While the government pursues its programme of income tax cuts which will extend into 2007, a new instrument for controlling public spending has been put in place. Although the governmentaeuroTMs budget deficit was contained in 2005, the national debt exceeded 60% of GDP. As a result, the government announced a further programme of spending cuts. Moreover, the fall in direct taxation (income tax) may be suspended after 2007, as the government seeks to control and regulate its spending.
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While the government pursues its programme of income tax cuts which will extend into 2007, a new instrument for controlling public spending has been put in place. Although the governmentaeuroTMs budget deficit was contained in 2005, the national debt exceeded 60% of GDP. As a result, the government announced a further programme of spending cuts. Moreover, the fall in direct taxation (income tax) may be suspended after 2007, as the government seeks to control and regulate its spending.
In 2005, the budget adhered strictly to the ceiling agreed on by parliament for the third successive year. Despite the slow-down in economic growth ( 1.4% in 2005, Economic indicators (INSEE, 2006; in French, PDF)), the budget deficit stood at less than 44 billion euro as a result of the contingency fund introduced by the government in 2005 and codified since January 2006 into the Framework Law on Budgets (Loi organique relative aux lois de finances- LOLF).
| . | Government spending | Government revenue | Balance: after such amendments as for corporate taxation |
| Budget: | 288,483 | 243,290 | - 43.47 |
Source: [Ministry of the Economy, Finance and Industry (MINEFI)](http://www.finances.gouv.fr/recherche/lance_recherche.php?mot=budget de l'état 2006&search_go=ok)
Cuts in income tax
The reduction of income tax by a third was an election manifesto promise made by Jacques Chirac when he stood for re-election as President in 2002. This commitment has been honoured despite recommendations to the contrary issued by members of his own political camp, who urged him to postpone it. The process culminated in a final battle, which begun in summer 2005 and ended in December 2005, with the passage of an overall reform through parliament, later amended by the Constitutional Council, and vehemently challenged by the opposition and the unions. The measures passed will have an effect on tax calculations for 2006 income, and therefore government revenue for 2007 (as the French pay their taxes on the previous yearaeuroTMs income).
The reform reduced the number of tax brackets and lowered the highest marginal rate. It established a aeuro~fiscal shieldaeuroTM, by placing an upper taxation limit of 60% of a householdaeuroTMs income. A rule had been introduced to limit the accumulation of tax advantages produced by the many loopholes in the system (such as reductions for employing people to work in your home, for buy-to-let residences under particular criteria, expenses related to childcare, etc.), but the Constitutional Council invalidated these restrictions. In doing so, the Constitutional Council further unbalanced a reform that already tipped the scales very much in favour of those on high incomes. Various cuts, including the extension of exemptions from inheritance tax on money or property passed on to heirs during oneaeuroTMs lifetime, and a new reduction for shares held by employees for more than six years, were added to the cuts of all kinds related to the tax on wealth (ImpA´t sur la fortune_- ISF_) in previous years or to the inheritance tax. The feeling that the reform was aeuro~for the richaeuroTM, as the Socialist Party maintained, was compensated for by an increase in the employment bonus (a negative tax) and by raising the cut-off point for incomes entitled to a 0% interest loan for the purchase of housing. Some voices from within the governing coalition itself, for instance, Pierre MA©haignerie, General Secretary of the Union for a PeopleaeuroTMs Movement (Union pour un mouvement populaire, UMP) and Chair of the parliamentary finance committee, warned of the risk of a tax-induced self-exile of the nationaeuroTMs wealthiest people. The government, however, rejected the notion of introducing a system containing limits, as there is in the US, for example. For the time being, one quarter of the total cuts in income tax will benefit the countryaeuroTMs 100,000 richest households.
New instrument for managing public spending
In 2001, a reform of the governmentaeuroTMs accounting system was passed almost unanimously by parliament. The new and sophisticated Framework Law on Budgets (Loi organique relative aux lois de finances_- LOLF_) came into force on 1 January 2006. It aims to bolster the monitoring of public spending by allocating credits according to performance and efficiency criteria. Instead of being attributed to the various Ministries, the credits will now be allocated to aeuro~assignmentsaeuroTM and aeuro~programmesaeuroTM, then divided up at departmental level into action plans and operating budgets. Indicators will ensure compliance with annual performance targets to be monitored and reported to parliament. Originally aimed at facilitating the process of expense monitoring by parliament and promoting government action and interventions, the Framework Law on Budgets will become the favoured instrument to achieve greater selectivity in spending in years to come. The principle of credit aeuro~interchangeabilityaeuroTM, which allows a department to exchange staffing credits for operating credits (the opposite transaction is not allowed), is to be promoted as a preferred instrument for reducing staffing levels, a stated objective of the governmentaeuroTMs plan. The unions, which are in favour of the modernising strategy inherent in the Framework Law on Budgets, may revolt against its consequences if it turns out that in practice, it primarily serves the objective of reducing the scope and extent of the public service.
