France: Selected Issues

This Selected Issues paper first explains the recent increase in trend growth and then discusses how labor market and tax policies could best sustain it. This study calculates French trend growth estimating simultaneously a Cobb–Douglas production technology and total factor productivity. The main conclusion is that French trend growth indeed increased during the second half of the 1990s to an average annual rate of 2.1 percent, from 1.8 percent in 1993. This was not owing to a recovery of total factor productivity growth.

Abstract

This Selected Issues paper first explains the recent increase in trend growth and then discusses how labor market and tax policies could best sustain it. This study calculates French trend growth estimating simultaneously a Cobb–Douglas production technology and total factor productivity. The main conclusion is that French trend growth indeed increased during the second half of the 1990s to an average annual rate of 2.1 percent, from 1.8 percent in 1993. This was not owing to a recovery of total factor productivity growth.

III. Tax Reform and Potential Growth in France47

78. The tax burden in France is very high by international standards, and is dominated by social security contributions and direct taxes on labor income with high marginal rates. While high taxes are thought to depress employment, investment, and growth, the evidence on the direct links between taxation and growth is mixed. Nevertheless, to address mounting concerns related to the heavy tax burden on individuals and corporations, a series of tax cuts has been initiated, though without altering the basic tax structure.

79. Against this background, this paper reviews France’s tax system, and recent tax reform initiatives, in the context of their possible impact on economic efficiency, with a view to suggesting feasible reform options. It pays particular attention to the taxation of labor, capital, and consumption, and its impact on growth through incentives to work, the demand for labor, and total factor productivity via savings and capital formation. Section A reviews the literature, including the main reform options proposed for tax reform in advanced economies. Section B describes the French tax system, focusing on its structure and the tax burden on production factors. Sections C reviews recent tax reforms, while Section E suggests options for further reform.

A. Brief Overview of the Literature

80. In an endogenous growth model where output depends on the combination of labor and capital factors, taxes may affect both output and growth. The taxation of output, labor, and capital affects the remuneration of factors and the alternative uses of income (consumption and savings). This in turn affects the supply of labor (through work incentives and decisions affecting the entry or exit from the labor market); the demand for labor versus capital; the demand and supply of capital; and total factor productivity. In particular, labor taxation (through payroll or income taxes) creates a tax wedge between labor costs and labor remuneration, thus affecting labor supply (via the trade-off between work and leisure) and labor demand (if higher labor costs cannot be fully shifted to the labor factor). Similarly, capital taxation (through corporate and personal income taxes, and taxes on wealth) affects the rate of return on capital and distorts investment and savings decisions; this may discourage otherwise profitable investments, entail inter-temporal efficiency costs, and reduce capital accumulation over time—ultimately affecting both the level and the growth rate of output. Finally, through its impact on labor and capital, taxation can distort the combination of these two factors, with a potentially negative impact on output and growth.

81. From the point of view of the intertemporal budget constraint faced by an individual taxpayer, several tax equivalence results hold in a world of perfect markets (Atkinson and Stiglitz, 1980). A proportional tax on wages (plus inheritance) is equivalent to a tax on consumption (plus bequests) in present value terms. A proportional tax on income (excluding interest income) is equivalent to a consumption (plus bequests) tax. A proportional tax on income excluding savings is also equivalent to a consumption tax. Finally, a proportional tax on interest income is equivalent, for the taxpayer, to a tax on wealth. While these results offer a benchmark to assess various types of taxes, the assumptions necessary to yield them rarely hold in models with more complex tax and market structures (e.g., progressive tax rates, unionized labor markets, and, more generally, imperfect markets). It also follows from these results that a tax on income (including interest income) is not equivalent to a tax on consumption, since the former taxes capital income in addition to wage income (Tanzi and Zee, 2000; Zee, 2002).

Tax policy and growth in OECD countries

82. Although theories differ as to the magnitude of the impact of taxes and welfare benefits on employment and growth, there seems to be a general presumption that higher average tax burdens have an adverse impact. However, there is no clear empirical evidence from cross-country comparisons to support this general proposition (Gerson, 1998; Disney, 2000). In the end, the specific effect of taxes on employment and growth may be an empirical issue in each individual country and for each tax and benefit system.

