles in transit, daily cross-border commuters and residents in border regions to refuel in Luxembourg. Total economic benefits of fuel sales go beyond fiscal revenue to include employment and income generated by petrol stations and related services. Total estimated economic benefits of fuel sales amount to EUR 2 billion per year, mostly from fuel exports. However, the estimated environmental and health costs are much higher. They are estimated at EUR 3.5 billion per year, three-quarters of which are from fuel exports. The bulk of these social costs are linked to heavy-duty vehicles travelling through, and refuelling in, Luxembourg (Ewringmann, 2016).

Declining world oil prices in 2012-16 partly eroded Luxembourg’s fuel price advantage over neighbours and the incentive to travel the extra time and distance just to refuel in the country. This, together with some tax adjustments in neighbouring countries, resulted in decreasing fuel exports and associated tax revenue in the same period (Ewringmann, 2016). It also led to declining emissions of GHGs and air pollutants (Chapter 1; Chapter 4). Fuel sales and related tax revenue have increased again since 2016, in line with increasing world oil prices (Figure 3.2).

Luxembourg committed to increase excise rates to counteract the recent increase in fuel exports and related GHG emissions.2 In May 2019, after nearly seven years of stable tax rates, the government increased the excise duty on transport fuels by EUR 0.01 per litre of petrol and EUR 0.02 per litre of diesel. In December 2019, the government announced additional increases of between EUR 0.01 and EUR 0.03 per litre of petrol and between EUR 0.03 and EUR 0.05 per litre of diesel to take effect in February-April 2020. Part of the tax hikes refer to the specific excise duty named “climate change contribution” (also known as “Kyoto cent”).3 Revenue from the climate change contribution is earmarked to the Climate and Energy Fund, in derogation of the budgetary principle that revenue should not be earmarked (Section 3.5). Revenue from the rate increase will be allocated partly to the Climate and Energy Fund for measures to support the low-carbon energy transition, and partly to social measures.

These increases are a step in the right direction, but do not appear sufficient to discourage non-residents to refuel in Luxembourg (OECD, 2019a). They would only bring the excise rate of petrol in line with that of Germany. Moreover, they would only marginally reduce the diesel tax differential with neighbouring countries (Figure 3.1), while diesel sales, mainly to heavy goods vehicles, account for 85% of GHG emissions linked to fuel exports. There is a need to further increase fuel taxes to bring them closer to those of neighbouring countries, although this could result in substantial revenue losses. Luxembourg’s resilience to declining fuel tax revenue in 2012-16 suggests that such losses could be relatively easily addressed. At the same time, narrowing the fuel tax gaps with neighbours would generate benefits in terms of reduced fuel consumption, GHG emissions, air pollution and congestion.

Overall, revenue from environmentally related taxes decreased to 1.8% of GDP and 4.5% of tax revenue in 2018. This is below the average of OECD Europe countries (2.3% of GDP and 6.3% of tax revenue). It represents a marked drop from the second half of the 2000s. At that time, revenue from these taxes accounted for a larger share of tax revenue than in most OECD Europe countries (Figure 3.3).

As indicated in the 2010 EPR, Luxembourg would benefit from a broader tax reform to make its tax and benefit system more coherent with its sustainable development ambition. In this context, the country should increase fuel taxes, remove related exemptions, close the petrol/diesel tax gap and introduce carbon pricing. It should also strengthen vehicle-related taxation and road pricing. In addition, Luxembourg should extend the use of quantity-based waste charges, reinforce the water pollution tax and consider introducing taxes on fertilisers and pesticides to help address the impact of these products on water and soil quality, biodiversity and human health (Chapter 1; Chapter 5).

Like many other EU countries, Luxembourg puts a price on GHG emissions via energy taxes and participation in the EU Emissions Trading System (EU ETS). The EU ETS covers only about 15% of domestic emissions due to the country’s service-based economy, largely imported electricity and major share of emissions from transport (Chapter 1).

Luxembourg applies energy taxes on oil products, natural gas, coal and electricity in the framework of the 2003 EU Energy Tax Directive. Energy tax rates are generally among the lowest in the EU. As in all OECD member countries, fuels are taxed at higher rates when used for road transport than when used for heating and process purposes. This can be justified by the higher environmental and other social costs of road transport (OECD, 2018).

Tax rates on energy products do not fully reflect the estimated environmental cost of energy use. Energy tax rates are low and several exemptions and discounts apply. For example, solid biofuels, fuels used for electricity generation, and diesel used in agriculture and forestry are not taxed. In addition, fuels used for heating benefit from lower excise duties and value added tax (VAT). Electricity consumption is also taxed at a lower rate when used in the industry sector than when used in the residential sector (OECD, 2019d).

The excise duty on diesel is still well below that on petrol, despite the higher carbon content of diesel and its local air pollution cost. This lower duty has contributed to promote diesel vehicles. Diesel cars are nearly 60% of the fleet, one of the highest shares in Europe. Luxembourg should consider raising the diesel tax rate to match that on petrol, although some time-bound discounts may be envisaged for commercial users of diesel. This would help counteract the dieselisation of the car fleet and reduce the incentives for trucks to drive through the country to fill their tanks.

