VZCZCXRO2682
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFR #0356/01 0301533
ZNR UUUUU ZZH
R 301533Z JAN 07
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 4543
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 02 PARIS 000356 
 
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: GOF POSTS LOWER 2006 BUDGET DEFICIT, PLANS FOR WITHHOLDING 
INCOME TAX 
 
 
¶1. SUMMARY:  France's central budget deficit decreased more than 
expected to 2.0 percent of GDP in 2006, prompting the government to 
announce that the overall budget deficit (including local government 
and social security budgets) would not exceed 2.6 percent of GDP. 
Nonetheless, the European Commission, which expects a withdrawal of 
excessive deficit procedures against France at the January 30 ECOFIN 
meeting, encouraged the government to reduce further the structural 
budget deficit in order to balance the budget and reduce the public 
debt by 2010.  The announcement comes as tax policy issues move 
front and center in France's presidential election campaign. 
Center-right candidate Nicolas Sarkozy promised to reduce payroll 
taxes and establish a direct tax ceiling of 50% of income, while 
Socialist candidate Segolene Royal has commissioned former Finance 
Minister Dominique Strauss-Kahn to flesh out employment-friendly 
fiscal reform ideas that would not threaten France's generous social 
safety net.  For its part the government has announced its intention 
to implement a new withholding tax in 2009.  END SUMMARY. 
 
Decline in the Central Government Budget Deficit 
--------------------------------------------- --- 
¶2.  Budget Minister Jean-Francois Cope announced a significant 
decrease in the central government (CG) budget deficit in 2006, 
confirming that the CG budget deficit stood at 36.1 billion euros 
(47 billion dollars), well below the initial 42.7 billion euros (56 
billion dollars) estimate.  Finance Minister Thierry Breton 
emphasized that the government was successful in stabilizing the 
amount of CG budget expenditures.  Expenditures decreased below the 
ceiling authorized by the Parliament.  The improvement was also due 
to additional tax receipts.  Receipts surpassed initial forecasts by 
10.2 billion euros (13 billion dollars), including an additional 6.4 
billion euros (8 billion dollars) in corporate tax receipts, 1.4 
billion euros (2 billion dollars) in VAT receipts and 1.1 billion 
euros (1.4 billion dollars) in income tax receipts. 
 
¶3.  In an interview by financial daily Les Echos, Breton stressed 
that "this was the first time in 15 years that the CG budget deficit 
decreased to 2% of GDP."  Consequently, the government will reduce 
issues of Treasury securities from 105 billion euros (135 billion 
dollars) to 102.5 billion in euros (132 billion dollars) in 2007. 
Breton indicated that the 2006 overall budget deficit (including CG 
budget, social security system and local authorities) could decrease 
to 2.6 percent of GDP.  This is better than the recent estimate of 
2.7 percent of GDP, and much better than the initial target of 2.9 
percent.  The government will notify the European Commission of the 
2006 overall budget deficit on April 1. 
 
European Commission Warns of Deficit after 2008 
--------------------------------------------- -- 
¶4.  The European Commission, which acknowledged that France has made 
progress, expects ECOFIN to put an end to the procedure for 
excessive deficit against France on January 30.  However, the 
Commission warned that the French budget deficit could increase 
further after 2008.  Balancing the budget by 2010 requires 
"additional effort since the structural deficit only decreased 0.3 
percent of GDP between 2005 and 2007."  This is below 0.5 percent, 
the recommendation made by the Commission given France's economic 
growth.  The Commission deemed that the planned decrease in the 
public debt from 63.6 percent of GDP in 2007 to 63.3 percent in 2008 
looked "slow" compared to the decrease from 66.6 percent of GDP in 
2005 to 64.7 percent in 2006. 
 
¶5.  In a comment to Les Echos, Breton said "there is no reason to 
weaken the virtuous dynamic started two years ago by postponing this 
objective (a balanced budget) beyond 2010.  The 2006 performance 
demonstrates that my program designed to balance budget accounts and 
to reduce the public debt by 2010 is achievable."  He said economic 
growth was "robust," although he admitted on January 10 that the 
rebound in Q-4 would be weaker than expected after a disappointing 
drop in industrial production in November.  Breton estimates GDP 
growth increased in a 2.4-3.2 percent (annualized) range in Q-4 
2006, which should put 2006 GDP growth close to or at 2.0 percent, 
the bottom of the 2.0-2.5 percent range forecast by the government. 
 
