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UNCLAS SECTION 01 OF 03 PARIS 002741 
 
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E.O. 12958: N/A 
TAGS: EFIN ECON PGOV FR
SUBJECT:  FRENCH TAX REFORM PACKAGE 
 
REF: (A) Paris 2089; (B) Paris 2003 
 
¶1. SUMMARY:  New French Finance Minister Christine Lagarde 
introduced a tax reform bill on June 20 "in favor of labor, 
employment and purchasing power".  The cost of the tax package could 
mean the government budget deficit in 2007 and 2008 will again 
exceed the EU-imposed limit of 3 percent of GDP.  The impact of the 
package on economic growth is likely to be modest in 2007 and 
slightly more significant in 2008.  END SUMMARY 
 
Exempting from Taxes Overtime Work 
---------------------------------- 
¶2.  Finance Minister Christine Lagarde introduced a tax reform bill 
on June 20.  The eight-chapter tax bill includes details of measures 
the GoF had announced in May. .  The tax package includes tax 
exemptions on overtime work to encourage companies to increase 
employment, which would allow employees to increase working hours 
and thus their purchasing power (ref A).  The bill proposes overtime 
work rates to be paid on the basis of collective agreements, and if 
there are none, at legal rates (25 percent or 50 percent more than 
normal hours) to employees working full time, and at 25 percent to 
employees working part time.  The key measure of the scheme is the 
proposal to exempt overtime work from income taxes and payroll 
taxes.  Exemptions will apply to both private-and government sector 
employees, who will benefit from exemption of both income tax and 
payroll taxes including the contribution on all incomes (CSG) and 
the contribution for the repayment of the social security debt 
(CRDS).  In the civil service sector the scheme will be negotiated 
with unions before the publication of decrees.  For special regimes 
(e.g. railroad company SNCF, railway company RATP, etc.), the 
implementation of the scheme raises a number of questions that will 
need to be resolved because changes to the transportation sector are 
politically difficult.  The government took into account 
recommendations of the supervisory State Council ("Conseil d'Etat", 
which assists the Executive with legal advice) on executives and 
part-time employees.  Executives working above the 1607-hour quota 
or giving up rest days above the annual 218-day quota would benefit 
from exemptions.  Tax exemption for part-time employees working 
above the contractual work duration would be increased from 10 
percent to 30 percent. 
 
¶3.  For their part, employers would be exempted from payroll taxes 
on overtime work depending on employees' positions and the size of 
the companies: 0.50 euro per overtime worked hour in companies with 
more than 20 employees and 1.50 euros in companies with less than 20 
employees.  Payroll taxes on overtime by employees in low wage 
positions in those companies would be fully offset.  The scheme, 
which should become effective on October 1, 2007, would be subject 
to an evaluation by July 1, 2009. 
 
Exempting Students from Income Taxes 
------------------------------------ 
¶4.  To improve the financial situation of young students who work to 
finance their studies, the proposal would extend income tax 
exemptions to all income earned by students younger than 25.  The 
annual ceiling for exemption would be three times the monthly 
minimum wage or 3,750 euros.  Students would still have the choice 
to opt for the Earned Income Tax Credit if that solution is more 
favorable. 
 
Implementing Tax Credit on Mortgage Interests 
--------------------------------------------- 
¶5.  Presently, only 56 percent of French households are landlords of 
their main residences, while the average in Europe is 75 percent. 
The tax package proposes tax credits for the acquisition or the 
construction of a main residence.  This new advantage, which adds to 
the current zero-interest rate loan scheme aimed at modest-income 
earners, would also benefit non-taxable households via a repayment. 
New home buyers would be allowed to deduct from their income taxes 
20 percent of their mortgage interest in the first five years.  This 
measure would apply to both existing and new loans, for any interest 
due after the first day following the implementation of the tax 
bill.  This measure, which is one of the top topics of conversation 
among the French, caps the tax break at 3,750 euros for singles and 
7,500 euros for households plus 500 euros per dependent child. 
 
