Belgium: Selected Issues

This Selected Issues paper analyzes fiscal devolution in Belgium. It examines long-term fiscal strategies for meeting the fiscal burden of population aging. The paper presents estimates of the fiscal costs of population aging in Belgium, and discusses their sensitivity to underlying assumptions. Strategies for meeting the fiscal costs of aging are discussed. Specifically, a strategy of swift debt reduction is discussed to see what budget surplus would be needed to reduce debt and interest payments rapidly enough to finance these costs. Alternative policy options are also discussed to show the consequences of delayed fiscal adjustment.

Abstract

This Selected Issues paper analyzes fiscal devolution in Belgium. It examines long-term fiscal strategies for meeting the fiscal burden of population aging. The paper presents estimates of the fiscal costs of population aging in Belgium, and discusses their sensitivity to underlying assumptions. Strategies for meeting the fiscal costs of aging are discussed. Specifically, a strategy of swift debt reduction is discussed to see what budget surplus would be needed to reduce debt and interest payments rapidly enough to finance these costs. Alternative policy options are also discussed to show the consequences of delayed fiscal adjustment.

I. Fiscal Devolution in Belgium1

A. Introduction

1. Belgium is a federal state composed of three economic regions (Flanders, Wallonia, and Brussels-Capital) and three linguistic communities (the Flemish, French, and German-speaking).2 It has three levels of government: the federal government, the regions and communities, and the provinces and communes.3 Currently, the federal government is responsible for nationwide functions, including the judiciary, defense, and foreign policies. It also manages the social security system, which is uniform across the country, and most parts of public health. Regions are responsible for regional economic development, environment protection, and other matters of regional interest, while communities are mainly responsible for education and culture. The provinces and communes are in charge of local matters, including local police.

2. Belgium has proceeded with fiscal devolution since the early 1980s, as have a number of other European countries (see Table). The Act on Regionalization in August 1980 introduced deep reforms to the centralized regime that had been in place since the Belgian State was first established in 1830. However, it was not until 1988-89 when devolution of power from the central to regional and community governments took place on a large scale, with the introduction of the Special Finance Act in 1989. The scale of transfers through federal grants declined and the share of primary spending devolved to local governments rose from about 15 percent in 1980 to 40 percent in 2001 (Figure I.1).

Share of Central Government in General Government

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Sources: WEO; and Belgian National Bank.

Data for 1985.

Primary expenditure.

Figure I.1.
Figure I.1.

Belgium: Fiscal Decentralization

(In percent)

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

Sources: Belgian National Bank; and Fund staff estimates.

3. Belgian fiscal decentralization since 1980 has been associated with sustained improvements in fiscal outcomes (Figure I.2). The large budget deficits that had characterized the 1980s were eliminated during the 1990s, and a small surplus was registered in 2000, well ahead of the time envisaged by the Belgian national Stability Program. Public debt, after reaching its peak of 138 percent of GDP in 1993, has since declined.

Figure I.2.
Figure I.2.

Belgium: Fiscal Performance During 1979–2002

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

B. Fiscal Devolution in Belgium Since 1980

4. The main motivation for fiscal devolution is well studied in the literature of fiscal federalism.4 Devolution aims to ensure that levels of public good provision are responsive to the preferences of local residents (according to the public good choice model), or to exploit certain advantages of smaller-scale units in the administrative implementation of polices (according to the agency model). In either case, fiscal decentralization is expected to improve the quality and cost-effectiveness of public services.

The institutional framework

5. Broad institutional changes since 1970, which led to the creation of the three regions, preceded the fiscal decentralization in Belgium. Until 1970, Belgium had been a constitutional monarchy and a unitary state, comprising the central government, provinces, and communes. The provincial and municipal authorities were considered subordinate tiers of government, but had limited autonomy (Allen and Ergec, 2002).

6. The current federal system is a product of four major state reforms during 1970–93. The first in 1970 recognized three “cultural communities”—Flemish, French and German—each endowed with a council vested with the powers to enact decrees with legislative force for the territories under their authority, and in matters mainly relating to cultural affairs. Subsequent revisions to the Constitution during the second, third and fourth state reforms of 1980, 1988, and 1993 led to the establishment of the Walloon, the Flemish, and the Brussels-Capital regions. Today, Belgian regions and communities enjoy full executive powers, are governed by their own parliaments and executives, and are not subordinate to the federal government.

