Cablegate: The Gof Turns to Deficit Cutting

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E.O. 12958: N/A
TAGS: EFIN ECON PGOV FR
SUBJECT: THE GOF TURNS TO DEFICIT CUTTING

1. (SBU) SUMMARY: Although part of the Sarkozy teamQs
campaign platform, fiscal adjustment was put on the
back burner in favor of other reform priorities
following the 2007 elections. Now under considerable
budgetary pressure, the GOF has ruled out further tax
cuts (with an exception for reform of the professional
tax and the elimination of a corporate tax) and
reiterated its commitment to eliminate the budget
deficit by 2012. But a stalled economy and the impact
of the August 2007 tax package will knock the GOF from
its intermediate deficit target in 2009, despite
efforts to rein in spending, eliminate fiscal
incentives and fight tax fraud. The difficult
budgetary environment will raise the bar for GOF
overseas engagements that impose new spending
commitments. END SUMMARY.

ELIMINATING THE BUDGET DEFICIT BY 2012
----------------------------------
2. (U) In recent interviews Economy Minister Lagarde
has said her fiscal priority through 2012 is to
eliminate the public deficit, not lower taxes. The
government hopes to reduce the budget deficit to 2.5
percent of GDP in 2008 and 2.0 percent in 2009, on its
way to balance (and a reduction in public debt from
63.9 percent to 60.0 percent of GDP) by 2012. The
2007 government budget deficit (central government,
social security system and local authorities) was a
higher-than-expected 2.7 per cent of GDP, and the
deficit has been running above forecast for the first
half of 2008.

ELIMINATING FISCAL INCENTIVES, REFORMING BUSINESS
TAXES
-----------------------------------
3. (U) In a move to increase revenue Lagarde has
proposed eliminating (on a case by case basis) a range
of existing tax incentives estimated to cost the
budget 5 billion euros annually. Although the GOF has
not specified the targeted measures, exemptions for
investing in FranceQs overseas territories and tax
breaks for investing in rental properties are among
those most frequently mentioned. Lagarde has defended
exemptions from the wealth tax (FranceQs tax on
households with assets over 750,000 euros) for
investments in small business, a measure introduced by
the Sarkozy government in 2007.

4. (U) Lagarde has proposed eliminating a flat rate
tax (QImposition Forfaitaire Annuelle Q IFAQ)
currently imposed on businesses with annual sales of
over 300,000 euros (paid on top of top of the
corporate income tax). And she says the government
plans to reform the controversial Qprofessional tax
as early as September. (Note: An important source of
revenue for local authorities, the professional tax is
based largely on a companyQs fixed assets and varies
from region to region. End note) A Ministry of
Finance budget document has described the tax as Qthe
most harmful tax for economic growth and
competitiveness of the economy.

FIGHTING TAX FRAUD
------------------
5. (U) The GOF is putting renewed emphasis on the
fight against tax fraud, which is estimated to have
cost the government 29 - 40 billion euros annually
over the past several years. (Note: The government
budget deficit in 2007 was 51 billion euros. End
note.) Budget Minister Woerth has proposed creation
of a special judicial unit, to be placed under the
authority of a judge, that would specialize in tax
fraud investigations. In early 2008 Woerth oversaw
the creation of the National Delegation for the Fight
Against Fraud (DNLF), a structure designed in part to
serve as a clearinghouse for improving coordination
among public institutions in the fight against fraud.

ECO-TAXES IN, JUNK FOOD TAXES ON THE HORIZON?
----------------------------------
6. (U) Following its broad-based 2007 consultative
forum on environmental policy -- the "Grenelle de
lQEnvironnementQ-- the GOF introduced a system of
financial rewards and penalties (Qbonus/malusQ) to

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steer consumers towards low-carbon emission
automobiles. The program has been popular and
Minister for Sustainable Development Borloo says
average emissions for new vehicles sold have dropped
nine percent in the eight months of the programQs
existence. But demand for heavily-polluting vehicles
has proven more elastic than expected, and a program
that was designed to be revenue neutral has cost the
government 140 million euros. Borloo now wants to
extend the Qbonus-malusQ system to other goods in 2009
(including refrigerators, light bulbs and flat screen
computers). Finance Minister Lagarde and Budget
Minister Woerth are pushing back, arguing that the
government should tax polluting goods rather than
provide payment for use of environmentally-friendly
products.

