Competing over Competitiveness

And so Louis finally handed in his report.  Mr Gallois, who faced, as I have blogged previously, the difficult decision of what medicine to prescribe to an obviously ill patient, published his report on French competitiveness yesterday.  The report was met with suspicion by trades-union, acclaim by the right, the centre and employers’ associations, and consternation by the government.

Ruled out immediately was the suggestion to pursue research into shale gas – a big no-no for the Greens.  However the key measure – finding some other source of financing the social security system by reducing employers’ and employees’ payroll taxes by 20 and 10 million euros respectively – has no become an unquestioned dogma in French politics.  The question is how to pay for it.  So who will the government stick with the bill?

Lumpy Socialist Thinking

It has taken something of a seismic shift in Socialist Party economic thinking to admit a rather simple proposition: if it costs a business a lot to hire a new employee, they will think twice before doing so, and try to make do with existing headcount.  The 35 hour working week was premised on an old Socialist fallacy known as the lump of labour: work is a cake that you can cut up into more slices, but never increase the size of.  In reality, as any housewife (or indeed, househusband) knows however, work makes more work.  Nicolas Sarkozy’s seized on this idea in his famous slogan: work more to earn more, and his signature policy from 2007 to 2012 was to encourage overtime by removing income tax and payroll taxes from overtime pay.  This expensive measure is thought to have created a damaging distortion, whereby employers were encouraged to create overtime hours at the expensive of normal hours.  The new government abolished it in short order.  But the question remains, how can you make work pay for business?  Wouldn’t it be simpler to reduce its overall cost?

Getting Competetive over VAT rates

Herein lies the issue of competitiveness.  France’s workforce is certainly amongst the most productive in the world, but the price of work, aside from wages which are not abnormally high, is high compared to other comparable economies in the EU, where the majority of France’s trade deficit originates.  Late in the day, the Sarkozy administration had decided to transfer a chunk of that cost to consumers, by raising VAT by 1.6% and reducing to the tune of 17 billion euros employers’ payroll taxes.  This measure was timed to come into force after the election, in something of a cynical ploy by the then government.  The Socialists, in opposition, criticised the measure for penalizing consumers, being regressive and constituting a simplistic tax break for big business and abolished it in July.  Closer examination of the businesses that would have benefitted, did indeed show that the service sector (that which is not in danger of much foreign competition) would benefit disproportionately and the level of reduction of payroll taxes would not be of a level that would have a significant impact on industry anyway.

Fast-forward 10 months to the choice now faced by the Ayrault administration.  The diagnosis is the same, but instead of 17 billion euros reduction, the Gallois Report advises 30 million in total.  Meeting this morning after the Report’s publication, the Government has announced that it will reduce employers’ costs by 20 billion, not through a reduction in charges (with the inconveniences of general application) but in a more surgical (if somewhat cumbersome manner) by creating a new tax credit of 20 billion euros for businesses, the equivalent of a reduction of 6% of payroll costs for salaries up to about 3,800 euros a month.  Businesses will have to maintain the amount they spend on salaries, either increasing the workforce or paying them more, to benefit from the credit.  This measure won’t of course help those businesses that aren’t already profitable and paying corporation tax, but it could make all the difference between a business expanding and making do with the employees it has.

Who Gets the Bill

To pay for this expensive measure, the government is preparing to increase standard VAT to 20% (an increase of 0.4%) and reduced rate VAT to 10% (an increase of 7%).  To compensate the increase in tax for poorer households, the reduced rate for essential items, like food, will be reduced to 5% (down by 0.5%).  As that package only raises half the necessary cash, the government will make further public spending cuts of 10 billion euros – although where they will fall is not at all clear, and the public can afford to be suspicious about promises to reduce spending by a government that has declared sacrosanct such high spending areas as education, health and policing.

Out of the Woods?

So is today’s announcement a triumph over those who doubted that the government would have the political courage to implement the Gallois report?  In part, but in part only.  The UMP will be able to attack the tax credit mechanism as overly complicated (and indeed they have done so, by branding it “a load of hot air”), and not providing assistance to businesses in difficulty.  The UMP will also lead the way in scepticism over spending cuts, playing the (perfectly fair, but maddeningly hypocritical) opposition game of demanding cuts, but then criticising them when they come.

The UMP will not be able to criticise the other source of funding of this measure, the increase in VAT, given that it had voted for a much higher increase in the standard rate without the compensating measures included here.  Nor can it use its now standard campaign slogan of a “bludgeoning tax policy”, with Socialists supposedly obsessed with tax increases at the expense of cuts in spending, given the spending cuts proposed here.

Ayrault can argue that his increase in VAT is therefore “good” (targeted, moderate) and Sarkozy’s was “bad” (too high, no compensation).  That is perhaps why the Ayrault government has plumped for an increase in VAT and not employees’ payroll taxes in the form of the CSG.  The apparent change of attitude with regard to raising VAT is however already attracting attention, given that ministers have spent months railing against the “anti-social” rise of Nicolas Sarkozy.  The government’s first major u-turn has plainly arrived, although the opposition on this measure will come mainly from the far left, on whom President Hollande has never been able to count.

In addition, the government has announced a fair amount of other reasonable-looking measures to be introduced, which cumulatively might bring some change, but importantly are chaff in the debate: employee representatives on big companies’ boards, new green taxes, more apprenticeships and a promise by the government not to modify give key tax measures for the remaining Presidential mandate. 

Ayrault will be on the main evening news tonight on TF1 to explain the new measures, in the hope that these bold decisions will convince the electorate and change the damaging narrative of the past few months.  With so much of the plan hinging on as-yet-unidentified public spending cuts, it is unclear whether that hope will be fulfilled.

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