Reducing Inheritance taxes 
-------------------------- 
¶6.  New measures would exonerate 9 out of 10 people from inheritance 
taxes, and would bring France more in line with most other European 
countries.  The tax package eliminates inheritance taxes for the 
surviving spouse or the surviving partner linked by a civil 
solidarity pact (PACS).  Partners linked by a "PACS" would benefit 
from the same tax exemption as spouses on gifts below 7,600 euros, 
 
PARIS 00002741  002 OF 003 
 
 
and would be subject to the same rates of taxation (5 percent to 40 
percent versus 40 percent and 50 percent currently) for gifts 
exceeding 7,600 euros.  Measures also include reducing inheritance 
and gift taxes in favor of ascendants and descendants or between 
brothers and sisters on inheritances up to 150,000 euros (versus up 
to 50,000 euros).  Gifts in favor of a child, a grand-child, a 
grand-grand child (or a nephew or a niece if there are no such 
inheritors) would be exempt up to 20,000 euros. The inheritance tax 
reform would be applicable as soon as the law is published in the 
French Official Journal.  An exception is made for stock options. 
 
¶7.  Stock options: the tax package proposes to submit the exercise 
of options in case of gift or sale to the tax regime applicable to 
the attribution of free equities.  The idea is to ensure that the 
increase in personal exemption applicable to inheritances (new 
version) does not benefit stock options.  The Confederation of 
Businessmen (MEDEF) succeeded in obtaining agreement that taxation 
would be applicable as of June 20, 2007, and not retroactively. 
 
Reducing Absolute Tax Ceiling of No more 50 Percent 
--------------------------------------------- ------ 
¶8.  Since January 1, 2007, direct taxes paid by an individual cannot 
exceed 60% of his or her income.  Taxpayers may ask for a refund of 
payments exceeding that threshold.  The tax ceiling includes income 
tax, wealth tax, and local taxes paid for the main residence, but 
not the contribution on all incomes "CSG" and the contribution to 
the repayment of the social debt "CRDS." The reform bill proposes to 
include CSG and CRDS, and to reduce the amount of direct taxes paid 
by a taxpayer from 60 percent to 50 percent of income.  The goal is 
"to improve the attractiveness of the tax system, and to give new 
confidence to investors in favoring the return in France of all 
talents that France needs."  The measure would apply on January 1, 
¶2008. 
 
Exempting from Wealth Tax Investments in SMEs 
--------------------------------------------- 
¶9.  To attract further investment in small-  and medium sized 
companies, the government now proposes to exempt from the wealth tax 
75 percent of any investment in SMEs (or enterprises inserting the 
jobless, education and research establishments, and public utility 
foundations) up to 50,000 euros.  The measure would apply on June 
20, 2007 on investment, and be included in the calculation of the 
wealth tax on January 1, 2008. 
 
Subordinating Golden Parachutes to Performance 
--------------------------------------------- - 
¶10.  Golden parachutes, which are not affected by tax measures, were 
nonetheless included in the tax package.  Sarkozy described "golden 
parachutes for top executive as intolerable" (ref B), saying the 
government wants to modify the system as soon as possible.  Sarkoky 
said "the measure is very simple, and will consist in linking the 
existence of departure bonuses, which have to be approved by the 
board of directors, to the performance of the executive", commenting 
"no performance, no premium."  The scheme also aims at improving the 
transparency of executive rewards and maintaining France as an 
attractive place to do business. 
 
Creating Active Solidarity Income 
--------------------------------- 
¶11.  Local governments ("departements") may volunteer to experiment 
with an "Active Solidarity Income," which should guarantee for three 
years an increase in incomes for all beneficiaries of the minimum 
income ("Revenu Minimum Income - RMI") who find jobs.  The scheme 
would offset the loss of allowances paid or advantages to RMI 
beneficiaries.  A similar scheme could be put in place for "isolated 
parents," who get specific allowances. 
 
Cost of the Tax Package 
----------------------- 
¶12.  Prime Minister Francois Fillon outlined the total cost of the 
tax package (11 billion euros or 0.6 percent of GDP): "between 5 and 
6 billion euros in overtime work exemption, 3 billion euros in tax 
deduction of mortgage loans and 1.7 billion euros in reduced 
inheritance taxes."  Critics, including former socialist Minister of 
Finance Dominique Strauss-Kahn, charged that the tax package would 
be extremely costly (at least 15 to 20 billion euros) at a time when 
the GOF is trying to bring spending under control.  Sarkozy and 
Fillon reiterated that the cost would be offset by higher tax 
receipts resulting from higher economic growth, and cuts in budget 
expenditures with the elimination of one out of two retiring civil 
servant positions (30,000 to 40,000 total positions to be cut in 
2008) and cuts in social security expenditures.  A 50 percent cap on 
income taxes would not prove a drain on government coffers because 
"if it works, it will reduce capital outflows."  The government 
 
