Tiny Luxembourg a Big Pain to Some Neighbors

The Grand Duchy of Luxembourg is a land where almost everybody has a job, the budget is balanced and incomes are among the world’s highest.

Small wonder the national motto is: “We want to stay what we are!”

That task is getting harder and harder.

“We’re having to make great efforts to stay what we are,” says Prime Minister Jean-Claude Juncker, sitting in his office in the heart of Luxembourg city’s historic old town.

Luxembourg’s partners in the European Union want to curtail the tax advantages and bank secrecy rules that have made this small nation one of Europe’s leading financial centers and given it a strong economy.

Germany, in particular, worries about billions of marks lured into Luxembourg bank vaults by secrecy rules and the absence of taxes on interest. Other nations share suspicions that Luxembourg is used for tax evasion and money laundering.

Luxembourg denies such charges and contends efforts to impose withholding taxes on savings and investments would simply push Germans to take their money to tax havens even further beyond the reach of German tax authorities.

“They will not solve the problem. They will increase the problems and send them somewhere else,” argues Lucien Thiel, general manager of the Luxembourg Bankers Assn. “There will be a delocalization of savings outside the European Union--for example, to Switzerland.”

The issue is crucial for Luxembourg because the capital’s gleaming financial district, with more than 220 banks, underpins the country’s prosperity.

Total revenue generated by financial institutions topped $328 billion last year. Although there are no taxes on interest earned by depositors, corporate income taxes are relatively high, meaning profit at all those foreign banks makes a major contribution to state coffers.

The tax revenue has been used to cushion Luxembourg’s 400,000 citizens from the economic woes afflicting other Western European nations.

For example, the Arbed steel company--Luxembourg’s biggest employer--has cut its work force from 27,000 to 6,000 since 1978 without major unrest because tax revenue financed generous early retirement pensions and retraining courses.

Healthy public finances also allow the government to offer incentives to attract high-technology industries.

Juncker says the fuss about Luxembourg’s low taxes is blown out of proportion. He points out that fears of losing business to rival banking centers--notably London and Dublin--forced him to slash corporate taxes in May.

“I’m astonished by reactions abroad,” he said during an interview. “Our so-called tax paradise has to cut taxes because elsewhere they have lower taxes.”

For the moment, Luxembourg can veto Germany’s drive to harmonize the tax laws of the European Union’s 15 member states. But efforts to shift the power balance in the EU away from small nations could limit Luxembourg’s room to maneuver in this and other areas.

The EU’s big powers worry that plans to add up to 12 new members early next decade will make the bloc top-heavy and weak, unless small nations’ powers are downgraded.

They point to rules giving Luxembourg two votes in key EU decisions--one per 200,000 citizens--while Germany gets 10 votes--1 per 8 million.

Then there’s the rotating presidency system that gives each member a lead role in running EU foreign policy for six months. Officials from big nations complain that having Luxembourg or potential members Malta and Lithuania in charge will not boost the EU’s voice in world affairs.

Juncker, at 41 the EU’s youngest leader, is determined to resist efforts by the bloc’s big guns to undermine Luxembourg’s influence.

“We have to stick to our rights,” he said. “In foreign policy, we are a nobody. We can become a somebody because the bigger member states are prepared to share their sovereignty.”

It may be outgunned, but Luxembourg has a friend in a high place. The head of European Commission, the EU’s executive body, is Jacques Santer, Juncker’s predecessor as Luxembourg prime minister.

Another challenge facing Luxembourg is partly of its own making. Luxembourg has been a firm supporter of plans for a common EU currency to replace national monies after Jan. 1, 1999.

But as a leader in European currency and bond dealing, it stands to lose out when there are no more francs, marks or guilders to trade.

Thiel, the banking association chief, is confident Luxembourg will be a center for trading the new EU currency, which will be known as the euro.

“Luxembourg is better situated to handle this new currency than all the European partners,” he said. “The monetary union is supposed to be a risk. We see it as a challenge and we hope to make it an opportunity.”