The carbon price signal is weak and tax rates on energy products are generally too low to encourage changes in production and consumption behaviour. Effective tax rates on carbon dioxide (CO2) emissions from energy use are among the lowest in OECD Europe (Figure 3.4). The effective tax rate on CO2 emissions from road transport is EUR 139 per tonne of CO2 (OECD, 2019d). As in most OECD member countries, this is above the benchmark of EUR 60 per tonne of CO2. The benchmark is a midpoint estimate of the damage of CO2 emissions in 2020, as well as a forward-looking low-end estimate of carbon costs in 2030 (OECD, 2018).4 However, in 2018, Luxembourg’s effective tax rate was still the fourth lowest in OECD Europe. The 2019 and 2020 increase in tax rates on road fuels would change the ranking only marginally, if at all. In addition, the average tax rate on CO2 emissions from fuels used in sectors other than road transport is just above EUR 2 per tonne of CO2. This is well below even the low-end estimate of environmental and other social costs of CO2 emissions of EUR 30 t/CO2 (Figure 3.4), which is not sufficient to meet the objectives of the Paris Agreement (OECD, 2019d; OECD, 2018).5

The low cost of energy provides little incentive to invest in renewables and energy efficiency (IEA, 2020), and to move towards electric vehicles and sustainable transport modes. As indicated in the previous section, the increase of excise rates in 2019 and 2020 on road fuels are welcome, but not sufficient. Luxembourg should reduce tax exemptions and further raise the energy tax rates in all sectors to reflect environmental and climate damage from energy use. This should be combined with social support measures targeting the most affected poor households.

The 2019 National Energy and Climate Plan (NECP) foresees carbon pricing as from 2021. The proposed initial price is EUR 20 per tonne of CO2, to be increased by EUR 5 in each of the two following years. This is a welcome announcement. A higher price on CO2 emissions would help the country increase efficiency of energy use, promote investment in renewables and expand the market opportunities of low-carbon technology, goods and services. It would also bring co-benefits through, for example, reduced air pollution (Chapter 4). Luxembourg should follow through on this plan of introducing carbon pricing in sectors not covered by the EU ETS. It should ensure systematic monitoring of the effect of carbon pricing on energy use and GHG emissions, and adjust prices appropriately.

The incentive mix in the transport sector is not consistent with Luxembourg’s objectives of promoting sustainable mobility, climate mitigation and air quality improvement in major cities. The mix includes fuel taxes, vehicle taxes and subsidies, taxation of company cars and commuting allowances, and road charges. In addition to raising fuel taxes (as indicated in Sections 3.3.1 and 3.3.2), Luxembourg should consider strengthening vehicle taxes and road pricing.

The annual tax on vehicles is based on CO2 emissions. The tax rate increases with CO2 emission levels per kilometre and is higher for diesel vehicles (Chapter 4). However, car taxation is relatively low and the rate differentiation is not pronounced. The tax provides few incentives to shift towards lower-emitting vehicles. While the vehicle fleet is relatively young, newly registered cars in Luxembourg are among the most carbon-intensive cars in the EU (Chapter 4). There is scope to increase car taxation and revising it to consider emissions of both CO2 and local air pollutants.

In 2017, Luxembourg introduced income tax credits to promote the purchase of electric or hybrid vehicles: EUR 5 000 for fully electric vehicles; EUR 2 500 for plug-in hybrid vehicles; up to EUR 500 for electric motorcycles and up to EUR 300 for electric bicycles. In 2019, the system was replaced by direct subsidies of the same amounts to simplify access to the financial incentives and improve their effectiveness (Chapter 4).

The traditionally favourable tax treatment of company cars is among the factors behind Luxembourg’s high car ownership rate and the high-carbon intensity of cars. This is because company cars used by cross-border workers are registered in Luxembourg. Company cars (which employees can use for their private travels) account for more than half the car fleet. They tend to be more carbon-intensive than personal cars. In 2017, the government revised the company car taxation treatment to encourage companies and employees to choose less carbon-intensive vehicles. According to the new rules, the estimated taxable benefits, added to the employee’s income increases with the CO2 emissions of the vehicle and is higher for diesel cars than for petrol cars (Chapter 4).

However, like many other countries, Luxembourg continues not taxing the full benefits employees derive from the personal use of company cars. On average, these in-kind benefits are taxed less than the equivalent monetary income. This lower taxation effectively subsidises the employee, which makes it attractive for employees to be paid part of their salary in the form of company cars. This is especially true for higher-income earners, who face a higher marginal income tax rate and are more likely to be provided with expensive company cars. In addition, fuel costs paid by the employer are deductible from the company’s taxable income and do not increase the employee’s taxable income. As a result, there is no incentive for employees to limit the use of company cars.

Commuting expenses are deductible from an employee’s taxable income. The tax deduction increases with the distance travelled to work, which encourages people to live farther away from their workplace and increases transport demand (Chapter 4). Deductions are not differentiated by type of transport and are granted regardless of whether the expenses are incurred. Hence, this system does not discriminate against public transport and active modes of transport such as walking and cycling, but it does not encourage them either.

In addition to burdening the public budget, the favourable tax treatment of company cars and commuting expenses tend to encourage car use and long-distance commuting. They can result in increased fuel consumption, GHG and local air pollutant emissions, noise, congestion and risk of accidents (Roy, 2014). This adds to problems related to urban sprawl, car-based commuting across borders and difficult access to public transport in peripheral areas. Luxembourg should consider further adjusting the tax provisions related to company cars and commuting expenses to reduce incentives to car travel.

Luxembourg is part of the "Eurovignette" co-operation with Denmark, the Netherlands and Sweden. These countries apply a road toll to heavy-duty vehicles (above 12 tonnes) circulating on motorways in their territory. Rates increase with pollutant emissions (on the basis of the Euro standards) and the number of axles. The charge is time-based (with daily, weekly, monthly and annual tolls) and does not change with distance travelled. The toll does not apply to smaller commercial vehicles or to passenger cars.