83. Some authors find that tax policy plays a fundamental role in affecting the long-run growth performance of countries but others disagree. Prescott (2002) and Lucas (2003) find a large negative impact of taxes on economic activity, suggesting for example that heavy labor and consumption taxation is responsible for the low output per working-age person in France, which is estimated to be 30 percent lower than in the United States.48 In general, policies that improve the neutrality of taxation and promote the accumulation of human capital may have the potential to enhance growth. In this regard, the structure of taxation could have important implications for growth (Tanzi and Zee, 1997). Not all authors agree, however. Harberger conjectured in 1964 that in practice tax policy is ineffective to influence growth, after observing that the tax mix did not produce significant effects on savings and investment rates in the United States. Stokey and Rebelo (1995) and Mendoza, Milesi-Ferretti, and Asea (1997) similarly find that tax reform has little impact on long-term growth, although the latter acknowledge that altering the tax mix may yield welfare gains induced by efficiency gains on the levels of consumption and output.49

84. Studies generally assume a negative relation between taxes on labor, and employment and growth in OECD countries. Social security contributions, payroll taxes, and personal income taxes may adversely affect the cost of labor (if industrial relations or regulatory constraints prevent the labor tax wedge to be fully borne by workers) and, thus, reduce labor demand by firms, employment and, eventually, economic growth. To the extent that part of the burden of labor taxes and social security contributions is shifted to workers, these taxes may also generate disincentives to seek work or raise work effort (OECD, 1995; OECD, 2001b). High labor taxation may also induce a drift into the informal economy, if tax enforcement is weak (OECD, 2001b). In reviewing the evidence, Zee (1997) and others point to several stylized facts:

  • High employers’ social security contributions and payroll taxes, which usually bear heavily on low-income workers, tend to be reflected in higher labor costs (because of labor market rigidities) and to reduce labor demand (this effect is usually reflected in high average tax wedges on labor).

  • High marginal effective tax rates (due to the combination of tax and benefit systems) can have a significant impact on labor supply by affecting the choice between additional work and leisure, entailing a disincentive to job search and increased work effort. Very high marginal rates (close or above 100 percent) may create so-called poverty or inactivity traps.50

  • Several groups of individuals are most likely to be negatively affected by high marginal effective tax rates: low-income workers eligible for in-work benefits; high-income workers, which face high tax rates and may be more mobile; individuals considering entering the labor force (e.g., young people, and married women); and workers nearing retirement. For these groups facing complex budget constraints with high effective tax rates over certain segments, empirical studies find a significant labor supply response to policy changes (Disney, 2000).

  • Regarding unemployment benefits, high replacement ratios associated with these benefits may reduce the incentive to seek work.

  • Taxes and benefits, however, are not the only factor explaining employment and growth. Taxation may exacerbate the impact of existing distortions, labor market rigidities, and union-employers bargaining processes.

85. Recently, the negative impact of labor taxation on employment and growth was emphasized by Daveri and Tabellini (2000) who attributed the slowdown in growth in Europe, associated with persistent unemployment, to the rapid growth in labor costs, particularly due to taxes on labor. With strong and decentralized trade unions, labor taxes are shifted into real wages thus reducing labor demand; this, in turn, leads to substitution away from labor and downward pressure on the marginal product of capital, reducing investment and growth. The authors estimate that the observed rise in labor tax rates (by 14 percentage points) between 1965-1995 in the European Union (EU) accounts for a decline in the rate of growth by 0.4 percentage points per year and a rise in unemployment of about 4 percentage points.

86. Consumption taxes are deemed to create fewer distortions. They do not affect savings and investment decisions (since current and future consumption are treated equally) and remain neutral with respect to various sources of income (labor, transfer, and capital income) and with respect to international trade. Daveri and Tabellini (2000) find that consumption taxes have no impact on employment (and growth), because they do not create a wedge between labor income and unemployment benefits—both being taxed the same way and absorbed by the labor factor.51 Milesi-Ferretti and Roubini (1995) show that while consumption taxes as well as income taxes have a negative impact on growth through their distortion of the choice between labor and leisure, the latter involve additional distortions in the production function (raising the capital/labor ratio, thus reducing the return on capital) that further reduce capital accumulation and growth. Kneller, Bleaney, and Gemmell (1999) validate empirically for OECD countries that consumption taxes have a non-distortionary effect on growth, suggesting that reducing distortionary taxes by 1 percent of GDP could raise the growth rate by 0.1-0.2 percent per year. Tanzi and Zee (2000) find that consumption taxes have a smaller negative impact on savings than income taxes (and confirm empirically that the interest elasticity of savings is positive).

87. The value-added tax (VAT), as a general tax on consumption, is regarded as relatively non-distortionary—and has indeed been adopted by most OECD countries. In practice, however, it still suffers from an imperfect implementation. Differentiated rates, product and sector-related exemptions, and significant problems with cross-country trade in the EU tend to distort competition and consumption patterns while increasing compliance costs. Complexities also reduce the capacity to detect tax evasion and fraud, thus further distorting competition (Joumard, 2002).