7. (U) Woerth has also teamed up with colleagues to
look at other tax policy options for correcting
perceived market failures and boosting revenue. The
GOF has considered a tax on trucks transiting
France indexed to distance travelled, a measure that
could bring in 1 billion euros a year by 2010. And
together with Health Minister Bachelot Woerth
commissioned a study of possible measures to fight
obesity, cardiovascular diseases and cancers.
Government staff recommended boosting the VAT rate
from 5.5 to 19.6 percent on mass market food stuffs
deemed "too rich, too sweet, too salty and not
strictly necessaryQ (including pizzas, hamburgers and
sandwiches). In the end the GOF delayed a decision
out of concern for penalizing Qthe most
underprivileged population, who eat badly,Q and in
light of the inauspicious inflationary environment.

CUTTING THE HEALTH INSURANCE DEFICIT AND FUNDING
PENSIONS
----------------------------------
8. (U) The government says elimination of FranceQs
national health insurance system deficit is essential
to achieving a balanced budget by 2012. Budget
Minister Woerth told the press the deficit would
increase 2.0 billion euros per year if steps werenQt
taken to rein in spending. To trim the current 4.1
billion euro deficit the government plans to raise 1
billion euros per year by increasing a tax on sales of
health insurance and mutual insurance companies that
provide top-up cover to the national health insurance
system. The government will also try to curb over-
prescription of medication, and reduce reimbursements
for x-rays, blood tests and hospital transport. The
government has ruled out increasing the QContribution
Sociale Generalisee (CSG),Q a tax on all forms of
income devoted to funding FranceQs broad welfare
system (Qsocial securityQ). But it plans to extend
the tax to include profit-sharing in income already
subject to the CSG, a proposal that has drawn the ire
of the business community.

9. (U) To cover pension shortfalls the government
plans to increase payroll taxes by 0.3 percentage
points on January 1, 2009 and 1 percent point by 2011
(in addition to steps taken to extend the retirement
age). The increase would be offset by an equal cut to
the unemployment insurance contribution. The
Unemployment Insurance Fund (UNEDIC), which collects
the contribution, is currently in surplus thanks to a
drop in unemployment.

RATIONALIZING PUBLIC SPENDING
-----------------------------
10. (U) The government initiated a Qgeneral revision of
public policiesQ a year ago under the direction of
Budget Minister Woerth to improve the efficiency of
the public sector and rationalize spending. Initial
results from the process will be reflected in the 2009
budget (due on September 24), and in a first-time
multi-year document laying out budget prospects for
2009 Q 2011. Spending increases will be capped at the
inflation rate and 30,600 civil servant positions will
be cut by attrition in 2009. Given constraints
imposed by non-discretionary items (debt service,
pensions, local government transfers, EU
contributions), the government has indicated that

PARIS 00001626 003 OF 003

it will favor education and research, among other
priorities, in its 2009 budget.

COMMENT
-------
11. (SBU) The economic slowdown will further constrain
the GOFQs already limited budgetary maneuvering room,
and make the goal of a balanced budget by 2012 that
much more difficult to achieve. The government is
clearly serious about holding the line on
expenditures. The pressure to limit discretionary
spending will remain a strong back-story to any effort
at boosting French international engagement that
involves new spending commitments. Over the longer
term the Sarkozy governmentQs proposed measures are
likely to improve FranceQs fiscal health, and some tax
reforms (including to the professional tax and the
QIFAQ) may help boost competitiveness. But with
general government spending still accounting for well
over 50% of GDP, real fiscal consolidation will
require stronger action on the expenditure side,
possibly to include reform of FranceQs multilayered,
and expensive system of regional and local
government.

PEKALA

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