Major reforms since 1980

7. The introduction of the Act on Regionalization in 1980 during the second state reform set the stage for large-scale fiscal devolution. The desire for fiscal decentralization was primarily driven by increasingly pressing demands for greater financial autonomy for the regions and communities, particularly from the Flemish who felt disadvantaged by the fixed-scale need-based allocation of financial resources (Allen and Ergec, 2002).

8. However, the fiscal autonomy from the 1980 reform was limited. Although the Act did provide the regions and communities with the power to levy taxes, this was limited in practice. For the Flemish and the French Communities, it remained entirely theoretical, since the law did not define the geographical area over which their taxation power could be exercised. For the regions, legal restrictions meant that they would have been able to raise only very small environmental taxes. Measured by the distribution of revenue and primary spending, the devolution process between 1980 and 1988 was indeed limited: the local governments’ share in total primary expenditure and in total government revenue was little changed at about 15 percent throughout this period (Figure I.1).

9. During 1988–1989 large-scale fiscal devolution took place. With the third state reform and the introduction of the Special Act of August 1988, the regions and communities were entrusted with the role of formulating and implementing regional policy objectives and strategies. In particular, the communities became responsible for education, and the regions for regional economic development and infrastructure (see Chapter III for a detailed discussion). Subsequently, a special financing act was introduced in January 1989 laying out budgetary principles and financing mechanisms for the local governments. Reforms during this period led to a significant decline in the revenue and expenditure share of the federal government (Figure I.1).

10. On the expenditure side, about 25 percent of primary spending was devolved to the regions and communities. The regions and communities were given complete autonomy over these financial resources. The Special Financing Act of 1989 granted regional authorities immediate responsibilities for spending mainly related to education, regional economic development, and infrastructure (Figure I.3). Operationally, the devolution of spending responsibilities was facilitated by transferring (in many cases simply reclassifying) associated administrative personnel and functions from the federal to the regional levels within a short time period.

Figure I.3.
Figure I.3.

Belgium: Expenditure Composition of Local Governments, 1990 1/

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

Sources: Belgian High Council of Finance; and Fund staff estimates.1/ Note that the composition has not changed much since 1990.

11. On the revenue side, the key element of devolution was a new tax-sharing system. Under this system, taxes are collected by the federal government, then some are transferred to local governments in accordance with an explicit set of “repartition keys” (see Box 1). This contributive-capacity-based tax-sharing system gradually replaced the old need-based grant system. Consequently, the scale of transfers through federal grants to local governments declined, but transfers to them through the tax-sharing system increased. By 1989 the share of tax revenue transferred to local governments in Belgium had risen to about 30 percent, a level comparable to those in the other EU federal states (Table I.1).5 Furthermore, the federal government alone can not alter the transfer system or the repartition keys.

Table I.1.

Attribution of Tax Revenues to Lower Levels of General Government

(In percent of total tax revenue of general government)

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Source: OECD.

Tax-Sharing System in Belgium

Taxes are collected by the federal government, then some are transferred to local governments according to “repartition keys.”

The regions receive a part of the personal income tax (IPP), based on an overall amount agreed in 1989 and increased each year in line with nominal GDP. This is distributed among the three regions in proportion to the amount of tax collected in each region. The communities also receive a small part of IPP, based on “perceived” tax shares (juste retour). The communities receive so-called VAT transfers, which are based on an overall amount agreed in 1989 and increased in line with inflation and changes in number of school-aged children (thus, they do not depend on actual VAT collected). The VAT transfers are shared between the French and the Flemish Community in proportion to the number of students in each community in 1989 (42.45 percent for the French Community and 57.55 percent for the Flemish Community; the main financing source for the German Community remains to be federal grants). In addition, following the Lambermont Agreement, which came into force in 2002, regions receive a share of wealth inheritance taxes, radio-television taxes, and registration fees, car taxes and others.

Under this tax-sharing system, about 40 percent of IPP and VAT have been transferred to regions and communities, while another 10 percent of IPP and the corporate profit and income taxes have been transferred to the provinces and communes (Figure I.4).