Luxembourg should consider adjusting road tolls for heavy goods vehicles to take account of distance travelled, in addition to the emission standards applied. It should also extend road tolls to smaller commercial vehicles and passenger cars. In addition, introducing congestion charges in Luxembourg City would help put a cost on travel during peak periods and encourage a shift to public transport. In areas poorly served by public transport, or where concerns over equity arise, social transfers could be used to partly compensate for road charges.

Complementing fuel taxes with distance-based charges would make pricing of transport more cost-effective (van Dender, 2019). This could also help offset tax revenue losses expected from two sources: the increase of diesel and petrol taxes to match rates applied in neighbouring countries; and the likely erosion of the tax base as Luxembourg and its neighbouring countries move towards electric mobility (especially for domestic and cross-border commuting).

Luxembourg has made progress in implementing the polluter-pays and user-pays principles in the water and waste sectors, in line with recommendations from the 2010 EPR.

According to Luxembourg’s water legislation, users should bear the costs of water services, including environmental and resource costs in line with the user-pays and polluter-pays principles. The law also introduced an abstraction tax and a wastewater discharge tax. Proceeds from these taxes are earmarked for the Water Management Fund in derogation of the budgetary principle that revenue should not be earmarked (Section 3.5). The water price comprises a drinking water charge and a wastewater treatment charge, whose revenue accrues to water service providers, as well as the abstraction and discharge taxes. The rates of the drinking water and wastewater treatment charges are set by communes or associations of communes (syndicats). The Water Management Administration verifies that the charges respect the cost-recovery principle.

Anyone who draws surface water or groundwater pays an abstraction tax, based on the volume of water drawn. The water abstraction tax is fixed by law at EUR 0.125/m3 of abstracted water, with a minimum of EUR 25 per year for withdrawal up to 200 m3/year. Withdrawals for certain uses are exempt from the tax.6

The wastewater discharge tax is proportional to units of pollution load (unités de charge polluante, UCP) at a rate of EUR 1.25/UCP. Coefficients are applied to determine the UCPs corresponding to 1 kg of chemical oxygen demand, nitrogen, phosphorus or suspended particulate matter. Installations such as industrial facilities that treat their own wastewater (without using public wastewater treatment plants) pay the tax proportionally to the pollution load authorised by their operating licence. While the tax amount is increased if that load is exceeded, it is up to the Water Management Administration to detect non-compliance. This makes the tax act as a fine. For water service providers, the rate is fixed annually by Grand-Ducal regulation, taking into account the pollutant loads in water discharged by all wastewater treatment plants. The tax is due if the pollutant load exceeds certain thresholds. Discounts are granted to municipalities that have installed rainwater treatment facilities. In 2019, the rate was set at EUR 0.12/m3 of discharged water. The rate has been reduced constantly in the last few years, reflecting the declining pollutant loads in wastewater due to improved treatment (Chapter 1). However, the tax provides little incentive to reduce water pollution, as the rate is based on average pollution.

The 2012 amended Waste Act requires that municipalities implement waste tariffs in line with the polluter-pays principle. According to the legislation, waste charges should cover all costs of providing waste services and should consider the quantities of waste actually produced. Charges need to include variable components based upon the weight and/or volume of the mixed residual household waste and of bulky waste. Only about one-quarter of municipalities apply quantity- or volume-based waste fees (pay-as-you-throw). Data show that in these municipalities per capita residual mixed waste is well below that produced in municipalities that do not apply pay-as-you-throw charges.7 About 70 municipalities have committed to apply waste taxes that respect the polluter-pays principle by 2020. This would bring the total number of municipalities complying with this principle to 95 of 102 municipalities in the country.

The 2018 law on the protection of nature and natural resources introduced a system of ecopoints for quantifying the ecological value of biotopes and habitats. This system is used to determine the financial compensation due for biodiversity losses resulting from development projects (Chapter 5). An ecopoint is worth EUR 1; the number of ecopoints depends on the biotope.

Like other countries, Luxembourg provides subsidies that could harm the environment. These subsidies, in the form of direct support or preferential tax treatment, exist primarily in the energy, transport and agriculture sectors. In general, such subsidies contravene the polluter-pays and user-pays principles. They distort competition, lock in inefficient technology, lead to inefficient allocation of resources and weigh on public finances. Luxembourg has made little progress to follow up on the recommendation from the 2010 EPR to identify and remove environmentally harmful subsidies and tax provisions (OECD, 2010).

The energy and transport sectors provide most subsidies implicitly through favourable tax treatments. As discussed in Section 3.3.2, energy products used in sectors such as farming, electricity generation and heating still benefit from total or partial exemptions from excise duties, as well as a reduced VAT rate. In 2017, the revenue loss due to exemptions and discounts from the diesel excise for these sectors was estimated at EUR 2 million. These exemptions undermine the carbon price signal and discourage an efficient use of energy resources. In addition, energy tax exemptions are not targeted to the most vulnerable population groups and do not help reduce poverty or inequality (Ewringmann and Deloitte Tax & Consulting, 2018). As discussed in Section 3.3.3, the favourable tax treatment of company cars and commuting expenses tends to encourage car ownership and use, as well as long-distance commuting, with several environmental impacts.

Luxembourg’s support to agriculture follows the EU framework. As in all EU countries, agricultural support is largely decoupled from production or input use. As part of the so-called green payment, 30% of the direct payment envelope under the Common Agricultural Policy is allocated to agricultural practices that are beneficial in terms of climate change and the environment. The environmental effectiveness of this support has been questioned, mainly due to the low level of requirements, which largely reflect the normal farming practice. The payment had resulted in more environment-friendly farming practices on only around 5% of all EU farmland (European Court of Auditors, 2017). Farmers also benefit from fuel tax relief.