88. In addition to raising the required rate of return on investment and depressing investment, corporate taxes in OECD countries tend to favor debt financing over equity financing or retained earnings, which may lead to an inefficient allocation of resources (in addition to raising insolvency risks and potentially discriminating against small companies that have more difficulties borrowing). These distortions arise because tax systems provide a more favorable tax treatment to interest payments than to distributed or retained profits, or because they maintain double taxation of dividends (once at the corporate level and once at the shareholders’ level). Corporate taxes are also non-neutral given the widespread use of rebates, exemptions, and special regimes for specific sectors or regions (OECD, 2001b; Joumard, 2002). Imperfectly coordinated tax regimes in the OECD may affect location decisions, which, as a result, may not be efficient, and give firms ample opportunities for tax avoidance (Bond et al, 2000). Empirical studies in the EU have documented significant distortions: tax systems tend to favor debt financing and investment in intangibles and machinery. There are also considerable differences across countries in the treatment of subsidiary companies of a parent company, depending on their location (European Commission, 2001). Empirical studies also suggest that large companies bear a smaller tax burden than small enterprises, suggesting that the former are more successful in avoiding taxes, possibly through tax planning and fiscal engineering (Nicodéme, 2002).

89. Taxation of capital income (interest income, dividends, and capital gains), although relatively low in the EU, remains distortionary. While there is little evidence in the literature that taxes affect the aggregate level of savings, they may affect its composition and location. Many EU countries tend to grant favorable treatment to specific savings instruments, such as retirement schemes and housing investment. Moreover, they generally apply a preferential treatment to non-residents, thus distorting savings flows and potentially enhancing tax evasion possibilities associated with cross-border investment (OECD, 2001b; Joumard, 2002). The EU recently adopted a tax directive to exchange information between tax administrations on interest income paid to non-resident individuals (three countries will impose withholding taxes instead), aimed at reducing these distortions and tax evasion possibilities.

Broad reform options in the literature

90. Studies generally point to two complementary directions for reform to increase employment and growth. First, direct reforms to reduce institutional labor market rigidities (such as improving skill mismatches, increasing labor mobility, reducing high minimum wages, and widening wage differentials); and second, reforms of tax and benefit systems, especially with less than fully flexible labor markets (Zee, 1997; IMF, 2003).

91. In general, lowering the tax burden on labor while also reducing labor market rigidities may lead to increases in both labor supply and demand, thus boosting employment and growth (Joumard, 2002). However, for tax cuts to be seen as permanent and, thus, to have their desired effects on agent’s behavior, reductions in the overall tax burden should—in cases where fiscal sustainability is in question—be matched with corresponding reductions in public expenditure. If the latter cannot be achieved, shifting the tax burden away from labor to other tax bases, such as consumption, in a revenue-neutral manner may in itself have positive employment effects (OECD, 1995; Zee, 1997; Tanzi and Zee, 1997 and 2000; Daveri and Tabellini, 2000; and European Commission, 2000). Specifically, key reform options include:

  • Shifting the tax burden from payroll taxes to broader-based taxes, such as consumption taxes. This would broaden tax bases, since the consumption out of other income (capital, property, income transfers) would be taxed; remove the pressure on labor costs stemming from payroll taxes and contributions; reduce disincentives to work effort, to the extent that marginal rates are reduced; and indirectly reduce the taxation of savings, thus potentially encouraging capital accumulation;

  • Introducing tax relief for employers of low-skilled and low-income workers to reduce labor costs for those categories, mainly through targeted reductions in employers’ payroll taxes so as to reduce the high tax wedge faced by these categories of workers; and

  • Addressing poverty and inactivity traps for low-income earners by reducing effective marginal tax rates. This can be done by directly lowering marginal tax rates for these income categories, increasing general deductions, or introducing income support schemes such as an earned income tax credit.

92. Some studies suggest that shifting taxes from labor to consumption (such as the VAT) could have a positive impact on growth, employment, and investment. Using a general equilibrium macroeconomic model (QUEST), the European commission (2000) estimated that such tax reform, with the shifting of 1 percent of GDP from labor taxes to the VAT, could increase the level of GDP by 0.4 percent after 10 years.52 Other studies, however, suggest that the impact on employment and growth of such reform is likely to be moderate, especially if wages and social benefits are increased to compensate for the rise in consumption taxes (OECD, 1995).

