VZCZCXRO1640
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHFR #4652/01 1880933
ZNR UUUUU ZZH
R 070933Z JUL 06
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 9294
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 03 PARIS 004652 
 
SIPDIS 
 
SIPDIS 
 
PASS FEDERAL RESERVE 
PASS CEA 
STATE FOR EB and EUR/WE 
TREASURY FOR DO/IM 
TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER 
USDOC FOR 4212/MAC/EUR/OEURA 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV FR
SUBJECT:  THE SPIRALING PUBLIC DEBT: PART II 
 
REF:  (A) PARIS 4549 
 
(B) PARIS 4417 
 
¶1. SUMMARY.  The government's intention to decrease the public 
deficit in 2006 and 2007 appears to be the first step towards the 
ultimate goal of reducing the national debt to 60% of GDP by 2010, 
as outlined in the Pebereau report, but thus far the proposed 
changes to the national budget remain short-sighted.  The 
government's objective to reduce the budget deficit to 2.5% of GDP 
in 2007 relies heavily on streamlining spending, making the national 
budget more efficient and less expensive.  The modest cuts in public 
sector employment and the 2.0-2.5% GDP growth found in government 
estimates, however, seem rather optimistic and, even if they were 
possible, would still be insufficient to reduce the 2007 budget 
deficit.  The debate over reducing the national debt will surely 
make waves in Parliament in advance of next spring's presidential 
elections. End summary. 
 
GOF Acknowledges Public Debt is Spiraling Out of Control 
---------------------------- 
¶2.  After reading the Pebereau report (ref A), Finance Minister 
Thierry Breton stated it was "possible to lower the public debt to 
less than 60% of GDP within five years through a combination of cuts 
in spending and the sale of assets."  (Note:  In this context, 
public debt is narrowly defined to exclude retirement pension 
liabilities.  End note.)  Later, at a conference, he acknowledged 
that government debt (broadly defined) was close to 120% of GDP or 
2.2 trillion euros, including 900 billion euros in pension 
liabilities for public employees (civil servants, health workers, 
local authority employees) to be paid by 2030.  Former finance 
minister and center-right UDF Senate Finance Commission President 
Jean Arthuis claimed the true debt total was "closer to 2.3 trillion 
euros" when the Post Office, Paris transport and railway companies 
are taken into account.  He warned that the public debt liability of 
every newborn was close to 38,000 euros. 
 
GOF Organizes Audits and Public Finances Conference 
------------------------------- 
¶3.  Since fall 2005, Finance Ministry experts have conducted 100 
audits to decide about spending cuts in the central government 
budget.  Breton concluded "it was possible to do better with less," 
giving some examples: a lower cost for analyses of finger prints (60 
euros versus 300 euros) if Justice Ministry centralizes its 
purchases; 300-500 job cuts in Education due to a better 
organization of exams; 750 job cuts and 1.3 billion euros in 
spending cuts at the Finance Ministry thanks to internet-based 
income tax filing. 
 
¶4.  The government launched the first Public Finances Conference in 
January 2006, "the starting point of a very active process to 
identify ways and means to put public finances on the 
getting-out-of-debt track," said De Villepin.  He also announced the 
creation of the Council of Public Finances, a permanent working 
group.  The Council suggested a gradual move toward "0% growth" in 
local government spending, and toward "1% growth" in social security 
spending.  The government budget includes central government, local 
governments and the social security system. 
 
Government Implements State Reform 
------------------------------ 
¶5.  Ministers have started to implement the State Reform ("Reforme 
de l'Etat"). Breton took the example of his ministry, citing the 
successful creation of a unique tax office ("guichet fiscal 
unique"), the implementation of internet-based income tax filing, 
and the distribution of income tax forms with key individual data 
already filled in to minimize errors and fraud.  Parts of the 
ministry have signed contracts ("contrats de performance") 
committing to increase productivity.  Breton promised to reward 
civil servants for their efforts by improving career perspectives, 
providing new social guarantees and incentives, including 120 euro 
premiums for high performance to civil servants as soon as 2006. 
 