Rise in national debt
At the request of the Minister of the Economy and Finance, a commission has been set up to assess the precise level of the governmentaeuroTMs budget deficit. Chaired by Michel PA©bereau, President of BNP-Paribas Bank (FR0008181N), the commission reported back on 14 December 2005. It estimated the governmentaeuroTMs accrued debt at 1,100 billion euro, which represents 66% of gross domestic product (GDP), and thus exceeding the 60% level allowed under the Stability and Growth Pact (SGP). Yet France is already under pressure from the European Commission due to an annual government deficit forecast at 3.5% of GDP for 2006. However, the report principally stirred up a debate by its criticism of how successive governments managed the public purse over the last 20 years.
Although this analysis is not challenged, it has led to a war of words between those parties that have alternated in power. While the report did not distinguish between them in its critique, the current majority party, UMP, placed the responsibility squarely in the hands of the previous socialist government. It accused the latter (due to the 35-hour week) of having increased the spending burden, when growth would have allowed the books to be balanced (FR9806113F) (FR0001137F). The Socialist Party (Parti Socialiste, PS) has emphasised the exacerbation of the situation since 2002, basically due, in its opinion, to the over-generosity of the tax cuts made by President Jacques ChiracaeuroTMs governments. The quarrel over the causes of the rise in national debt has run parallel with a debate over the PA©bereau reportaeuroTMs recommendations (http://www.minefi.gouv.fr/notes_bleues/nbb/nbb301/pebereau.pdf). These have raised some doubts among a number of economists (both from the left and the right).
Government actions
The exhortation to balance the government budget in five years is based on ambitious hypotheses that some deem tenuous, such as forecasting a 2.25% annual growth rate; balanced budgets for the social security funds (pensions, sickness insurance); a serious reduction in government funding for local authorities, even though the government continues to transfer new and greater responsibilities to them; and a sizeable cut in the central government operating budget.
The government promptly responded to these recommendations. During the first meeting of the National Conference on Public Finances (formerly the National Audit Commission) on 11 January 2006, Prime Minister Dominique de Villepin announced a drastic programme of cutbacks. In February, he also asked Ministers to send him their proposals for staff redeployment and the non-replacement of retiring personnel for 2007. More than 83,000 retirements are expected, alongside a planned reduction of 5,300 full-time equivalent civil service posts. In addition, the Prime Minister committed himself to suspending the reduction in direct taxation after 2007, thus ending a drive that has been relentlessly pursued since 2002. The announced objectives aim to trim the national debt to 60% of GDP and to successfully balance the books by 2010.
In terms of the government budget, the Prime MinisteraeuroTMs commitment is above all to be assumed by his successors, as the budget passed for 2006 contains a greater deficit than the one passed the previous year (45.2 billion euro, based on an improbable predicted 2.5% economic growth rate), while the amount forecast for 2007 must incorporate the serious decrease in tax revenues brought about by a new wave of tax exemptions passed in December 2005.
Reactions by the unions
The unions responded in various ways, but all stressed the lack of credibility of the governmentaeuroTMs intentions. The French Democratic Confederation of Labour (ConfA©dA©ration franA§aise dA©mocratique du travail, CFDT) emphasised the 'hypocrisy' of a government that has consistently increased government borrowing over recent years, while the General Confederation of Labour - Force ouvriA¨re (ConfA©dA©ration gA©nA©rale du travail - Force ouvriA¨re, CGT-FO) - pinpointed the risk inherent to social cohesion entailed by a swift withdrawal of public services. The General Confederation of Labour (ConfA©dA©ration gA©nA©rale du travail, CGT) was critical of the apocalyptic tone assumed by both the government and the PA©bereau Commission, and emphasised that there were two ways of reducing the size of the deficit, one of them being through a policy aimed at bolstering economic growth and job creation. The Movement of French Enterprises (Mouvement des entreprises de France, MEDEF), for its part, recalled that for two decades it had been telling all the successive governments about the necessity to cut back on the size of government departments and the number of civil servants.
Commentary
Changes in the tax system will certainly be central to the manifestos competing for votes in the 2007 presidential and parliamentary elections. It should be acknowledged that the programme of reducing income tax, implemented in the name of economic recovery, is far from having produced the expected impact, and is again fuelling questions about its legitimacy.
In a society shaken by the increase in social exclusion and which has traditionally accorded an important place to the government and public servicesaeuroTM roles as guarantors of equality, the new political agenda has created a risk of distortion. It was brought about by the rise in public spending and the tax policy of recent governments. While the authorities have proved incapable of stimulating growth and shaping the future, the cuts in the number of civil servants, towards which all government policies are heading, may lead to debates and social tensions throughout a pre-election year.
The issue of government borrowing is bound to dominate both the social affairs agenda (issues such as wage hikes and staffing levels in the civil service) and the debate already under way in the run-up to the elections set for 2007. (Jean-Marie Pernot, Institut de Recherches Economiques et Sociales, IRES, France)
Eurofound recommends citing this publication in the following way.
Eurofound (2006), New rules for government spending and borrowing, article.
