France’s public finances
François Hollande’s fiscal puzzle
The new Socialist government tackles its budget deficit—but with more taxes than spending cuts
JULY is a month when most French governments wind down ahead of the summer break. Not this year. Freshly elected deputies have begun an extraordinary parliamentary session that will last until the end of the month, to enable François Hollande's new Socialist government to pass urgent measures. This week, Jean-Marc Ayrault, his unassuming prime minister, gave a taste of what the French can expect.
The good news is that the new team is committed to meeting deficit-reduction targets of 4.5% of GDP this year and 3% next. It has at last recognised the extent of France's fiscal problems. In his speech Mr Ayrault called the weight of public debt, nearly 90% of GDP, “crushing”. He would not be the one who left this legacy to his children and grandchildren. Mr Hollande and Mr Ayrault even talked of “structural reform” to boost competitiveness.
The election of Mr Hollande has also shifted the euro debate. During his campaign, Mr Hollande promised to veto the planned fiscal compact unless it was “renegotiated” to put more emphasis on growth. This he has not achieved. But, by siding with the Italians and Spanish in a showdown with Germany's Angela Merkel, Mr Hollande helped to extract concessions at the most recent European summit. They include allowing euro-zone rescue funds directly to recapitalise troubled banks and a “growth pact”, worth €120 billion ($151 billion), drawn mostly from existing resources. This has allowed Mr Hollande to tell voters he has “rebalanced” the overall package. He will now put both pacts to parliament in the autumn.
There are two problems in all this. First, if there was any remaining doubt about what France needs to do on the public finances, it was laid bare in a report on July 2nd by the Cour des Comptes, the national auditor. Chaired by Didier Migaud, a former Socialist deputy, it could hardly come from a more credible source. France, he concluded, must find an extra €6 billion-10 billion this year to stay on track; next year it needs a further €33 billion. Neither figure, he noted, takes into account Mr Hollande's extra spending plans. If GDP growth does not reach as much as 1% next year, the gap will be bigger still.
Mr Ayrault's response for 2012, outlined on July 4th, was simply to increase taxes by €7.2 billion, mostly on business and the rich. These include extra levies on those who pay the wealth tax, higher inheritance tax, an extra 3% tax on dividends, heavier charges on stock options, higher taxes on financial transactions, banks and oil firms, and a 5% extra tax on big companies. Since his idea is to spare the middle class, he is also scrapping the previous government's planned VAT increase. Mr Ayrault confirmed that, when he presents the 2013 budget in September, he will introduce a new top rate of income tax at 75% for households earning over €1m.
Yet, as the auditor's report points out, France needs to make a far greater effort at controlling its spending. At 56% of GDP, public spending is higher than in any other EU country bar Denmark. Next year, said Mr Migaud, would be “crucial” for maintaining France's “fragile” credibility with creditors. The country, he said, is in a “danger zone”; any slippage in reaching targets would risk setting off a debt spiral. And even if broad-based tax increases are necessary, the “effort to reduce the deficit should focus on spending”.
The second flaw is the government's policy on competitiveness, which the auditor describes as “the other major problem of the French economy”. Over the past decade, a large competitiveness gap has opened up between France and Germany. The auditor pointed to the need to cut heavy payroll charges that keep labour costs high. The European Commission, in a recent report, pleaded for greater labour-market flexibility.
To fix the competitiveness problem, however, the prime minister promises fiscal reform, “priority to youth”, decentralisation and an “energy transition”. When Mr Ayrault talks of structural reforms, he is not referring to what the auditor or most economists want. For instance, the labour minister, Michel Sapin, says that he plans to make it even harder for profitable companies to make lay-offs. Mr Hollande has appointed a minister of “productive recovery”, Arnaud Montebourg, whose job is to stop factory closures. There is much speculation over the future of a PSA Peugeot-Citroën car plant north of Paris that employs 3,000 workers.
On public spending, it could be that Mr Hollande is waiting until the autumn to take the hard decisions. By then, he will have made plenty of gestures, such as taxing business and the rich, that afford him cover for broader and more painful measures. His government will also have begun what it calls “social democracy”, or talking to the trade unions about change. Even by Mr Hollande's own calculations, he will be up against some unpleasant choices. He has promised to create 60,000 new teaching jobs without increasing the overall public-sector payroll. With job cuts in the police service, security and justice ruled out, this means much bigger cuts somewhere else.
The puzzle for Mr Hollande is how to carry out all this as a Socialist president elected to end excessive austerity in Europe who did not warn voters about the fiscal shock ahead. Many Socialists had hoped to be able to blame the previous government for leaving a greater budgetary mess than expected; yet, to its credit, the auditor explained that the gap was mostly down to disappointing growth and over-optimistic forecasts. Mr Hollande is running out of options. The stark choice was best summed up by Mr Migaud. “Better to make an effort now than tomorrow,” he said, “because tomorrow it could be heavier, more painful, and, above all, imposed from outside.”