Any change of the repartition keys requires legislative approval and agreement by all levels of government. The repartition keys for VAT transfers were modified in 1999 by the Saint-Éloi Agreement. The modification was in favor of the French community, and led to a loss of VAT transfers to the Flemish community, who agreed only after being compensated with larger federal grants for foreign students and so-called drawing rights for employment programs organized by regions.

Inter-region equalization: a national solidarity measure was introduced in 1990 to increase the share of revenues transferred to the region with the lowest per capita tax payment. This led to a transfer in favor of the Walloon region and another in favor of the Brussels-Capital region in 1997 (Gerard, 2001).

Social security contributions are collected at the federal level and the federal government is responsible for paying the benefits, including pensions, unemployment benefits, early retirement benefits, and health care. To the extent that social security contributions and benefits are unequally distributed across regions—reflecting disparities in regional economic activity or demographics—the social security fund transfers income across regions.

Figure I.4.
Figure I.4.

Belgium: Tax-Sharing Among Federal Government, and Other Levels of Government

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

Source: OECD (2001); and Fund staff calculations.

12. Despite the substantial increase in local governments’ influence over the distribution of tax revenues, the devolution of taxing power resulted from the reforms in 1988–89 was limited. The federal government alone remained responsible for the majority of decisions concerning the parameters of tax law.6 The taxing powers of the regions and communities were confined to small margins or rebates on a selection of tax rates, mainly registration fees and, to lesser extent, personal income tax (Table I.2). For the provinces and communes, about half of their revenues remained in the form of federal grants, over which they had no decision-making power. They were allowed to levy surcharges on income taxes and a withholding tax on real estate, but the amount concerned was fairly small (Table I.3).

Table I.2.

Devolution of Taxing Power Under the Special Financing Act of 1989

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Source: Van der Stichele and Verdonck, 2001.

Have been devolved to the regions under the Lambermont agreement in 2001.

100% regional since 2002.

13. The Special Financing Act of 1989 also set forth the devolution of public finances for the transitional period of 1989-1999, particularly the shift from the spending-need-based grant regime to the contributive-capacity-based tax-sharing regime. The share of federal government tax revenues transferred to the regions and communities rose marginally between 1989 and 1999, either as a percent of GDP or as a share of the federal government’s total tax revenues (Table I.3). Grants from the federal government to regions and communities, declined initially in 1990—in absolute amount as well as in percentage of GDP—but then rose slightly as a percentage of GDP. The importance of own taxes and own revenues in local finances increased. By 1999, although transferred tax revenues from the federal government still constituted an important part of financing for the regions and communities, about 20 percent of the revenues of the regions and communities were from their own tax and nontax revenues, compared to 14 percent in 1989.

14. Nonetheless, the apparent lack of alignment between devolution of spending responsibilities and that of fiscal instruments with the proper levels of government at times led to budgetary problems for local governments, notably the communities. In particular, the financing mechanism stipulated in the Special Financing Act of 1989 led to structural under-financing of the French and Flemish communities. For instance, between 1991 and 1998, the growth of revenues for the French community was lower than GDP growth (Van der Stichele and Verdonck, 2001). The Flemish community faced a similar problem, but was able to benefit from the pooling of community and regional resources after merging with the Flemish region. Consequently, the financing mechanism for the communities has been modified three times in the past ten years (often under lengthy negotiations among various levels of government), in order to increase revenues for the communities.7

Table I.3.

Belgium: Revenue Sources of Regions and Communities, and Provinces and Communes

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Sources: Belgium National Bank; and Fund staff estimates.

15. The Lambermont Agreement (a 2001 Amendment to the Special Financing Act of 1989) sets out new steps for further fiscal decentralization. According to official estimates, the proportion of revenues over which the regions and communities have total autonomy would increase to 21 percent, and the proportion of taxes for which they may set rates or exemptions would rise to 26 percent.