PARIS 00002741  003 OF 003 
 
 
forecasts its budget deficit to decrease to 2.4 percent of GDP in 
2007 and to 1.7% in 2008 partially due to the tax package.  That 
strategy should worry the European Union, which wants France to rein 
in its government budget deficit.  France has attempted to reassure 
its euro zone partners about its plan to foster economic growth with 
tax cuts.  Former finance minister Jean-Lous Borloo (now Minister of 
Environment, Sustainable Development and Planning) left Luxemburg 
Prime and Finance Minister Jean-Claude Juncker with no doubt on June 
4 that France would respect the EU Stability and Growth Pact. 
Sarkozy subsequently reaffirmed that France will balance its budget 
by 2012.  That said, Philippe Seguin, the head of the Public 
Accounts watchdog ("Cour des Comptes") recently acknowledged that 
public finances have improved, but warned they remained "fragile." 
 
 
Reactions to the Tax Package 
---------------------------- 
¶13.  The daily left-wing newspaper Liberation argues that Sarkozy's 
tax package will increase the gap between the classes, "favoring the 
richest and best-placed French."  The daily Le Monde remarks that 
the real efficiency of the measure in favor of overtime work 
requires companies to have order books full enough, and favors 
employees, not the unemployed.  Unions have focused on perverse 
effects of the tax exemption of overtime work since the cost of 
overtime work will be lower than that of regular work hours.  On 
their part, some economists find the overtime scheme too complex. 
The new government spokesman Laurent Wauquiez admitted that the 
overtime work scheme could "evolve" during the examination of the 
tax package by the new National Assembly in early July.  Morgan 
Stanley senior economist Eric Chaney asserted that tax breaks for 
existing housing loans are only tax gifts, "which will increase the 
budget deficit without helping the economy to grow faster."  In 
contrast, tax breaks for new housing loans and "more substantial 
reforms" including tax breaks for overtime "go in the right 
direction, albeit, regrettably, with some fiscal laxity."  Chaney 
raised its GDP forecast for France in 2008 to 2.3 percent from 2.2 
percent, and government deficit forecast from 2.6 percent of GDP to 
2.7 percent in 2007, and from 2.7 percent of GDP to 2.9 percent in 
¶2008. 
 
President: Tax Package is a Step 
-------------------------------- 
¶14.  Sarkozy says that the tax package is only a first step. In 
explaining his economic program for the next five years to UMP 
deputies and also to the French on the TF1 TV channel on June 21, he 
said he wanted to give a new impulse to reforms, reiterating plans 
for a minimum service in public transportation and giving autonomy 
to universities (ref B), reform taxes and social contributions "to 
encourage labor, production and investment", reform of the minimum 
wage income ("SMIC"), end of early retirements, new limits 
("franchises") to health repayments, and quicker moves in the 
government reform.  Sarkozy also said he did not rule out the 
implementation of a social VAT to fund health expenditures, although 
opponents argued it would raise prices, cut domestic consumption, 
dampen economic growth and increase joblessness.  Sarkozy said "we 
haven't yet decided anything.  If we find that social VAT did show 
that it facilitates job creation, we'll do it, but not before 2009; 
if it didn't show, we'll not do it."  The union of farmers (FNSEA) 
opined they were ready to experiment with a social VAT, arguing it 
would be painless to the French consumers if the government reduces 
social taxes paid by farmers. 
 
Comment 
------- 
¶15.  The tax package should be easily passed during the summer 
session ending August 10 by Sarkozy's UMP party, which controls a 
large majority of seats at the National Assembly.  The impact of the 
package on economic growth will be modest in 2007 (septel) since 
measures will take place in the second half, but should be more 
significant in its full year of implementation, in 2008.  The main 
risk of the tax package is an increase in the government budget 
deficit.  Nevertheless, the wave of structural reforms announced by 
Sarkozy will help boost potential economic growth in the medium 
term.  Investors and companies welcome reform plans as they are 
widely seen as positive for the French economy. 
 
Stapleton#