2007 Budget Plan to Cut Civil Servants Jobs 
------------------------------- 
¶6.  Breton's commitment to reduce the public debt to below 60% of 
GDP was obviously not met in 2005.  Data released in March 2006 
showed the public debt even higher than expected, increasing to 
66.8% of GDP (889.2 billion euros), although the 2005 central 
government budget deficit was reduced to "exactly 2.87% of GDP", a 
performance in line with Breton's commitment to reduce the budget 
deficit to below the EU limit of 3% of GDP.  Spending cuts, better 
management of central government short-term funds, and earlier 
corporate income tax down-payments helped.  Otherwise, the 2005 
budget deficit would have remained close to 3.4% of GDP, the 
 
PARIS 00004652  002 OF 003 
 
 
estimate made by Finance Ministry experts during summer 2005. 
 
¶7.  Wanting to remain positive, De Villepin said it would be 
possible to balance budget accounts and to reduce the public debt to 
below 60% of GDP by 2010.  Breton and Budget Minister Cope said they 
worked hard as a team to reduce the budget deficit from 2.9% in 2005 
to 2.8% of GDP in 2006 and 2.5% in 2007.  Since June 18, Cope has 
been inviting internet users to step into his shoes by playing 
"cyber-budget" and see how difficult it is to reduce the deficit. 
(Fittingly, the prize will not be money.  The first 50 winners may 
visit the finance ministry. The thousandth may meet Cope.)  On June 
22, Breton introduced the main outlines of the 2007 central 
government budget at the National Assembly, saying the government 
stuck to its 2.0-2.5% GDP forecast.  He announced a cap on central 
government budget spending growth, restricting it to 0.8%, which 
meant a 1% real cut (assuming inflation of 1.8%), a significant 
change compared with the three previous years when the rule was 
"zero growth" in real terms.  Most notably, the government plans to 
cut 15,000 civil service jobs.  Wages, payroll taxes and pensions 
accounted for 44% of the central government budget spending (130 
billion euros) in 2005, including 27.6% (35.9 billion euros) for 
pensions. 
 
¶8.  De Villepin promised more policemen and fewer teachers (due to 
declining school enrollments).  About 19,000 jobs would be 
eliminated by not replacing all 80,000 civil servants who are 
scheduled to retire next year. The most affected would be Education 
(8,700), Defense (4,400), Finance (3,000) and Transportation 
(1,300).  Productivity gains and cuts in budget spending will help 
finance 4,000 jobs in government priority areas - security, justice, 
university education and research (1,568) - after November 2005 
unrest in suburbs, the fiasco of the Outreau affair (a miscarriage 
of justice that has forced France to reconsider its system of 
investigating magistrates) and the CPE (First Employment Contract) 
crisis.  De Villepin said that cuts in budget spending would fund 
"the most ambitious tax reform of the last 25 years," making France 
a "normal" country compared with its European partners. 
 
Reactions to Audits 
------------------- 
¶9.  Unions warn about the impact of job cuts on the quality of 
services.  Socialist deputy and former budget spokesman Didier 
Migaud emphasized that "permanent audits would be more helpful than 
analyses made in a few weeks."  Center-right UDF National Assembly 
Finance Commission member Charles de Courson argued that sending a 
few inspectors and experts to make audits contradicted the new 
public finances law (Loi organique relative aux lois de finances - 
LOLF) designed to give a new consistent framework to budget 
decisions. 
 
Economists are Skeptical 
------------------------ 
¶10.  Economists deemed the planned reduction in civil servants jobs 
as relatively modest compared to the 80,000 civil servants expected 
to retire next year.  They were skeptical over whether plans 
expected to save 500-600 million euros would be put into action. 
Reductions have been difficult in 2006.  The government promised to 
cut 10,000 civil servants jobs in 2006, but has now admitted this 
will be only 5,300.  The government had to back off of to its 2002 
objective to cut positions of one out of two retirees. 
 