 
Government Prepares Withholding Tax 
----------------------------------- 
¶6.  France has had a withholding tax for a long time, but it is only 
applied to dividends and interest payments, and it is optional.  In 
recent weeks, Breton has strongly supported a withholding tax on 
income, saying it was his responsibility "to have everything ready" 
for France "to implement without delay" this reform "if the next 
presidential majority elected in May so wishes."  He agreed with 
center-right candidate Nicolas Sarkozy that a withholding tax could 
 
PARIS 00000356  002 OF 002 
 
 
create confidentiality problems since employers would need to 
collect personal information on their employees.  Breton revealed 
that the French tax administration has been mulling "safe and 
concrete" solutions, giving examples of foreign countries which have 
found "reliable solutions."  Additional issues surrounding a 
withholding tax include the kinds of income that should be subject 
to withholding, the tax rate per family, and the financial support 
to companies which will suffer extra costs due to the new system. 
 
¶7.  Breton created some confusion with his announcement that the 
French would not pay income taxes in 2008 and would only have to 
start paying under the new withholding tax system beginning in 2009. 
 Staggering the introduction of a withholding tax is needed to avoid 
subjecting the population to paying taxes in one year for the income 
earned the previous year while withholding taxes that same year for 
current income.  Breton's announcement was immediately criticized by 
Socialist party leader Francois Hollande, who said "this is a trick 
before elections. The French will pay in 2009 what they did not pay 
in 2008."  Hollande added "the withholding tax is a technical trick, 
not a reform." 
 
¶8.  Commentators emphasize the withholding tax would bring France 
into line with other OECD members.  It would simplify tax 
collection, helping the government to reduce the number of civil 
servants.  However, they say, the new system could be complex for 
employers, and the reduction in net incomes could make the French, 
who have complained about a decrease in purchasing power, feel 
poorer. 
 
Tax Policy becomes Presidential Campaign Issue 
--------------------------------------------- - 
¶9.  Center-right, Union for a Popular Movement (UMP) candidate 
Nicolas Sarkozy made taxation a campaign issue in January 2007, 
identifying tax policy as a way to solve the persistent problem of 
French unemployment.  He stressed that his top priority is to 
restore the value of work and lift France's sluggish economic 
growth.  He promised to reduce payroll taxes "because wages are too 
low, payroll taxes are too heavy, the fiscal pressure is too high." 
In his typically detailed fashion, he listed a number of specific 
measures he would take as President.  To boost consumption, he 
proposed cutting payroll taxes by four percent.  He also proposed 
offering income tax incentives to employees working more than 35 
hours per week.  Employers would be exempt from additional payroll 
taxes.  Sarkozy also promised to reduce the total tax ceiling from 
60 percent to 50 percent of income, reduce the wealth tax for 
investments in small and medium-sized companies, and reduce the 
percentage of people subject to the individual inheritance tax. 
Sarkozy said he would finance tax cuts by cutting central government 
spending, primarily by not replacing retiring civil servants. 
 
¶10.   Center-left, Socialist Party (PS) candidate Segolene Royal 
denounced Sarkozy's tax proposals as "scandalous," arguing they 
would widen the gap between rich and poor in France.  She wryly 
wondered if it was "really credible to promise cutting payroll taxes 
given the levels of the budget deficit and the public debt."  Rather 
than detail rebutting proposals, Royal commissioned former Finance 
Minister Dominique Strauss-Kahn to flesh out employment-friendly 
fiscal reform ideas that would not threaten France's generous social 
safety net.  In response, Breton said Royal "has no idea about 
taxation," and offered to publicly debate Strauss-Kahn's 
recommendations whenever he completes them.  Some of Strauss-Khan's 
proposals will be incorporated in the detailed statement of policies 
that Royal has said she will release on February 11. 
 
¶11.  The controversy over tax policy subsequently prompted the media 
to investigate the wealth taxes paid by the candidates.  This led to 
yet another (slightly more entertaining) campaign issue, but the 
revelations about the candidates' earnings ultimately only sharpened 
the budget debate. 
 
Comment 
------- 
¶12.  The decline in the 2006 CG budget means that the government is 
likely to have reached its objectives for reducing the 2006 overall 
budget deficit.  However, achieving longer term goals will depend on 
more robust fiscal adjustment, notably further cuts on the 
expenditure side.    Regardless of who wins the presidential 
election, this will be a political challenge.  Discussion of the 
withholding tax, and public finances generally, may help prepare the 
ground for further rationalization of the French tax system going 
forward. 
 
STAPLETON#