Luxembourg, from a Rural Country to the Seventh Most Significant Financial Centre in the World
In the global economy it often appears that relatively small countries, like Switzerland or Luxembourg for instance, attract a lot of interest from the financial services and consequently start to manage a constantly growing amount of foreign money. This represents a considerable loss of funds for the major financial centres, like New York or London. This strange phenomenon can be explored by studying the particular case of Luxembourg.
Luxembourg is a small country in the centre of Western Europe. It is surrounded by Germany, Belgium and France and with its population of around 400000 people it is one of the smallest countries in the world. Nevertheless it has its own language, Luxembourgish, and its very own identity. But more importantly it also happens to be one of the most significant financial centres in the world.
Luxembourg wasn’t always fortunate enough to manage a lot of foreign capital; this has merely been due to a number of developments in the past century.
In the 19th century, Luxembourg was a poor rural country and its population regularly suffered from starvation, the last famine taking place in 1855. This was due to bad soil and a rough climate. Consequently only very few people lived on Luxembourgish grounds back then and Luxembourg City was the only town in the country. The statutes of the first official issuing bank (Banque Internationale à Luxembourg) were only approved in March 1856 by grand-ducal order.
The Luxembourgish economy really started to take off around 1870 after a more effective road and rail network was built and after plenty of iron ore was discovered in the southern parts of the country. For the first time Luxembourg had to work in close relationship with its neighbouring countries, indeed Belgian and German banks started investing in its steel industry. Modernisation of the production chains completely depended on the foreign investors and foreign workers, because the small size of the country made it impossible to keep up with the growing needs of this new successful industry.
For the first time in its history of independence, Luxembourg was wealthy and in close relationship with an important number of influential countries. These factors made it possible for it to try and develop new economic sectors in the beginning of 20th century. This was also necessary because the agricultural industry was decreasing everywhere in Western Europe and Luxembourg did not want to entirely depend on the metal industry. Around 1920 a number of agreements and customs unions with its neighbouring countries attracted several new banks, like the Banque Générale du Luxembourg (a branch of the Société Générale de Belgique) in 1919 for instance.
Furthermore the law stating the creation of the Luxembourg Stock Exchange was passed on the 21st of December 1927.
At this stage Luxembourg was not a major financial centre yet, but several countries already feared the loss of capital. This was partially due to the law on holding companies, passed in 1929. These holding companies were not subject to the income tax or to the surcharge. The owner only needed to pay a registration fee and a stamp duty. These facts made the taxation on this new type of companies around 90% lighter than on ordinary companies. Similar laws in Switzerland and Liechtenstein had inspired this new legislation.
The Second World War (1939-1945) slowed the economic activity in Luxembourg down and it was only around 1950 that the financial sector acquired its stability back and one saw the creation of the first mutual investment funds.
After 1960 Luxembourg fully developed into a leading financial centre. This was mainly due to its liberal legislation. Indeed it did not have a central bank and there were no statutory reserves for the banks. Furthermore there was the Luxembourgish bank secrecy act (i.e. a law that protects foreign clients from lawyers, courts and most importantly their governments) and there was no payment of income tax at source for bond dividends and eventually the absence of any inheritance tax.
These factors, together with the laws on holding companies and the fact that Luxembourg was famous for its political and monetary stability attracted banks and investors from all over the world. The small country acquired a worldwide reputation and got frequently compared to Switzerland. Similarly to its counterpart in the Alps, Luxembourg developed a very high standard of life, in fact the highest in the European Union (in 2000). With around 220 financial institutions, the small country has nowadays one of the greatest concentration of such companies in Europe.
In 2000 the European Union seemed to put the now 7th most significant financial centre in the world in a critical situation. Indeed the European Union wanted to change the Luxembourgish legislation on taxation and bank secrecy in order to conform it to the other member countries. The outcome of the talks was widely considered as an important victory for the Luxembourg government. Indeed the ECOFIN (Council of the Ministers of the Economy and Finances of the European Union) decided on the 26th and 27th of November 2000 that Luxembourg has to agree to having a withholding tax of 15% on savings for non-residents. This will take effect from the 1st of January 2003 and will be raised to 20% in January 2006. Furthermore the bank secrecy has to be abolished in 2010. All these new laws might sound quite dramatic for Luxembourg, but the Luxembourgish ministers negotiated the following: the mutual funds that are mainly invested in stocks and the Euro-bonds issued before March 2001 will be exempted from the new taxation laws. Furthermore the new regulations will only be ratified if all the countries of the OECD (Organisation of Economic Co-operation and Development) (i.e. Switzerland, Liechtenstein, Monaco, Andorra, the Channel Islands…) will follow suit. It is very unlikely that this will be the case, but if it happens, "tax havens" will no longer exist in Europe. So the future of the Luxembourgish economy is closely linked to the future of all the other small countries with more liberal taxation laws.
The example of Luxembourg is very representative for most of the so-called "tax havens" in Europe. They are all small countries, which started of with an agricultural industry and took great profit of the industrialisation and their central geographical positions. Their liberal legislation then attracted investors from all over the globe. Consequently the countries acquired a good standard of life and earned the jealousy of many countries that saw their capital leaving their own territories.
It remains to be seen for how long "tax havens" will continue to exist in a unified Europe
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