VZCZCXRO8978
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFR #3401/01 2251629
ZNR UUUUU ZZH
R 131629Z AUG 07
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 9474
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE

UNCLAS SECTION 01 OF 03 PARIS 003401 
 
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 PGOV FR
SUBJECT:  FRENCH BUDGET DEVELOPMENTS 
 
REF:  Paris 2741 
 
¶1. (SBU) SUMMARY:  The French parliament approved on August 1 one of 
France's largest-ever tax packages, a tax reform bill "in favor of 
labor, employment and purchasing power."  The tax cuts are intended 
to improve France's competitiveness, but may have a modest impact on 
economic growth in the near term and will compound the central 
government budget deficit. The government revised its plans on 
cutting the civil service in 2008, and will replace two out of three 
(vice one out of two) retiring civil servants.  The general 
government budget deficit (which includes the central government, 
the social security system and local authorities) is expected to top 
2.4 percent of GDP in 2007 and drop to 2.3 percent in 2008.  END 
SUMMARY 
 
Lawmakers Pass the Tax Package 
------------------------------ 
¶2.  (U) On August 1 Parliament approved a tax reform bill "in favor 
of labor, employment and purchasing power."  The bill notably 
includes tax breaks on overtime pay, introduces deductions for 
mortgage interest payments, reduces inheritance taxes, and lowers 
the maximum tax levied on all income from 60 to 50 percent (reftel). 
 Finance Minister Christine Lagarde stressed that the tax package 
was, in the first instance, a tool to boost economic growth.  She 
underscored that it was "not a gift to please the rich or a package 
to harm economic growth" -- an allusion to Socialist objections that 
the tax cuts will widen inequalities and fail to spur demand. 
 
¶3. (U) The Parliament made only slight modifications to the original 
bill.  Of note, deputies increased the exemption from the "wealth 
tax" (a tax on individuals with net assets greater than 760,000 
euros) applicable to a principal residence from 20 percent to 30 
percent to take into account the rise in real estate prices.  Among 
other amendments was a measure to allow for a 50% wealth tax 
deduction for investments of up to 10,000 euros in small and 
medium-sized companies (SMEs) via mutual funds ("Fonds 
d'Investissement de Proximite").  The 75% wealth tax exemption on 
investments of up to 50,000 euros in general-interest non-profit 
organizations was extended to France's National Agency for Research 
(which supports basic and applied research, innovation, partnerships 
between public and private sectors and technological transfer 
between public and private sectors) and to registered private 
research organizations. 
 
Cost of the Tax Package 
----------------------- 
¶4. (U) On July 25, Minister of Finance Lagarde confirmed that the 
cost of the tax package would be no more than 10-11 billion euros in 
2008 (or 0.6 percent of GDP), and 13 billion euros per year once the 
tax cuts are fully implemented.  (Note: This estimate includes costs 
associated with amendments passed by the National Assembly, but not 
the cost of amendments approved by a Senate/National Assembly 
reconciliation committee subsequent to Lagarde's comments.)  The 
Finance Minister underscored that 93 percent of the cost is 
concentrated on four measures that "benefit all French citizens, 
notably the middle class": 
--Cost of tax exemptions for overtime work:  6 billion euros net, 
including subsequent additional social security receipts); 
--Cost of tax credits on mortgage interest: 3.7 billion euros; 
--Cost of reducing inheritance taxes:  2.2 billion euros. 
--Cost of exempting students from paying income tax: 40 million 
euros. 
 
¶5.  (U) The fifth measure, which accounts for 7 percent of the total 
cost, is "to reconcile the French with success" by lowering the tax 
ceiling from 60 to 50 percent of income (cost:  600 million euros) 
and by exempting investments in SMEs from the wealth tax (cost: 410 
million euros).  Lagarde also stressed that it was necessary "to 
reestablish the link between success and merit" by imposing strict 
conditions on the award of "golden parachutes," including through 
fiscal disincentives and by insisting that payouts be tied to 
performance. 
 
Impact of the Tax Package on Economic Growth 
-------------------------------------------- 
¶6. (U) The government argued that its tax cuts were part of a wider 
structural reform that will lift confidence and deliver stronger 
growth and purchasing power.  President Nicolas Sarkozy stated that 
the tax package would bring "the one percent growth which is 
missing."  Recently, Lagarde told reporters that the tax package 
should contribute 0.3 percent "or maybe a bit more" to the 2008 
economic growth forecast of 2.5 percent. 
 
 
PARIS 00003401  002 OF 003 
 
 
¶7. (U) There is general consensus among French economists that the 
package will do more to stimulate demand than to improve the 
supply-side competitiveness of the French economy.  The 
"Observatoire des Conjonctures Economiques (OFCE)" a think tank that 
favors demand-side measures to spur economic growth, said the tax 
package "will secure an economic recovery that is slow to 
concretize, and will bring the French economy closer to 
full-employment."  France's "Bureau d'Information et de Previsions 
Economiques (BIPE)" estimates the measures will result in an 
additional 8 billion euros in consumption, "a substantial portion of 
which will fuel imports."  The corporate and investment bank Natixis 
deemed the likely final impact on consumption "marginal" (between 
0.1 and 0.2 percent of GDP per year).  The bank warned that "given 
the situation of public finances, the implementation of a clearly 
pro-cyclical policy appears to be risky since France has 
budget-reduction objectives to satisfy." 
 