16. One main objective of the Agreement is to stabilize tax transfers to the regions and communities relative to GDP over the next twenty years. Absent such an agreement, transfers to the communities and regions would have risen by 1.5 percent a year in real terms, implying a decline as a share of GDP. More specifically, the VAT transfers to the communities will be increased, in principal to cover education expenditures, and will be eventually linked to economic growth. Moreover, the Agreement also seeks to modify the revenue-sharing mechanism in order to minimize volatilities in the revenue transferred to the regions and communities. These volatilities were a result of the design of the revenue-sharing formula. In any given year transfers are calculated on the basis of inflation and growth in the preceding year, and adjustment takes place the following year. This time lag has led to a saw-tooth pattern in communities’ and regions’ revenue streams, which was particularly pronounced in the past two years, with nominal increases of 0.7 percent in 2000 and 9.8 percent in 2001. The new formula will link revenue transfers to the growth of the current year.

17. The Lambermont Agreement also entails further devolution of taxing powers to the regions. A number of taxes—including all registration fees, the motor vehicle duty, the road fund tax, and the “euro vignette” tax—have been transferred to the regions since 2002. Furthermore, the agreement will increase the IPP margin from the current 3.25 to 6.75 percentage points from the beginning of 2004. This means that the regions will be able to grant piggyback taxes or tax refunds up to 6.75 percent of their IPP revenues, as long as the progressivity of the personal income tax is not reduced.

18. Recognizing the budgetary impact of these changes, the Sainte-Térèse Agreement sets out principles for a twofold budgetary neutrality. Most importantly, vertical budgetary neutrality would require that losses in federal government revenue due to the devolution of taxes be offset by a reduction in IPP transfers to the regions. On the other hand, horizontal budgetary neutrality would ensure that no region is financially disadvantaged. According to official estimates, for the regions and communities, the share of own taxes in their total revenue would increase from 8.6 percent in 2001 to 15.3 percent in 2002, but the share of tax transfers would decrease from 71.6 percent to 63.3 percent, largely due to the reduction in IPP transfers (Table I.3). Hence, in 2001 the losses in federal government revenue are fully offset by the decline in IPP transfers to the regions and communities. However, the feasibility of maintaining the vertical neutrality in subsequent years has been questioned because of technically difficulties, for which several solutions have been proposed (Van der Stichele and Verdonck, 2001).

C. Macro economic Management and Fiscal Consolidation

19. It is clear that decentralization, if not managed properly, could jeopardize macroeconomic stability. Lack of fiscal discipline at the local level has in some countries been associated with large national deficits and debt, as demonstrated in the recent experience of some Latin America countries, notably Argentina and Brazil (Alesina, et al., 2002). On the other hand, decentralization is has also been associated with better fiscal outcomes in countries with strong governance (Drummond and Mansoor, 2002).

20. The large fiscal devolution after 1988 took place just as Belgium was facing challenges of fiscal consolidation required by the Maastricht Treaty. Devolution in 1988/89 left the regions with immediate unrestricted fiscal authority over a large fraction of their expenditure (about 40 percent of the public expenditure at that time were managed by the regions and communities), but the revenue base was devolved only gradually. This led to the concern that general government deficits could get out of control. In the event, Belgian fiscal decentralization since 1980 has been associated with sustained substantial improvements in the federal government’s budget balance, and sound fiscal situation at the level of local governments (Figure I.5). This section reviews key policy instruments the government used in managing the decentralization process in Belgium.

The role of the High Finance Council and the Internal Stability Pact

21. The High Finance Council (HFC) was assigned a crucial role in ensuring that fiscal decentralization would not jeopardize macroeconomic stability.8 The HFC was completely restructured in 1989, and three permanent sections within the HFC were created: the first, “Besoins de Financement des Pouvoirs Publics (Borrowing Requirement Commission or BRC),” to monitor the fiscal policies of all public authorities; another to deal with matters related to tax laws; and a third to cover issues related to financial institutions and markets. Council members for the BRC included representatives from the Ministry of Finance, the National Bank of Belgium, the Federal Planning Bureau, and the regional governments.

Figure I.5.
Figure I.5.

Belgium Budget Balance at Levels of Government

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

Sources: Belgian National Bank; and IMF, WEO.