The government commissioned a study to identify and quantify environmentally harmful subsidies. The 2018 study identified seven types of such subsidies in Luxembourg. These included reduced excise and VAT rates on energy products, the tax disparity between diesel and petrol, and the favourable tax treatment of company cars and commuting expenses. Overall, the estimated annual cost of these subsidies varies between EUR 750 million and EUR 1 billion (Ewringmann and Deloitte Tax & Consulting, 2018). Luxembourg should build on this study to establish a process for the systematic review of environmentally harmful subsidies. It could consider introducing a mechanism to screen all current subsidies and new subsidy proposals against their potential environmental impact. This would improve the transparency of the tax and public expenditure system. It could be the basis for reforms of subsidies and special tax treatment that are not justified on economic, social and environmental grounds.

Public environmental expenditure (current expenditure and investment) increased between 2005 and 2009, and then decreased after the financial crisis. In 2017, it was 0.9% of GDP and 2.3% of total government expenditure. Central government expenditure dropped markedly, while local governments – which have major responsibilities in providing environment-related services – increased their spending (Figure 3.5).

As in many other countries, wastewater and waste management absorb most public environmental expenditure. Expenditure on wastewater management declined in the early 2010s, reflecting the progressive application of the polluter-pays principle (Section 3.3). It rebounded in 2014, due to large investment in bringing wastewater treatment plants in line with EU requirements (Chapter 1). Expenditure on waste management has hovered around the same levels in the last decade, as investment in disposal and treatment infrastructure had been already completed. Expenditure on pollution abatement and biodiversity protection accounts for a minor share, but it has been increasing in recent years reflecting renewed policy focus on these areas (Figure 3.5).

Investment needs remain high. Ageing infrastructure, such as urban wastewater pipelines, needs to be upgraded. Networks and services will also need to be extended to accommodate population growth and continuing urbanisation. For example, the government plans to equip the country's main wastewater treatment plants with a fourth level of treatment (micropollutants and microplastic) by 2023 (Chapter 1). In this context, enhancing cost-effectiveness of public spending is essential to ensure access to high-quality services for all. Demand-side management and incentives for less resource-intensive production and consumption patterns could reduce reliance on public expenditure.

Luxembourg’s policy focus on climate change mitigation has led to increasing public financial assistance to investment in renewables, energy efficiency and sustainable mobility (Chapter 4). Some State aid has been increased as part of the fiscal stimulus to help the economy recover from the consequences of the COVID-19 pandemic (Box 3.1). This has been accompanied by a range of regulatory measures and voluntary programmes. All municipalities have signed the Climate Pact, a co-operative agreement through which local governments commit to implement certain environment- and climate-related measures. In return, they receive government financial and technical assistance, as well as an environmental certification (Box 3.2).

Several support mechanisms have contributed to the growth of renewable electricity generation (IEA, 2020; Chapter 1). However, more cost-effective support measures will be needed to achieve the ambitious 2030 target of 25% of renewables in gross final energy consumption (from 6.5% in 2017) set by the NECP. Support to electricity and heat generation from renewables takes the form of feed-in tariffs, premium tariffs and capital investment subsidies for renewable energy projects developed by households, companies and municipalities. In 2018, Luxembourg introduced a tender system for photovoltaic projects. In 2017, the feed-in and premium tariffs cost EUR 99 million. The Climate and Energy Fund paid EUR 38 million of this amount with the remainder recovered through electricity bills.

In 2017, Luxembourg strengthened its flagship PRIMe House grant programme to provide higher subsidies to energy efficiency renovation and integration of renewables into building, as well as to extend support to sustainable construction. Expenditure under the programme amounted to more than EUR 5 million that year and to about EUR 20 million in 2015-19. In 2017, Luxembourg launched the Climate Bank and Sustainable Housing programme, which provides zero- or low-interest loans to households and companies for energy efficiency renovations, including the use of energy from renewable sources. Low-income households can benefit from grants to replace energy-intensive appliances, as well as from technical advice on how to reduce energy consumption.8 Luxembourg enacted regulations requiring all new residential buildings to meet the nearly zero-energy building (NZEB) standard. It also launched a voluntary national sustainability certification system for new housing construction (LENOZ).

It is not clear whether this public financial assistance is delivering the desired energy savings, or climate and environmental benefits. The building renovation rate in Luxembourg is low, less than 1% in 2017 (IEA, 2020). There is a lack of interest in energy renovation, mainly due to the high cost of these projects, the overall pressure on the housing market, the complexity of administrative procedures and the nuisance caused by renovation works. The government set up an online one-stop-shop for all housing-related public aid. However, further efforts are needed to increase public awareness about PRIMe House and other support programmes, as well as to facilitate access to them. Low energy prices hamper the effectiveness of support programmes. They are too low to provide sufficient incentives to renovation investment, especially when considering the high average income of households. Gradual introduction of carbon pricing (Section 3.3) would be more cost-effective in driving the energy efficiency investment needed to reduce final energy demand (the NECP foresees reductions of 40-44% in 2030 compared to baseline projections). The government should also track how renovation is helping achieve energy efficiency targets (IEA, 2020).

As Chapter 4 discusses in more detail, Luxembourg has been investing heavily in public transport infrastructure and services. This is part of implementing the 2018 sustainable mobility strategy (Modu 2.0). It invested EUR 1.8 billion in public transport in 2015-19. Investment includes the first tramline in Luxembourg City, new bus corridors, and park-and-ride facilities. It also includes the purchase of new buses, many of which were hybrid and electric vehicles. Luxembourg aims to increase the number of public transport users by 50% from 2017 to 2025. The decision to make public transport free across the whole country for all users as from March 2020 is expected to contribute to this goal. In addition, the country has invested in active mobility, for example by extending its bicycle lane network.