The Government Prepares the 2008 Central Government Budget 
--------------------------------------------- -------- 
¶8. (U) The 2008 central government (CG) budget is based on an 
inflation-adjusted GDP growth rate forecast of 2.5 percent and an 
inflation rate of 1.6 percent.  Following a government 
inter-departmental seminar on the 2008 CG budget, Prime Minister 
Francois Fillon said in late July that overall public spending would 
not increase in 2008, thanks in part to the non-replacement of one 
out of three retiring civil servants (a cut of approximately 22,700 
positions).  Budget Minister Eric Woerth said this was expected to 
generate 350-450 million euros in annual savings.  A portion of the 
money would be used to increase remaining civil servants' salaries. 
Research, justice and national education are among budget priorities 
that would be relatively sheltered from planned cuts (though only 
two out of three retiring teachers will be replaced). 
 
¶9. (U) In a recent interview, Gilles Carrez, the National Assembly 
Finance Committee spokesman, warned that "missions of the government 
must be redefined" before cutting the civil service.  Polling data 
released on August 12 indicate that the civil service reduction is 
the least popular of Sarkozy's reforms, with 61% of respondents 
disapproving of the measure. 
 
Government Forecasts a Decrease in the General Government Budget 
Deficit 
--------------------------------------------- --------- 
¶10. (U) The GOF forecasts that the general government budget deficit 
(including central government, social security system and local 
authorities) will decrease to 2.3 percent of GDP in 2008 from a 
projected 2.4 percent in 2007.  President Sarkozy promised the 
European Commission "to do everything possible" to accelerate 
reduction of the public debt from 65 percent of GDP in the first 
quarter of 2007 to 60 percent by 2012 at the latest.  The government 
has started to explore additional means of adjustment, including 
through measures to control health insurance expenditures and the 
creation of a social VAT.  The government is also planning to pursue 
pension reform, but has yet to provide details. 
 
Social Security Deficit Remains a Concern 
----------------------------------------- 
¶11. (U) The social security system is likely to incur a 12 billion 
euro deficit in 2007 according to the Social Security Accounts 
Commission.  This is almost 4 billion euros more than the deficit 
set in the December 21, 2006 social security financing law.  The 
deterioration is largely due to deficits in health insurance (6.4 
billion euros) and pensions (2.8 billion euros).  The GOF forecasts 
that in ten years there will be 2 million French men and women over 
the age of 85, resulting in a 20% increase in the number of 
dependent people in France.  In a July 31 visit to a health unit in 
Dax, France, Sarkozy announced the creation of a fifth branch of the 
French  social security system for the aged and the handicapped (the 
four existing branches include health insurance, work-related 
accidents, family allowances, and pensions). 
 
¶12. (U) He also announced a new levy on health care to fight cancer 
and Alzheimer's disease.  Under the plan, patients would pay a 
non-refundable 0.50 euro fee on top of the price of each medication 
and paramedical aid, and 2 euros for medical transport such as 
ambulance journeys.  The amount levied would be capped at 50 euros 
maximum per year, per person.  Health Minister Roselyne Bachelot 
indicated that the levies are expected to result in an additional 
850 million euros in revenues.  Government spokesman Laurent 
Wauquiez made clear that the fees would finance "tomorrow's 
challenges," such as Alzheimer's disease, and would not be used to 
cover the social security deficit. 
 
 
PARIS 00003401  003 OF 003 
 
 
Social VAT to Finance Social Security Expenditures? 
--------------------------------------------- ------ 
¶13. (U) Prime Minister Fillon has invited Eric Besson, former 
Socialist chief economist and current State Secretary in charge of 
Forward Planning and Evaluation of Public Policies, to make 
proposals on a social Value Added Tax (VAT) to help finance health 
expenditures.  The social VAT, vetted controversially by 
then-Finance Minister Jean-Louis Borloo between rounds of 
legislative elections in June, would consist of an increase in the 
VAT paid by households and a reduction in payroll taxes.  Besson 
made an initial report to the Prime Minister in late July following 
fact-finding trips to Denmark and Germany (where the social VAT has 
been implemented).  Besson should provide his final official 
conclusions by the end of August.  The ruling majority party UMP is 
studying the issue separately and will present its own conclusions 
in September before the party's National Council.  The Socialists 
have denounced a social VAT, saying it would hurt those with modest 
incomes the most. 
 
Comment 
------- 
¶14. (SBU) The Sarkozy government's tax reform package represents an 
important symbolic step in making the French economy more 
competitive, in part by loosening the 35 hour work week and through 
initial (albeit limited) steps to reduce the weight of the state 
sector in the economy.  However, its short-term direct impact on 
economic growth is likely to be modest, and its pro-cyclical timing 
has come in for considerable criticism.  Efforts to reduce 
rigidities in France's labor market, currently the subject of 
negotiation between unions and employers, and eventually 
product-market reform, will be the real tests for the Sarkozy 
government.  In the meantime the unpopularity of the civil service 
reductions and the considerable squawking over the modest health 
service co-payment proposals indicate the considerable challenges 
that lie ahead in bringing government spending under control. 
 
PEKALA