22. One key function of the HFC (more precisely the BRC) was to coordinate fiscal policies between the federal and the regional governments. Close coordination was facilitated by the cooperation agreements concluded regularly between the federal and the regional governments, seeking to ensure that regional fiscal policies were consistent with Belgian national Stability Program. The HFC, among things, was responsible for monitoring the implementation of the cooperation agreements. In so doing, it has published annual advisory reports, with an evaluation of the financial needs of each government entity and fiscal policy recommendations (in terms of deficit targets). The scope of these reports was initially limited to financial matters related to the federal state, the regions, and the communities, but was soon expanded to include the social security funds, and provinces and communes

23. Cooperation agreements were produced in the framework of fiscal adjustment required by the national Stability Program, and set permissible fiscal targets for the federal and the other levels of government. The first agreement was in 1994, and subsequent intergovernmental agreements were reached in 1996 for 1996–99, in 1999 for 1999–02, and most recently in 2000 for 2001–05. In particular, under the first agreement the federal state and the regions were obliged to incorporate the adjustment effort required by the Convergence Plan of 1992, the first national stability program adopted in June 1992 after Belgium signed the Maastricht-Treaty early that year. The second agreement reflected the framework of the Convergence Plan of 1996.

24. In 1999, when Belgium joined the third stage of the EMU, the cooperation agreement was produced in the form of a five-year “internal stability pact,” which, to a large degree, internalized the national Stability Program.9 To ensure that the budgetary policy of the communities and regions fits in with the national Stability Program, the communities and regions draw up an evolving internal multi-annual stability program each year. These programs specify how the communities and regions are to attain the targets for each of the budget years concerned. The High Council of Finance carries out an annual evaluation of the execution of these internal stability programs.

25. The policy targets specified in the cooperation agreements have evolved over the years. Under the agreement of 1994, policy objectives were expressed in the form of a maximum ceiling on the so-called “natural deficit” for the regions. However, in the 1996 agreement, the reduction of the total debt ratio by 10 percent between 1996 and 1997 was an explicit objective, but, in contrast to the 1994 agreement, no explicit fiscal target was set for the federal government. The internal stability pacts since 1999 set explicit budget deficit targets for the federal and local governments. For example, the agreement reached at end-2000 specified the budget target for Entity II (the regions, communities, provinces, and communes) to be a surplus of 0.6 percent of GDP in 2001, and a surplus of 0.2 percent of GDP by 2005. Thus far, these agreed policy objectives have largely been met (Figure I.6).10

Revenue sharing arrangements

26. A range of considerations need to be taken into account in the devolution of taxing powers to regional and local governments, to avoid undermining macroeconomic control at the level of central government. The general guidance provided in the literature suggests that local governments should focus on taxes that are less sensitive to income fluctuations, so as to shelter themselves from cyclical effects and to provide the central government with stabilization instruments. Other considerations include the mobility of tax bases (to limit distortionary tax-induced migration of capital and/or labor), and the distribution of tax bases across regions (to avoid increased regional disparities) (Oates, 1998). Moreover, governments that rely on their own sources of revenue are likely to be fully aware of the costs of their programs, whereas reliance on discretionary grants from the central government undermines incentives for efficient spending decisions. In practice, tax-sharing arrangements have compared favorably with complex and discretionary systems of transfers between levels of government. Hughes and Smith (1991) found that in France, Italy, Spain, the increase of tax transfer and the decrease of grants over a period of 25 years resulted in downward pressure on the overall level of local government expenditure.

Figure I.6.
Figure I.6.

Belgium: Budget Target and Outcome For Regions and Communities

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 050; 10.5089/9781451803181.002.A001

Sources: Belgian Ministry of Finance; and IMF, WEO.1/ Positive number indicates that actual outcome is better than target.

27. The shift from the need-based federal grant system toward the contributive-capacity-based revenue-sharing regime appears to have improved the incentives for efficient spending decisions at the lower levels of government. Although the federal government made the major decisions on tax rates and bases, the fiscal power of the regions and communities increased as they were able to impose small margins or grant rebates on a selection of tax rates. Preliminary empirical analysis also indicate that for the provinces and communes, their marginal spending is positively correlated with the changes in their own tax revenues after 1989 and such correlation is absent for period before 1989.

Restricted financing at regional levels

28. The criteria governing access of lower levels of government to borrowing are a key determinant of effective control over public spending. Experiences from advanced OECD countries indicate that borrowing constrains—either rules-based control or market-based discipline—help to safeguard overall public sector deficit targets (Drummond and Mansoor, 2002).