Electric mobility is expected to play a key role in the decarbonisation of the transport sector. Large investment has been made in extending the electric vehicle charging network. As of 2019, the network counted more than 200 stations, one of the densest networks in Europe. The government plans to quadruple the number of charging stations by the end of 2020. Subsidies are available to buy electric cars and bikes, and state-owned vehicles can only be electric. These measures aim to achieve the NECP target of 49% of vehicles registered in Luxembourg to be electric by 2030. Another objective is to make the fleet of the regional bus company fully electric by the same year. Achieving Luxembourg’s electric mobility goals will entail a significant growth of electricity demand, which may stress the electricity system. As a result, Luxembourg will require increased renewable electricity generation and imports (IEA, 2020).

Luxembourg provides financial support to environment-related investment under various forms to local governments, companies and individuals. The Ministry of Environment, Climate and Sustainable Development (MECDD) manages three investment funds for environmental protection, water management, and climate and energy. However, effectiveness of support for environment-related investment could be enhanced.

The Environmental Protection Fund was established in 1999 to finance central government expenses in key areas. These include air pollution, noise, climate change mitigation, waste prevention and management, nature and natural resource conservation, clean-up and rehabilitation of landfills and contaminated sites, energy efficiency and renewable energy sources. The fund disbursed nearly EUR 25 million in 2017. Of this amount, more than 40% was used to finance the Climate Pact (Box 3.2), 35% was spent on finance waste management (and primarily the SuperDrecksKëscht©; see Chapter 1) and 12% financed nature protection.

The Water Management Fund, also created in 1999, can support investment in wastewater treatment, flood risk management, watercourse rehabilitation, protection of water quality and efficient use of water resources. It is funded by budgetary allocations and the proceeds of the water abstractions and pollution taxes (Section 3.3). The fund expenditure increased substantially in the last decade, from EUR 50 million to EUR 92 million between 2011 and 2018. This was in part due to increased investment on wastewater treatment plants (Chapter 1).

Established in 2004, the Climate and Energy Fund finances implementation of domestic GHG emission reduction measures, the purchase of international GHG emission allowances and Luxembourg’s contribution to international climate finance commitments. The fund disbursed nearly EUR 57 million in 2017. Of this amount, 33% financed feed-in tariffs for renewables, 27% supported international climate finance and 5% supported domestic climate mitigation measures, including investment subsidies for photovoltaic installations and electric mobility. The fund includes an annual budget envelope of EUR 3 million for projects implemented by Luxembourgish non-governmental organisations in developing countries.

In 2019, the fund was well-endowed, with around EUR 600 million unused budgetary appropriations (IEA, 2020). In addition to an annual budgetary allocation, the fund receives the proceeds from auctioning EU ETS emission allowances. It also receives part of the revenue from the excise duty on road fuels (the “climate change contribution” or “Kyoto cent”, see Section 3.3) and from the annual vehicle tax (Section 3.3). Many countries participating in the EU ETS, such as France and Italy, commonly earmark revenue from carbon pricing to funds devoted to climate mitigation. The practice can help build support for stronger carbon pricing and secure reliable, sufficient resources. However, constraints on revenue use should be transparent, broad and flexible to ensure efficiency of revenue allocation in the long term (Marten and van Dender, 2019).

As a general rule, the three funds provide financial support to eligible projects on a first-come, first-served basis until available annual resources are exhausted. Financial allocations have been sufficient to support all eligible projects so far. However, Luxembourg conducts no cost-benefit analysis of eligible projects and does not evaluate the environmental effectiveness of the financed projects ex post. Therefore, public funds risk not being used cost-effectively to support projects that provide additional environmental benefits.

Luxembourg has a strong innovation performance, with an attractive research system and an innovation-friendly environment. The population has a higher level of education than on average in the OECD (see Basic Statistics). Innovative activity is high, as one-third of small and medium-sized enterprises (SMEs) reported introducing new or significantly improved products, services or organisational methods in 2018. However, these enterprises appear less able to translate these innovations into economic returns than in many other European countries (EC, 2018a).

Expenditures on research and development (R&D) are low. At 1.3% in 2017, Luxembourg’s share of GDP allocated to R&D activities stands far below the OECD average of 2.4% and its own national 2020 target of 2.3-2.6% of GDP. Luxembourg tripled expenditures for government and higher education R&D over the past decade. It also expanded the grant schemes, amended its R&D tax incentive and broadened the scope for action of Luxembourg’s innovation agency, LuxInnovation.

Luxembourg has become one of Europe’s top eco-innovation players (EC, 2019). Both Luxembourg authorities and the business community have been placing growing policy focus on eco-innovation. The 2016 Third Industrial Revolution study (Section 3.2) and the 2017 Research and Innovation Smart Specialisation Strategy identify clean technology and the circular economy among key policy priorities on the path towards the country’s economic diversification.9

Luxembourg provides public support for environment-related R&D in the form of grants and tax incentives, as well as financial support to enterprises for improving environmental performance (Section 3.5). Eco-innovation promotion programmes have a strong focus on the circular economy (EC, 2019). For example, the “Fit 4 Circularity” programme aims to help SMEs integrate the circular economy models into their general innovation activities. Eco-innovation is also among the themes pursued by LuxInnovation in its activities to promote collaboration among companies, research institutes and public organisations for the development and exchange of technology. Sustainable mobility is another key eco-innovation area, with several projects on electric mobility (Chapter 4), intelligent public transport systems and smart mobility. A digital test bed between Luxembourg, Germany and France, for example, promotes connected, automated and co-operative cross-border mobility on the highways between Luxembourg City, Saarbrucken and Metz.