93. Streamlining the VAT structure by minimizing exemptions and the scope for reduced rates is generally suggested as a way to reduce distortions. Using reduced VAT rates for social and redistributive purposes is an ineffective and costly instrument. Consumption patterns are not very differentiated across income classes, which means that high income consumers generally benefit as much as low-income ones from reduced rates, and even more so in absolute terms since they consume more. This makes such policies extremely untargeted and, consequently, costly to the budget. A more effective policy would be to target specific income or social groups with cash transfers (Ebrill, Keen, Bodin, and Summers, 2001).53 Moreover, reducing VAT rates selectively to boost employment in labor-intensive sectors is also likely to be costly to the budget and moderately effective.54 Finally, simplifying cross-border trade regimes for the VAT in the EU would reduce distortions, increase trade, and cut compliance costs.55

94. To improve the neutrality of capital income taxation with respect to different sources of income, several Nordic countries56 moved toward a so-called dual income tax system in the early 1990s. Under this system, all capital income (interest income, dividends, and capital gains) and corporate profits are taxed at a low uniform, proportional rate, while labor income is taxed at higher, progressive rates. This is in contrast to a system of a global income tax, which taxes the sum of all types of income according to a single, progressive schedule, but taxes corporate income separately at lower rates. Thus, the dual income tax is deemed to ensure greater neutrality between capital and corporate incomes and reduce the opportunities for tax arbitrage between those types of income and across borders (Keen, 2003; and Cnossen, 1999).”57

95. In the area of corporate taxation, reform options include improving the neutrality of taxation regarding various forms of corporate financing, in particular by reducing the tax advantage given to debt financing; eliminating double taxation of dividends; and streamlining special corporate tax regimes and relief to “level the playing field.” A general lowering of corporate tax rates (possibly associated with a broadening of the base by reducing depreciation allowances, as done recently in Germany—see Keen, 2002) may contribute to minimizing the impact of existing distortions. In addition, simplifying administrative requirements and tax filing obligations for business may increase compliance and reduce costs, especially for small and medium-size enterprises.

B. The French Tax System: Stylized Facts and Issues

96. After reaching a high of 45.5 percent of GDP in 1999, tax revenue in France dropped below 44 percent of GDP in 2002. Social security contributions figured prominently as the main source of revenue, representing over 51 percent of total revenue (although the generalized social contribution (CSG) has many characteristics of a direct income tax and could be deducted from that figure). Local taxes were relatively marginal, representing only 11 percent of total (Table III.1).

Table III.1.

France: Structure of General Government Revenue, 2002

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Source: Direction de la prevision; INSEE.

Excluding tax transfers to local governments and social security.

Mostly local indirect taxes and tax transfers from central government.

Including “other central government institutions” which are mostly social security contributions.

97. Since the early 1990s, social security contributions increased steadily from 19.6 percent of GDP in 1990 to 22.5 percent of GDP in 2002, while taxes remained relatively stable around 23 percent of GDP on average. Following the tax cuts effected in 2000-02, however, tax revenue dropped to 21.4 percent of GDP, below social contributions (Figure III.1).

Figure III.1.
Figure III.1.

France: Tax Burden, 1982-2002

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 335; 10.5089/9781451813548.002.A003

Source: Ministry of Economy and Finance, Economic. Social, and Financial Report 2002; and INSEE, April 2003.

Tax burden

98. The tax burden in France is among the highest in the OECD, After dropping to 42.7 percent of GDP in 1992, the tax ratio increased sharply during the second half of the 1990s, buoyed by economic growth, tax measures in the run-up to the third stage of the EMU, and the need to finance rising social security benefits and transfers, reaching an all-time high of 45.5 percent of GDP in 1999 (Figure III.1). Although it was reduced in 2000-02, the tax ratio remained much higher than the OECD average of 37 percent of GDP and even than the EU average of 42 percent of GDP in 2001 (Figure III.2).58 To address this issue, the authorities engaged in several rounds of tax cuts over the period 2000-2003.

Figure III.2.
Figure III.2.

France; General Government Total Tax Revenue, 2001

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 335; 10.5089/9781451813548.002.A003

Source: OECD, Revenue Statistics.

Tax structure or tax mix

99. The tax structure in France is dominated by social security contributions and, to a lesser extent, indirect taxes. These account for about 40 percent and 34 percent of total tax revenues, respectively (Table III.2).59 In contrast, the share of direct taxes on households and businesses (20 percent and 6 percent of total, respectively) is relatively low compared to other OECD countries.

Table III.2.

France: Structure of General Government Revenue in Selected OECD Countries, 2003 (Projections)

(In percent of total)

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Source: OECD, Analytical database (December 2002).

