VZCZCXRO2431
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFR #2089/01 1420822
ZNR UUUUU ZZH
R 220822Z MAY 07
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 7463
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 02 PARIS 002089 
 
SIPDIS 
 
SENSITIVE 
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 ELAB PGOV FR
SUBJECT: SARKOZY'S TAX CUTS 
 
REF: Paris 2003 
 
¶1. (SBU) Summary:  President Nicolas Sarkozy's proposed fiscal and 
macro-economic policy reforms are every bit as ambitious as his 
micro-economic agenda (reftel).  In short order we expect Sarkozy to 
propose eliminating payroll taxes on hours worked above 35 hours, 
cutting inheritance taxes, introducing the tax deductibility of 
interest on primary residence mortgages, and limiting overall taxes 
to 50% of income.  Sarkozy hopes to accomplish this - and to 
increase R&D spending - while cutting France's debt/GDP ratio to 60% 
(from its current 64%).  In combination with proposed labor market 
reforms (reftel), Sarkozy's program is likely to have a positive 
short-term impact on economic growth, and a longer-term benefit for 
French competitiveness.  Downside risks include likely push-back 
from civil servants, whose ranks Sarkozy hopes to thin, and the 
potential for rising deficits should efforts to trim state spending 
not take hold.  End summary. 
 
The Challenge for Sarkozy 
------------------------- 
¶2. (SBU) President Nicolas Sarkozy's macro and fiscal policy 
proposals respond to France's numerous well-publicized economic 
challenges.  These include the burden of a state whose spending 
represents 53.7% of GDP, public debt of nearly 64% of GDP, low 
levels of R&D spending, significant payroll taxes, pension systems 
that discourage labor force participation among 55 - 64 year olds, a 
rigid labor market, and a tax environment non-conducive to small 
company growth (among others). 
 
Cutting Government and Pensions 
------------------------------- 
¶4. (SBU) Sarkozy hopes to cut France's budget deficit to 1.5% of GDP 
by overhauling ministerial structures, and in part by replacing just 
one out of two retiring civil servants.  He has taken an initial 
symbolically-significant step toward government reform by halving 
the number of ministries to 15.  Moreover, by establishing a budget 
minister with full cabinet rank (previously the budget minister 
reported to the Minister of Economy), he creates a guardian of the 
purse strings whose overriding interest is to balance the books. 
 
¶5. (SBU) That Sarkozy has placed oversight of public administration 
issues (previously the domain of a separate "public function 
minister") under the authority of the budget minister is 
significant.  The move has already been contested by unions who say 
that it is indicative of an approach that treats civil servants as 
little more than an "expense."  Sarkozy is also likely to increase 
patient fees and focus on prevention in an effort to cut France's 
healthcare deficit. 
 
¶6. (SBU) One of the most sensitive proposals is likely to be reform 
to France's "special" pension regimes for certain categories of 
government workers (including in the energy and transportation 
sectors).  Sarkozy has proposed that workers covered by these 
systems pay into the system for 40 years, versus 37 and a half as is 
currently the case.  Numerous governments have been down this road 
before - including most recently Francois Fillon as Labor Minister 
in 2003 - only to founder on the shoal of strong union opposition. 
 
 
Cutting Taxes 
-------------- 
¶7. (U) Sarkozy has tasked his new budget minister, Eric Woerth, with 
preparing a number of tax reforms in the coming months.  These 
include the elimination or reduction of taxes paid by employers and 
employees for "overtime" above the 35 hour workweek, and encouraging 
employers to boost overtime pay by 25 percent (reftel).  Sarkozy's 
government will also move in the coming months to reduce or 
eliminate the inheritance tax and to make mortgage interest payments 
tax-deductible. 
 
¶8. (U) Additional tax measures that can be expected in the near to 
medium-term include the following: 
 
--Lowering payroll taxes paid by employers by testing a social VAT 
in "some sectors". 
--Cutting income taxes and social charges as a percent of GDP (44.4 
percent in 2006) by 4 percent in ten years (or over a two-term 
presidency), including one percent (15 billion euros or 20.4 billion 
USD) as soon as 2007; 
--Exempting students' part-time work from income taxes; 
--Imposing an absolute ceiling for total taxes of no more than 50 
percent of personal income (versus 60 percent currently) as soon as 
2007; 
 
PARIS 00002089  002 OF 002 
 
 
--Exempting from wealth tax any investments in small and-medium 
sized companies up to 50,000 euros (68,000 USD); 
--Cutting the value-added tax (VAT) paid by restaurants to 5.5 
percent. 
 
The Risks 
---------- 
¶9. (SBU) While the business and economic policy communities have 
generally applauded the direction of Sarkozy's proposals, some 
economists have pointed up potential problems.  According to some 
estimates, proposed cuts in payroll taxes could cost the government 
up to 5% of GDP in revenue.  Moreover, there is concern in some 
quarters about the potential for fraud associated with the 
elimination of payroll taxes on overtime.  The policy could 
incentivize employers to use the measure to award payroll-tax-free 
salary increases, rather than to encourage legitimate overtime work. 
 Many economists have also taken issue with the distortional effects 
of making mortgage interest tax-deductible, and the efficiency of 
cutting inheritance taxes. 
 
Comment 
------- 
¶10. (SBU) Sarkozy's biggest challenge will come not from the policy 
wonks, but rather from the entrenched interests who have 
successfully seen off many attempts at reform in France.  This time 
may be different, and Sarkozy is off to a good start by having 
reached across party lines to put together his government.  We 
expect that some measures -- payroll and inheritance tax cuts and 
deductibility of mortgage interest -- are likely to be enacted 
quickly and with minimal controversy.  However, pension reform and 
proposed measures to shrink the state are both likely to raise the 
ire of French civil servants who have successfully blocked reform in 
the past.  Each of these issues, along with unification of the labor 
market and guaranteed minimum service (reftel), has the potential to 
put protesters on the street. President Sarkozy will have to tread 
carefully to keep his ambitious program from getting derailed. 
 
STAPLETON