With increased public R&D funding, Luxembourg has developed a specialisation in environmental technology in recent years. It spends 3.6% of the government R&D budget on environment-related research, a share among the ten highest in the OECD (Figure 3.6). Luxembourg is a European leader in terms of environment-related innovations, with nearly 23 environment-related patent applications per capita. Patent applications for environment-related technology do not show a constant trend, but tended to be above the OECD and OECD Europe average for the best part of the last decade. Despite declining in the first half of the 2010s, they reached 12% of all patent applications in 2014-16 (Figure 3.7). Most patents are filed in traditional environmental management fields (air and water pollution abatement and waste management). They are also filed in some climate-related fields, such as energy storage, hydrogen technology, fuel cells, vehicles and GHG emission reduction in metal processing.

The environmental goods and services (EGS) sector is relatively small in Luxembourg. It accounted for more than 11 000 jobs and 2% of Luxembourg’s gross added value in 2016, a share that remained almost stable between 2008 and 2016. The industrial sector, as a whole, produced half the EGS gross added value in 2016; most employment (65%) was in the construction sector.

Compared to the EU average, slightly more SMEs design and produce greener products in Luxembourg (EC, 2018b).10 However, the country’s SMEs are less inclined to invest in improving their environmental performance than on average in the EU, except for investment in recycling and renewables. According to a 2017 Eurobarometer survey, 67% of Luxembourg’s SMEs have invested in resource efficiency, slightly below the EU average. Most have invested less than 1% of turnover. Luxembourg’s SMEs performed below the EU average in terms of actions to save energy, materials and water, and to minimise waste (EC, 2018b).

The small domestic market and still low demand for cleaner technology, products and services are the main barriers to eco-innovation. Luxembourg has implemented several programmes and measures that could enlarge EGS markets and drive eco-innovation. For example, the subsidies for electric cars and bikes (Chapter 4), the LENOZ certification and the NZEB standard (Section 3.5) can contribute to stimulating demand for cleaner transport and building solutions. The EU acknowledged the campaign and label “Clever akafen” (Buy Smart), launched within the framework of the SuperDrecksKëscht (Box 1.1), as a best practice to encourage environment-friendly consumption choices. Products can be awarded the “Clever akafen” label if they meet a set of environment criteria.11

A clearer policy on green public procurement (GPP) would also help increase demand for cleaner products and services. While the public procurement law encourages contracting authorities to look at environmental criteria, these are not mandatory and there are no GPP targets (EC, 2019). Luxembourg should develop and implement a clear GPP policy by integrating mandatory environmental criteria and targets into public procurement regulations.

The impact of the eco-technologies sector on the diversification of the economy is difficult to assess (ODC, 2018). Luxembourg should continue to support environment-related R&D, with a focus on SMEs. At the same time, it should systematically evaluate the cost-effectiveness of its support programmes and their contribution to improve environmental performance, resource productivity and energy efficiency. More efforts are needed on the demand side, primarily by ensuring that prices of energy and of water and waste services adequately reflect the environmental and other social costs of resource use and pollution.

The financial sector is a pillar of Luxembourg’s economy, accounting for 27% of GDP and 11% of total employment in 2018. Luxembourg is home to many international financial institutions, has a solid financial infrastructure and a highly specialised labour market (Dörry and Schulz, 2018). Sound policies and institutions have enabled the financial sector to remain competitive and develop new areas, such as financial technology (FinTech) and green finance (OECD, 2019a).

Luxembourg has grown as a green finance centre since the European Investment Bank (EIB) listed the first-ever Climate Awareness Bond on the Luxembourg Stock Exchange in 2007. The World Bank’s first green bond followed in 2008. In 2016, Luxembourg established the Luxembourg Green Exchange (LGX), the first platform dedicated exclusively to green, social and sustainable securities.12 LGX has grown rapidly and lists nearly EUR 200 billion green, sustainable and social bonds, or half of the world market (LGX, 2019) (Figure 3.8). Luxembourg was ranked second in terms of green finance specialisation (or market depth) and seventh in terms of quality of green finance products in the fourth Global Green Finance Index (Wardle et al., 2019).13

The government aims to make Luxembourg an international centre of excellence on sustainable finance. For the period 2018-23, it set four main priorities for the Luxembourg financial centre, with a particular focus on sustainable finance and FinTech.14 Luxembourg is committed at the international level to sustainable and green finance. It actively participates in EU discussions, for example on developing an EU Green Bond Standard and the EU taxonomy of activities that can make a substantial contribution to climate change mitigation. Luxembourg also financially supports the International Network of Financial Centres for Sustainability, which aims to help financial centres redirect their investments to support the goals of the Paris Agreement and of the UN Agenda 2030. Luxembourg also joined the Paris Agreement Capital Transition Assessment initiative, which provides a methodology to assess the climate compatibility of investment and financing by insurance companies and pension funds.

Luxembourg has adopted a multi-stakeholder approach to green finance, with a strong focus on public-private green finance initiatives and partnerships. Since 2015, the government and financial actors have been participating in the Climate Finance Task Force, subsequently integrated into the Luxembourg Sustainable Finance Initiative (LSFI). The task force developed the Luxembourg Climate Finance Strategy with the aim of making Luxembourg an international centre for financing the fight against climate change. Several other initiatives have followed (Box 3.3). The vast majority of green finance initiatives have focused on climate change mitigation. Other environmental issues, including biodiversity conservation, water, pollution and circular economy, deserve more attention.

