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DE RUEHFR #6668/01 2791614
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R 061614Z OCT 06
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 2034
INFO RUEATRS/DEPT OF TREASURY WASHDC
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UNCLAS PARIS 006668 
 
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E.O. 12958: N/A 
TAGS: EFIN ECON PGOV FR
SUBJECT: THE GOF INTRODUCES ITS 2007 BUDGET 
 
¶1. SUMMARY:  French Finance Minister Breton unveiled the proposed 
budget for 2007, which includes tax cuts and measures to boost 
consumption (and please voters in a presidential election year). 
Spending priorities remain essentially unchanged from 2006: 
education, defense, safety, justice, employment and R&D.  Based on 
forecasts of continuing economic growth, the budget also aims to 
reduce the overall budget deficit to 2.5 percent of GDP, and public 
debt to 63.6 percent of GDP.  Economists see the 2.0-2.5 percent GDP 
growth forecast as too high.  Opposition parties have contested the 
budget, notably the decrease in taxes, and demanded an audit.  END 
SUMMARY. 
 
Government Cuts Taxes to Improve Purchasing Power . . . 
------------------------------------------- 
¶2. On September 27, Finance Minister Thierry Breton introduced the 
draft 2007 central government (CG) budget.  He pledged more than 7 
billion euros (9 billion dollars) in tax cuts, and rebates 
benefiting students, commuters, and lower-income wage-earners, all 
measures to buoy consumer spending and effective early 2007.  A June 
poll had revealed that unemployment and purchasing power were among 
key concerns for the electorate.  Breton said the tax cuts were 
designed to boost household purchasing power and fuel consumer 
spending, but claimed they were not linked to upcoming elections. 
 
¶3. Income tax cuts are part of an overhaul that will reduce the 
number of tax brackets from seven to four with the top marginal rate 
cut from 48.09 percent to 40 percent.  With the new measures, income 
tax cuts since 2002 have amounted to approximately 20 percent 
(versus the 33 percent pledged by President Chirac during the 2002 
presidential campaign).  The government also set a 60 percent 
ceiling ("bouclier fiscal") for the total tax imposed on an 
individual (excluding payroll taxes and social contributions), 
thereby helping indirectly to curb France's "wealth tax."  Low-wage 
earners will benefit from a higher earned income tax credit (EITC), 
at a cost of 1 billion euros (1.3 billion dollars) to the budget. 
Budget Minister Jean-Francois Cope underlined that "a single person 
who is paid the minimum wage will start each month in 2007 with 130 
euros more in his or her pocket than in 2002 thanks to tax cuts, 
increases in the SMIC, and the increase in the EITC." 
 
¶4.  The 2007 CG budget also cuts corporate taxes, notably by capping 
the professional tax (a tax paid to local authorities) to no more 
than 3.5 percent of value added, and by introducing measures in 
favor of small and fast growing companies.  In order to find 
additional resources, the 2007 CG budget is reintegrating capital 
gains in the income tax base for sales of shares exceeding 22.8 
million euros (29.2 million dollars).  Below that limit a 5 percent 
tax will be levied on capital gains. (Note: This is not a major 
change for companies, since the corporate capital gain for shares 
held for more than two years will disappear.)  The CG budget 
projects tax receipts will rise to 225.9 billion euros (289.1 
million USD) from 221.5 billion euros (283 billion USD). 
 
 . . .And Boost Economic Growth 
------------------------------- 
¶5.  Taking into account effects of tax measures on consumption and 
corporate investment, the government expects GDP growth between 
2.0-2.5 percent in 2007, unchanged from this year and double 2005 
growth.  The government expects 250,000 new jobs to be created in 
2007, mainly in the private sector, compared to the recent estimate 
of 260,000 created in 2006.  Government forecasts assume the euro 
will trade at USD 1.28, up from the USD 1.25 used in the 2006 CG 
budget, and that oil will trade at USD 70 per barrel ("to maintain a 
security margin" according to Finance Minister Breton.)  The 
government forecast is in line with the 2.3 percent IMF forecast, 
which nonetheless outlined risks from oil prices and a U.S. economic 
slowdown. 
 
Reducing the Budget Deficit 
--------------------------- 
¶6.  A contrasting government concern is to reduce the CG budget 
deficit to 41.6 billion euros (53.3 billion USD) in 2007 from an 
estimated 42.7 billion euros in 2006, a figure sharply lower than 
the 46.9 billion set out in 2005.  The 2007 CG budget deficit, the 
lowest since 2001, will meet the government objective of reducing 
the overall budget deficit (including CG, social security system, 
and local authorities).  As part of this objective, the government 
plans to reduce the social security deficit to 8 billion euros (10.2 
billion USD) in 2007 from 9.7 billion euros (12.4 billion USD) in 
2006 (septel). 
 