Criticism of the 2007 Budget from All Sides 
------------------------------- 
¶11.  Socialists criticized the government for cutting jobs while 
proposing a 3.6 billion euros tax break to middle classes, which 
will come into effect just a few weeks before next year's 
presidential election.  Francois Hollande, Socialist Party leader, 
emphasized that "rather than cutting the number of civil servants in 
a purely ideological way, the government would be better off giving 
up its planned income tax reduction in 2007."  Cope accused the 
Socialist Party of "permanent double talk" on public finances, 
saying he valued the cost of Socialist proposals at 115 billion 
euros, and Socialists did not specify how spending would be funded 
-"by raising taxes or increasing debt?" 
 
¶12.  Charles de Courson of the center-right UDF party stressed that 
the cap on budget spending was a sham since the 2007 budget would 
increase tax exemptions ("depenses fiscales") to 61 billion euros 
from 51.6 billion euros in 2004, and other elements of the budget 
(transfers to state-owned companies, and use of receipts) were just 
lax government fiscal policy.  Cope replied that, given their 
nature, tax exemptions could not be compared directly with budget 
spending growth.  National Assembly budget spokesman Gilles Carrez 
of the center-right UMP majority party estimated that reducing the 
 
PARIS 00004652  003 OF 003 
 
 
public deficit to 2.5% of GDP would be possible only "in an 
optimistic scenario" of 2.5% GDP growth in 2006 and 3% growth in 
¶2007.  He found more realistic the 2% GDP forecast recently made by 
the National Statistical Agency INSEE (ref B).  Philippe Marini, the 
UMP Senate's spokesman on the 2007 budget debate, stressed that "the 
more or less unanimous talking about the necessity of reducing 
public debt, has not yet had a practical impact." 
 
¶13.  Philippe Seguin, the head of the authority in charge of 
overseeing public finances, the Cour des Comptes, characterized as 
"symbolic" the cut in the civil service, calling for "a permanent 
effort to reduce deficit and debt."  He suggested 30 billion euros 
in spending cuts to avoid the "vicious spiral" of indebtedness.  He 
denounced the increase in tax exemptions, and sales of government 
assets used "to conceal" budget deficits.  He criticized the 
government for its "lack of long-term fiscal policy and a vision 
flaw."  He suggested implementing new schemes to ensure a durable 
improvement in public finances by balancing social security 
accounts, notably with a better use of new technologies and 
seriously controlling spending. 
 
The EU Commission Encourages Fiscal Consolidation 
------------------------------ 
¶14. On June 2, Joaquim Alumnia, the EU Commissioner for economic and 
monetary issues, reiterated fears about insufficient efforts made by 
France to reduce budget deficits.  According to the Commission, the 
French budget deficit would increase to 3% of GDP in 2006 and 3.1% 
in 2007 if nothing was done.  However, the government won praise 
from Alumnia for its 2007 budget plan.  He said that "fiscal 
consolidation launched in 2005 and 2006 could be sustainable in 
¶2007.  In that case, France will be one of the countries that will 
no longer have an excessive budget deficit." 
 
Comment 
------- 
¶15.  It would take four years to balance the central budget deficit 
and to reduce the public debt to 60% of GDP if all recommendations 
of the Pebereau report were strictly followed.  The government 
agreed with this deadline and was inspired by some of its 
recommendations, but nonetheless, has a short-term vision, focused 
on the 2007 presidential elections.  2.0-2.5% GDP growth in 2007 
looks both optimistic and insufficient to reduce the budget deficit. 
 The government target for cutting the civil service in 2007 is very 
modest, but the CPE crisis and upcoming presidential elections 
impede any major reform. 
 
STAPLETON