Taxation of labor, capital, and consumption60

100. The French tax system is characterized by the high taxation of labor. France’s effective tax rate on labor (LETR) is estimated by the European Commission at close to 42 percent in 2001, much higher than in the EU (36 percent) and in the United States and Japan (24 percent and 21 percent, respectively).61 Although these rates declined in 2000-01, the differential between France and other countries remained. About 68 percent of the LETR is due to non-wage labor costs (social security contributions and other payroll taxes) and the remaining 32 percent to personal income taxes. As a result, while non-wage labor costs are as high as 32 percent of total labor costs in France, they are only 24 percent on average in the EU and as low as 11 percent in the United States in 2001 (Table III.3). Alternative calculations by the OECD Secretariat for the overall period 1990-2000 yield broadly similar conclusions (Table III.4). At 40½ percent, the effective taxation of labor in France was higher than on average in the EU (38 percent) and much higher than in the OECD (32 percent).62

Table III.3.

France: Effective Tax Rates in the European Union, 2001

(In percent)

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Sources: Martinez-Mongay (2000), European Commission (2000).

101. Estimates of effective taxation of consumption vary. It is estimated by the European Commission at 24 percent in 2001, much higher than the EU average of 21 percent (Table III.3).63 In contrast, the OECD estimates this tax to be only 15 percent on average over 1990-2000, lower than the EU average of 18 percent, but close to the average in the OECD of about 16 percent (Table III.4). The OECD data suggests that there is room for increasing taxes on consumption.

Table III.4.

France: Effective Tax Rates in Selected OECD Countries, Average 1990-2000

(In percent)

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Source: OECD, Carey and Rabesona (2002).

Unweighted average.

102. Capital taxation in France is estimated to be at or above the EU average. While the European Commission estimates the effective tax rate on capital in France at 22 percent, slightly lower than the average in the EU and in the United States (23 percent) (Table III.3),64 the OECD finds higher values for France (33 percent) than on average in the EU (29 percent) (Table III.4). This would suggest that there may be room for reducing taxes on capital income.

103. The combination of high taxes on labor and consumption leads to a large total tax wedge on labor income. The total tax wedge on labor income, resulting from wages being taxed directly and indirectly (through consumption), is estimated by the European Commission to reach close to 56 percent in 2001—much higher than the EU average of 50 percent, and than the United States at 31 percent. In fact, France has among the highest labor tax wedges in the EU, topped only by Sweden, Denmark, and Finland (Table III.3). Similar results are found by the OECD with total labor and consumption taxation reaching 51 percent in France, against 49 percent on average in the EU and 43 percent in the OECD (Table III.4).

104. Employers face very high non-wage costs on labor. Non-wage labor costs (social security contributions and other payroll taxes) paid by employers represent 22.5 percent of total compensation of employees, the highest rate in the EU with an average of 16 percent (Table III.3).

105. Micro-simulations of the tax wedge on labor income suggest broadly similar conclusions. Table III.5 presents average and marginal tax wedges on labor income calculated for an average worker in the manufacturing sector earning the average gross wage (OECD, 2003a). The average labor tax wedge is much higher in France than on average in EU and OECD countries for single as well as for married wage earners (48 percent of gross labor costs in France against 41 percent in the EU for a single worker; 39 percent against 29 percent in the EU for a married couple with two children and one wage earner; and 40 percent against 34 percent for a married couple with two children and two wage earners). The difference with the EU is less striking, however, with respect to the marginal labor tax wedge (it is even lower in France than in the EU for a married couple with two children and one income earner).

Table III.5.

France: Average and Marginal Tax Wedge in Selected OECD Countries, 20021

(In percent of labor costs)

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Source: OECD (2003).

Income tax plus employee and employer contributions less cash benefits, for wage earners at the income level of the average production worker.

167 percent of the average production wage.

The second earner’s income level is two-thirds of that of the average production worker.

Unweighted average.

Marginal effective tax rates

106. France’s marginal tax rates on labor income are close to the EU average (about 50 percent of total labor costs for revenues up to 167 percent of the average production wage, Table III.5). High income earners, however, face higher marginal rates, mainly due to the sharp progressivity of the personal income tax, which has a maximum rate of close to 50 percent (plus 8 percent for the CGS and the CRDS), and the absence of ceilings on health insurance contributions (Debonneuil and Fontagné, 2003; OECD, 2001c and 2003b). These high marginal tax rates may induce a reduced labor supply, in addition to tax avoidance or relocation decisions.65 In addition, wealthy individuals face an annual tax on their net wealth.

107. Certain combinations of taxes and benefits induce high marginal effective rates of taxation for low-income households. High METRs may lead to strong disincentives to work and “inactivity traps” for certain groups, in particular low-wage and older workers, as well as spouses of low-income earners.66 Although several reforms implemented before 2000 (in particular, reductions in the CSG for low-income workers) have reduced some cases of high METRs, they have not succeeded in eliminating all of them (Mahfouz, 2000).