¶7.  The government target is to reduce the overall budget deficit to 
2.5 percent of GDP, well below the euro zone's Stability and Growth 
Pact limit of 3 percent of GDP.  The government revised its deficit 
estimate for 2006 from 2.7 percent of GDP to 2.6 percent after 
stronger-than-expected GDP growth boosted tax receipts above 
forecasts.  France had breached the limit of 3 percent of GDP 
between 2002 and 2004. The 2005 deficit went back under the limit, 
largely thanks to a one-time payment from utility EDF-GDF in 
exchange for the government having assumed pension liabilities. 
 
Remedy is Cutting CG Budget Spending 
------------------------------------ 
¶8.  To meet the deficit objective, 2007 CG spending would increase 
0.6 percent to 267.8 billion euros from 266.1 billion euros.  This 
is one percent less than the forecast inflation rate, following 
three years during which CG budget spending increased at the same 
pace as inflation.  The government will rely on spending cuts, 
notably a reduction of 15,000 civil servant jobs by attrition, with 
over 7,000 reductions slated for the education system.  Though the 
cut is modest given France's 2.3 million civil servants, it is twice 
as large as last year and represents the largest cut in 15 years. 
Breton stressed that the government objective was to spend money 
more efficiently ("doing better with less money") while modernizing 
the public service.  To meet this objective, the government has 
launched 100 audits in various ministries to identify modernization 
plans aimed at increasing government productivity, improving public 
service and enhancing the use of new technologies. 
 
Ultimate Goal is Reducing Public Debt as a Percent of GDP 
----------------------------------------- 
¶9.  The reduction in the overall budget deficit would allow the 
public debt to fall to 63.6 percent of GDP in 2007 from 66.6 percent 
in 2005, and 65.5 percent in the second quarter of 2006.  Finance 
Minister Breton said the government would use any unexpected 
receipts to reduce the public debt as it did in 2006 with 5.1 
billion euros (6.5 billion USD) in additional tax receipts.  The 
government will sell 106.5 billion euros (136.3 billion USD) in 
bonds in 2007 after buying back 13.2 billion euros (16.9 billion 
USD) of 2007 and 2009 debt on proceeds from real estate asset sales. 
 The government medium-term objective is to reduce debt as a 
percentage of GDP to 60 percent, the euro zone's Stability and 
Growth Pact limit, by 2010. 
 
Government is Very Supportive of Its Budget 
------------------------------------------- 
¶10. Breton hoped the European Commission would end an inquiry into 
France's public finances, given its deficit and debt targets.  He 
stated "we set a process in motion; our successors will have to 
follow the same direction." 
Breton told reporters "our budget is solid; we are confident that 
we'll reach the 2.5-of-GDP budget deficit goal." Budget Minister 
Cope termed the 2007 CG budget a "good budget, beneficial to 
purchasing power, employment and debt reduction." 
 
Economists Wonder about Future GDP Forecasts 
-------------------------------------------- 
¶11.  Private-sector economists expressed concerns that government 
forecasts might be overly optimistic, due to signs of a U.S. 
slowdown and doubts about the economic strength of Germany, France's 
major trading partner.  Morgan Stanley senior economist Eric Chaney 
forecast 1.9 percent GDP growth in 2007, expecting a fiscal 
tightening in Germany and Italy and the rise in short-term rates 
would affect French economic growth.  He forecast the 2007 overall 
budget deficit to decrease to 2.7 percent of GDP.  Xavier Timbeau, 
head of analysis at Paris-based think tank Observatoire Francais des 
Conjonctures Economiques remarked "the 2007 CG budget is not going 
to be easy to implement.  Another question is whether the strength 
of tax receipts will remain the same as in 2006 or be back to 
normal." He concluded "to reduce the deficit requires both a strong 
slowdown of public spending and tax receipts rising faster than GDP 
growth, like this year." 
 
Opposition Demands Audit 
------------------------ 
¶12.  Eric Besson, an opposition socialist lawmaker in charge of 
economic issues said "the government is going to brag during the 
election campaign about its economic results, but it's going to bump 
into reality."  The Socialist Party criticized the center-right's 
rosy picture of the economy, and stressed that the new president 
elected in June 2007 would not implement the budget.  Budget 
Minister Cope replied that the government was ready for a complete 
audit of its budget, as demanded by Socialist Party leader Francois 
Hollande (who notably contested the decrease in taxes).  Cope warned 
that Socialist proposals for 2007 would result in a surge of the 
budget deficit. 
 
Comment 
------- 
¶13.  The 2007 CG budget looks coherent, with controlled budget 
spending, tax cuts for taxpayers and companies, and a decline in the 
public debt as a percent of GDP.  However, it relies heavily on 
economic growth estimates.  If GDP growth loses steam, the budget 
deficit would increase above the limit of 3 percent of GDP.  More 
importantly, fiscal policy could be significantly altered by the 
result of the 2007 presidential elections.  Despite recent efforts, 
French public finances have deteriorated since 2002.  Reducing 
significantly the overall budget deficit will heavily depend on 
further cuts in spending, notably in the bloated civil service, and 
a reduction in social security spending. Both will be difficult to 
achieve politically. 
 
HOFMANN#