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 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 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