In 2018, Luxembourg adopted the Luxembourg Sustainable Finance Roadmap, drafted in partnership with the UN Environment Programme. The government committed to implement the recommendations of the roadmap. To that end, under the joint leadership of the environment and finance ministers, it established the LSFI to develop a national green finance strategy. Ultimately, the strategy aims to provide a framework to accelerate the development of green and sustainable finance to help meet the goals of the Paris Agreement and, more broadly, the SDGs. This would help better co-ordinate the multiplicity of green finance initiatives.

Anchoring ambitious targets for sustainable finance, aligned with international environmental goals, would provide a long-term framework to catalyse and better co-ordinate the financial sector's efforts. The climate framework law (under discussion at the time of writing) offers an opportunity to enshrine in legislation the commitment under the Paris Agreement of “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development” (Article 2.1c). In line with this commitment, the central and local governments could lead by example. For instance, they could pledge to measure, report and reduce the environmental and social impact of public investments, sovereign wealth funds and public pensions.

Thanks to its financial expertise, Luxembourg could make a significant contribution to integrating environmental, social and governance (ESG) considerations into financial products and investment decisions, both nationally and internationally. It could do more to ensure that green finance has a positive environmental impact and to manage the financial risks of climate change. Luxembourg can also further exploit the opportunities provided by FinTech and large foreign direct investment (FDI) to advance the sustainability agenda.

As in other countries, it is difficult to measure the actual environmental impact of the investment funded through green finance instruments. There is a lack of indicators and monitoring measures that would ensure the credibility of financial products, measure their environmental impact, enhance the impact of LuxFLAG’s labels (Box 3.3) and avoid “greenwashing”. For example, it is not clear whether the renewable energy covered bonds (Box 3.3) have contributed to additional investment in renewables and energy efficiency projects or whether these projects would have materialised anyway (OECD, 2019a). Luxembourg should develop official statistics and indicators for green and sustainable finance to monitor the environmental impact of green finance products.

At global level, the financial sector is exposed to climate-related risks as many financial institutions hold high-carbon assets. These assets are likely to lose value when countries step up their actions to meet international climate change mitigation targets (TCFD, 2017). A project assessing the current portfolio exposure to climate risks is underway in Luxembourg’s insurance sector (OECD, 2019a). However, this remains a voluntary initiative. Asset managers and institutional investors are not required to disclose their exposure to climate risks. The financial and insurance market regulators do not have a mandate to assess the effects of climate change risks on financial stability, or to take actions to mitigate them. Luxembourg should consider developing a legal framework for considering environmental and climate risks and impact in investment decisions. This should complement the 2019 EU Regulation on sustainability‐related disclosures in the financial services sector. There is also a need to strengthen non-financial transparency by setting harmonised ESG reporting requirements for companies and investors. For example, France included similar reporting obligations in its 2015 law on the energy transition for green growth.15

As a large provider of FDI, Luxembourg needs to ensure that its FDI stocks and flows respect the environment and contribute to the transition towards the green economy at global level. At the end of 2018, Luxembourg's outward FDI stocks stood at 343% of GDP, the highest share in the OECD. Luxembourg adhered to the OECD Guidelines for Multinational Enterprises, which set voluntary standards for responsible environmental conduct for internationally active companies. It also implements the OECD Recommendation on Common Approaches for Officially Supported Export Credits and Environmental and Social Due Diligence (OECD, 2010). More than 30 Luxembourg companies adhere to the UN Global Compact, a voluntary corporate sustainability initiative.

Luxembourg could further exploit the synergies between FinTech and green finance (green digital finance). The country has attracted prominent FinTech companies. These companies perform various activities (e.g. banking, payment or e-money institutions) and service customers all over Europe. Luxembourg House of Financial Technology, a public-private platform that stimulates innovation in the digital finance sector, could develop measures to use FinTech innovation for scaling up green finance and investment.

Luxembourg is a generous donor, devoting 1% of its gross national income (GNI) to official development assistance (ODA). This makes it one of the few members of the OECD Development Assistance Committee to exceed the UN target of 0.7% of GNI. ODA consists solely of grants. About one-third of bilateral aid has environmental protection as a primary or significant objective, which is relatively low compared to other donors (Figure 3.9). The environment-focused aid figures exclude international climate finance, however. Luxembourg launched a revision of its aid database to better assess the allocation of bilateral aid for environmental protection and make more accurate comparisons across countries.

Luxembourg provides a large amount of international climate finance to help developing countries mitigate and adapt to climate change. It pledged to provide EUR 120 million in 2014-20 and EUR 200 million in 2020-25 to support developing countries’ climate actions. These funds were to focus on the least developed countries, the small island developing states and the Luxembourg development co-operation partner countries. The commitment included an annual envelope of EUR 5 million for the Green Climate Fund. International climate finance comes on top of ODA and is made available through the Climate and Energy Fund managed by the MECDD (Section 3.5). The 2017 strategy for Luxembourg international climate finance funds aims at an indicative allocation of 40% for mitigation measures, 40% for adaptation and 20% for activities to reduce emissions from deforestation and forest degradation (REDD+). In 2019, LuxDev, the country’s development agency, received accreditation with the Green Climate Fund. This is expected to enable the agency to implement more climate-related projects and programmes to complement the development co-operation projects.