108. Reforms in benefits, as well as the introduction of the earned-income tax credit (primepour l’emploi) in 2001 have contributed to reducing high METRs for low-income earners. Successive reforms to the minimum income support scheme (RM1) and to the housing subsidy have succeeded in removing a great deal of inactivity traps. In particular, METRs of 100 percent and over seem to have disappeared, although METRs remain high in some cases and time horizons, particularly for benefit recipients seeking part-time employment (Hagnere and Trannoy, 2001). incentives to work remain low for some categories, such as single mothers with children, because their benefits are high and their potential wages are low (Gurgand and Margolis, 2001). Nevertheless, by supplementing the income of low-wage workers, recent reforms may have potentially stimulated labor supply and, by moderating wage pressures, stimulated labor demand as well (OECD, 2001c).67

Corporate taxation

109. Corporate income taxation is high. Estimates by the European Commission (2001) suggest that France, with a rate of 33 percent, had the highest effective marginal rate in the EU in 1999, and, at over 37 percent, the second-highest average rate after Germany (Table III.6). High corporate tax rates may have powerful negative effects on incentives to invest and, thus, on growth.68 Other calculations by Devreux, Griffith, and Klemm (2002), however, suggest that marginal and average effective tax rates in France are broadly in line with the major EU and OECD countries (Table III.7). These results may reflect, in part, the reductions in the statutory corporate tax rate implemented in France in 2001.

Table III.6.

France: Statutory and Effective Tax Rates on Corporations in the EU, 19991

(In percent)

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Sources: European Commission, 2001, Tables 7 and 8; Thakur, Keen, Horvath, and Cerra (2003).EMTR: Effective tax rate on a marginal investment earning a normal after-tax real rate of return of 5 percent.EATR: Effective tax rate on a profitable (infra-marginal) investment with a pre-tax real rate of return of 20 percent.

Only corporation taxes, including surcharges and local taxes.

Table III.7.

France: Statutory and Effective Tax Rates on Corporations in Selected OECD Countries, 20011

(In percent)

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Source: Institute for Fiscal Studies; Devereux, Griffith, and Klemm (2002).EMTR: Based on an investment in plant and machinery, financed by equity or retained earnings.No economic rent. Real discount rate 10 percent. EATR: Economic rent and real discout rate 10 percent.

Only corporation taxes, including local taxes.

Value-added taxation

110. The standard VAT rate in France (19.6 percent) corresponds exactly to the average in the EU, but is higher than the average in the OECD (17.6 percent). The reduced rates (2.1 percent and 5.5 percent) are lower, however, than in most EU countries, and the difference with the standard rate is rather large, implying significant losses for the budget (Table III.8).

Table III.8.

France: VAT Rates in the EU and OECD Countries, 2002

(In percent)

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Source: European Commission, OECD, and IMF Staff.

111. While still high, the yield of the VAT has steadily eroded over time. With VAT revenues at 7.4 percent of GDP in 2001, France is only slightly above the average in the EU and the European countries of the OECD (6.8 and 7.0 percent of GDP, respectively), and many OECD countries have higher yields, up to 10 percent of GDP in Denmark (Figure III.3). Revenue from the VAT fell further to 7.1 percent of GDP in 2002. Moreover, the efficiency ratio of the French VAT is not exceptionally high at about 38 percent, indicating the widespread use of reduced rates, exemptions and, possibly, collection inefficiencies (Figure IV.4).69 Finally, France is one of the few EU countries to have seen its VAT revenue-to-GDP ratio decline since 1980 (Figure IV.5). This was the result of successive rate cuts, the elimination of the augmented rates, and the extension of exemptions. In particular, the standard rate was reduced by 1 percentage point in 2000 and the coverage of the reduced rate was extended to renovations and repairs of private dwellings, domestic care services, and cleaning services in private households (at a budgetary cost estimated at about 0.6 percent of GDP).

Figure III.3.
Figure III.3.

France: VAT Revenue, 2001

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 335; 10.5089/9781451813548.002.A003

Source: OECD, Revenue Statistics.
Figure III.4.
Figure III.4.

France: VAT Efficiency Ratio, 2001

(In percent)

Citation: IMF Staff Country Reports 2003, 335; 10.5089/9781451813548.002.A003

Source: OECD, Revenue Statistics; and staff calculations.
Figure III.5.
Figure III.5.