29. In theory, the Special Financing Act of 1989 grants the regions complete autonomy on their financing policy and related debt management. Regions and communities are therefore allowed to finance their deficits by borrowing in domestic or foreign capital markets and in domestic or foreign currencies. In practice, however, the borrowing is restricted (see Table below). Regional authorities are subject to formal qualitative and quantitative restrictions on their borrowing. The federal government can impose restriction on the borrowing capacity of a region for a period of up to two years, following the advice of the HFC and after the region has been consulted. Foreign borrowing by the regions is subject to the approval of the federal Minister of Finance, as are the conditions and timing of debt issuance on domestic capital markets (von Hagen et al., 2001).

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D. Concluding Remarks

30. The fiscal devolution in Belgium since 1980 has been accompanied by sustained improvement in fiscal outcomes. As the lower levels of government (regions, communities, and local municipalities) now account for 40 percent of government primary spending, they will clearly play a key role in efforts to contain spending growth. With the introduction of the Lambermont agreement in 2001, greater decentralization is inevitable. In this regard, it is important to emphasize the critical role of the internal stability pact in maintaining macroeconomic stability in Belgium during fiscal devolution. Of equal importance is the HFC’s monitoring of the implementation of the internal stability pact and coordination of fiscal policies between the federal and regional governments.

References

  • Alen, André, and R. Ergec, 2002, Federal Belgium After the Fourth State Reform of 1993, Ministry of Foreign Affairs, Brussels.

  • Alesina, A., C. Carrasquilla, and J. Echavarria, 2002, “Decentralization in Colombia” (Mimeo).

  • Conseil Superieur Des Finances, 2002, Rapport Annuel 2002, July (Belgium).

  • Fossati, A. and G. Panella, 1999, “Fiscal Federalism in the European Union,New York, N.Y.: Routledge.

  • Gérard, Marcel, 2001, “Fiscal Federalism in Belgium”, paper presented at conference on fiscal imbalance, Québec City, Canada.

  • Hughes, G., and S. Smith, 1991, “Local Government,Economic Policy, October.

  • Drummond, P. and Ali Mansoor, 2002, “Macroeconomic management and the devolution of fiscal powers,IMF Working Paper WP/02/76.

  • Oates, Wallace, 1998, “The Economics of Fiscal Federalism and Local Finance,An Elgar Reference Collection, Cheltenham, U.K.

  • OECD, 2001, Revenue Statistics 1965–2000.

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  • Poterba, J. and J. von Hagen, 1999, Fiscal Institutions and Fiscal Performance, Chicago: University of Chicago Press.

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1

Prepared by Jianping Zhou.

2

The relationship among these government entities is complicated by the fact that the regions are defined territorially and the communities linguistically. As a result, the Brussels-Capital region has the presence of both the French and the Flemish community. The Flanders and the Flemish community have merged their public institutions into what is now called the Flemish Community.

3

In this Chapter, the regions, the communities, and the provinces and communes will often be collectively referred to as “local governments.”

5

When the central government collects taxes and transfers them in whole or in part to local governments, it is necessary to determine whether the revenues should be considered to be those of the central government (and the related transfer as grants) or those of the local governments (the central government acts only as their agent). According to the OECD definition, tax revenues are attributed to regional and local governments if (i) the regional and local government have exercised some influence or discretion over the setting of the tax or the distribution of its proceeds; (ii) under the provisions of the legislation they automatically and unconditionally receive a given percentage of the tax collected or arising in their territory; or (iii) they receive tax revenue under legislation leaving no discretion to the central government. (OECD, 2001; and OECD, 1999)

6

Belgium National Bank, Annual Report 2000.

7

In 1993 (the Saint-Michel agreement); in 1999 (the Saint-Éloi agreement), and in 2001 (the Lambermont agreement). See Van der Stichele and Verdonck (2001) for a detailed discussion on these agreements.

8

The HFC was established in 1936 as an advisory body within the Ministry of Finance.

9

Belgian Stability Program 1999–2002.

10

The HFC has no explicit sanction instruments if governments were to miss their policy targets.

Belgium: Selected Issues
Author: International Monetary Fund