Luxembourg should maintain the commitment to international climate finance and further increase the environmental component of its development co-operation. There is scope to further harnessing the potential of Luxembourg’s strong financial centre to leverage private finance for climate investment, as well as development more generally (OECD, 2017). This, in turn, would help the country contribute to the global climate finance target of USD 100 billion by 2020. Luxembourg is well-placed to continue to explore opportunities for leveraging private funds for development, building on initiatives such as the Luxembourg-EIB Climate Finance Platform (Box 3.3).

Poverty eradication is the main objective of the 2018 development co-operation strategy, in line with the third PNDD and the SDGs (Section 3.2). The country’s bilateral co-operation focuses on a limited number of countries to maximise the impact of aid. Luxembourg allocates at least half of its bilateral aid to its priority partner countries, and maintains a regional focus primarily in countries in West Africa and the Sahel.

The development co-operation strategy is structured around four priority themes, which are considered to have the largest poverty eradication potential: improve access to basic social services; strengthen the socio-economic integration of women and young people; promote inclusive governance; and promote sustainable and inclusive growth. There are also three cross-cutting dimensions: environmental sustainability; respect for human rights; and gender equality and equity.

In 2012, LuxDev developed guidance for consideration of the cross-cutting dimensions in its development activities. With respect to environmental sustainability, the guidance aims to help practitioners identify and avoid adverse environmental impacts of development co-operation programmes and projects; identify and seize opportunities to improve environmental conditions; promote a better environmental dialogue with institutions and stakeholders in partner countries; and identify potential climate-related risks to projects and programmes.

All development project proposals go through an environmental and climate screening. This seeks to identify the potential environmental impact, as well as the potential influence of climate change, on the project. The screening indicates whether an environmental impact assessment (EIA) and/or a climate risk assessment (CRA) are needed. For projects that do not require an EIA or CRA, any significant environmental issues identified during the screening should be addressed during the project formulation phase. The formulation phase should identify the necessary measures to mitigate environmental and climate impacts by target groups and ecosystems and provide financial resources to implement them. The project can include an environmental management plan to be executed during project implementation. The environmental indicators included in the project design should be tracked to trigger adjustments in project management when needed. An environmental review of an ongoing project is also possible to identify areas where environmental performance can be improved.

Environmental issues are systematically assessed once projects have been identified. However, environmental opportunities and threats are not strategically considered during the elaboration of multiannual country-specific development programmes (OECD, 2017). In addition, guidance for implementation is not sufficient. The agency plans to complement its guidance with environmental and social safeguards. There is also a need to strengthen capacity of authorities to mainstream the environmental and other cross-cutting dimensions into development activities.

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Notes

← 1. The priority fields of action of the third National Sustainable Development Plan are: ensuring social inclusion and education for all; ensuring the conditions of a healthy population; promoting sustainable consumption and production; diversifying and ensuring an inclusive and future-oriented economy; planning and co-ordinating land use; ensuring sustainable mobility; halting the degradation of the environment and respecting the carrying capacity of natural resources; protecting climate, adapting to climate change and ensuring sustainable energy; contributing globally to poverty eradication and policy coherence for sustainable development; and guaranteeing sustainable finances.

← 2. An inter-ministerial committee (finance, environment, energy and economy) monitors the evolution of fuel sales and defines measures to reduce their impact on Luxembourg's GHG emissions, with a view to achieving the country’s climate commitments.

← 3. Before the raises, the climate change contribution was set at EUR 0.02 per litre of petrol and EUR 0.025 per litre of diesel.

← 4. Rising benchmark values over time for carbon costs reflect that the marginal damage caused by one tonne of CO2 increases with the accumulation of CO2 in the atmosphere.

← 5. Pricing emissions above EUR 30 per tonne does not guarantee that polluters pay for the full damage they cause, or that prices are sufficient to decarbonise the economy. A price below EUR 30 per tonne does mean, however, that emitters do not face the social costs of emissions and that incentives for cost-effective abatement are too weak.

← 6. Exemptions from the abstraction tax are granted to water withdrawals related to aquaculture, water troughs in stream-fed pastures, public or private civil engineering works, rescue services and hydropower generation.

← 7. In 2016, the average annual quantity of residual mixed waste was 157.5 kg per inhabitant in municipalities applying quantity- or volume-based waste charges, compared to 208.2 kg per inhabitant in other municipalities.

← 8. The grant covers 75% of the appliance price, with a limit of EUR 750 per appliance.

← 9. The other priority sectors of the Smart Specialisation Strategy are manufacturing industry, information and communication technologies, space technologies, logistics, health sciences and technologies.

← 10. According to a 2017 Eurobarometer survey, 25% of the country’s SMEs offer green products and services, compared to the EU average of 24%. In all, 27% of SMEs have taken steps to design products that are easier to maintain, repair or reuse (the EU average is 25%).

← 11. The “Clever akafen” criteria include: recyclable packaging; no or low level of dangerous substances; long-lasting product with a low energy consumption at use; and easy recycling of the product after use. The label covers rechargeable batteries and accessories, lighting equipment, lacquer and paint, detergents, personal care products, and school and office material.

← 12. A green bond is a debt instrument issued to fund projects that have a positive environmental or climate impact. Social and sustainable bonds are debt instruments whose proceeds are exclusively used to finance or refinance social projects and sustainability-focused projects, respectively.

← 13. The fourth edition of the Global Green Finance Index is based on a worldwide survey of finance professionals’ assessments on the quality and depth of green finance offerings across 114 international financial centres.

← 14. The four priorities are: support to new growth sectors (sustainable finance, digitalisation, investment funds); excellence in regulation and compliance; promotion and communication; and education and research.

← 15. Law 2015-992 of 17 August 2015.

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