France: VAT Revenue in Selected OECD Countries, 1980-2001

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 335; 10.5089/9781451813548.002.A003

Source: OECD Revenue Statistics, 2002

Local taxes

112. France levies two unusually-designed local taxes which yield low revenues (1.8 percent of GDP in 2002). First, local governments levy a tax on businesses (taxe professionnelle) based on the rental value of commercial and industrial buildings and equipments and, until 2003, part of the payroll of the company. Rates vary between municipalities, and the tax is levied regardless of the actual turnover or profits of the enterprise. Because this tax is capped, increasing amounts have been covered by the central government (over 60 percent of total revenue of the tax). Second, local governments levy a housing tax (taxe d’habitation), which is due by individuals based on the notional rental value of the occupied dwelling, with numerous deductions depending on the family situation and varying rates between municipalities.

113. Real estate taxation is moderate but on the high side of the OECD average. Real estate taxes (taxe fonciere), which are collected by local governments, yielded only 1.1 percent of GDP in 2002. In contrast, real estate taxes represented 3.3 percent of GDP in the United Kingdom and 2.6 percent of GDP in the United States, while the average in the OECD was below 1 percent of GDP.

Tax administration

114. The tax system is managed by several administrations and entails heavy administrative requirements for taxpayers. Direct taxes and social contributions are assessed and collected through various administrations and channels. Social security contributions (including the CGS on wages) are collected from employers by a specialized semi-public agency (URSSAF); personal and (until 2003) corporate income taxes are assessed by the tax administration (DGI) but collected by a separate unit, the public accounting administration (DGCP); and the VAT is managed entirely by the DGI. Taxable bases, procedures, and filing periods vary across taxes. Unlike most EU countries which withhold most personal income taxes at source, in France only the CSG and social contributions are withheld at source. Filing under the PIT is mandatory for every resident, even if there is no tax liability, making this tax costly to administer, while being subject to considerable collection lags. Finally, the tax code is complex and difficult to understand for both taxpayers and the tax administration (Conseil des Impôts, 2002).

Progressivity of the tax system

115. The French tax system is considered fairly progressive. While this paper does not deal with the equity of the tax system, this remains an important consideration. In this regard, the VAT and social security contributions are considered more or less proportional, while direct income taxes are somewhat progressive (Bourguignon and Bureau, 1999), although the small yield of the personal income tax limits its redistributive impact.

C. Recent Tax Policy Reforms

116. This section summarizes the main tax reforms implemented in France during the period 2001–2003.70

  • Personal Income Tax (PIT): The rates of the PIT were reduced by the previous government by 1.25 to 3 percentage points between 1999 and 2002, corresponding to reductions of about 2 to 29 percent. During that period, the highest rate was reduced from 54 percent to 52.75 percent, and the lowest rate from 10.5 percent to 7.5 percent. The current government extended these reductions by cutting all rates by another 5 percent in 2002 and by 1 percent in 2003, bringing down the highest rate to 49.58 percent and the lowest rate to 7.05 percent in 2003 (Table III.9). Income taxes will be cut by another 3 percent in 2004.

  • Despite these high marginal rates, the average rate faced by the top decile of taxpayers is only 12 percent, owing to the large deductions equal to 28 percent of net income, up to a ceiling,71 and the system of quotient familial limiting the impact of progressive rates for couples and families. Only about half of taxpayers have a positive tax due. Nevertheless, the PIT remains quite progressive, with the 10 richest percent of taxpayers contributing 73 percent of total collections in 200272 while earning about 30 percent of total income.73

  • The earned income tax credit (PPE) was introduced in 2001 and benefited about 8.5 million taxpayers in 2002. The PPE is a refundable tax credit for low-income workers. Benefits are maximum for workers earning the minimum wage (SMIC) and decrease as revenues increase up to twice the SMIC. Benefits under the PPE were increased in 2002 and in 2003, and modified to address the bias against part-time work, bringing its total cost to about 0.2 percent of GDP. Although this scheme is smaller than similar programs in the United Kingdom and the United States, it is fairly well-targeted and may create less disincentive effects on labor market participation for secondary earners that these programs entail, because both earners can claim the PPE (Detragiache, 2001).

  • Corporate income tax (CIT): The 10 percent surcharge on the CIT, introduced in 1995, was eliminated in three stages between 2001 and 2003, bringing its rate back to the statutory rate of 33⅓ percent. However, changes in the rules for the taxation of dividends between subsidiaries will increase slightly the corporate tax burden in 2003.

  • Local business tax: The gradual elimination of wages from the tax base of the taxe professionnelle, initiated in 1995, was achieved in 2003.

  • Social security contributions were cut for workers earning wages below 1.8 times the SMIC, starting progressively in 2001, to reduce labor costs and encourage job creation, particularly among the low-skilled. They will be cut further to compensate for part of the increase in the minimum wage.

  • A reform of the tax administration aimed at transferring the tax collection function from the DGCP to the DGI was attempted in 2000 but canceled due to opposition from unions and local governments. Smaller scale reforms were implemented instead to coordinate the activities of the DGI and the DGCP, resulting in the transfer, in 2003, of the collection of the CIT to the DGI in 2003. Another positive step was the creation of a large taxpayer unit (DGE) in 2002 covering about 23,000 taxpayers (accounting for about 25 percent of VAT collections and 45 percent of corporate income tax revenues) and offering a one-stop window for companies with respect to their VAT and CIT obligations.

Table III.9.

France: Personal Income Tax Rates, 1999-20031

article image
Source: Ministry of Economy and Finance.

On income from the previous year.

Brackets for 2001 onward.

117. All in all, reforms in 2001-03 have succeeded somewhat in reducing the tax burden. The tax burden is estimated to have declined by 1.2 percentage points of GDP between 2000 and 2003.74 Further modest reductions are envisaged over 2004–06.

D. Reform Options

118. Reducing the absolute and marginal tax burdens is likely to spur growth provided tax cuts are seen as credible, thus accompanied by expenditure reduction. Nonetheless, efficiency gains could be had from altering the overall tax structure, mainly away from labor and toward consumption. Such reforms would be most effective to increase employment and growth if accompanied by overall labor market reforms aimed at reducing institutional rigidities.

119. The previous sections highlighted several stylized facts and issues regarding the French tax system. The overall tax burden is high and in particular weighs heavily on labor. Marginal tax rates on labor are higher than the OECD average, but close to the EU for average wage earners; however, marginal effective tax rates remain high for low- as well as for high-income earners. Capital taxation and corporate taxes are higher or close to the EU average. Revenue from the VAT is not particularly high and has been eroding over time. Finally, local governments levy two atypical taxes yielding low revenues.

120. Against this background, it appears that consideration should be given to tax reforms along the following lines: (i) shifting from labor to consumption taxation; (ii) continuing to selectively reduce taxes on low and high-income earners; (iii) improving the yield and efficiency of the VAT; (iv) reducing corporate taxation; and (v) eliminating low yielding and costly local taxes, to be replaced by more efficient revenue sources. In addition, administrative reforms and simplifications could reduce compliance costs and potentially improve tax revenues while reducing government collection costs.

Rebalancing the tax burden from labor to consumption

121. Rebalancing the tax structure away from taxes on labor and toward taxes on consumption may have the potential to raise the level of output in the medium term. A shift in the tax mix may alleviate pressures on labor costs (to the extent that firms are unable to resist wage pressures associated with taxes on wages) and, thus, increase labor demand, employment, investment and growth. Reducing the marginal labor tax wedge may improve incentives to work and participate in the labor market, eventually increasing labor supply. Finally, taxing consumption may broaden the tax base, since income from other sources than labor (i.e., capital, property, pension benefits and other income transfers) would be taxed through consumption, thus reducing distortions against labor (despite the equivalence, in an inter-temporal setting, between taxing wages and taxing consumption).

122. Switching part of the tax burden from labor to consumption could be implemented by reducing social security contributions while simultaneously increasing the VAT or the CSG in a revenue-neutral way. As noted in Section B, there may be some room for moderate increases in the VAT rate, which currently is not above the average in the EU. The financing of social security could be decoupled from exclusive reliance on wage contributions, and instead would be financed in part by general taxation.75 If a tight budget constraint on social security spending is of order, contributions could be replaced by a fixed number of points of VAT, specifically allocated to social security.76 An alternative would consist in increasing the CSG while lowering regular social security contributions, since the former has a broader taxable base that includes non-wage incomes.

Reforming direct income taxation

123. Continuing to selectively reduce marginal rates of income taxes or social contributions would improve incentives to increase labor supply, especially if the cuts are targeted in favor of low- and high-income earners which have a relatively high income-elasticity in their labor supply. The policy of targeted rebates on social security contributions for low-skilled workers, which may have reduced labor costs for these categories, could be maintained though its cost-effectiveness from a budgetary perspective should be established.

124. The wide difference between marginal and average effective tax rates of the PIT points to the need for a comprehensive overhaul of this tax. As noted earlier, the top marginal rate is as high as 50 percent but the average rate for the top decile is only 12 percent, suggesting a large disincentive effect accompanied by small tax collections. While the authorities have cut PIT rates considerably over the past few years, more could be done to reduce marginal rates while broadening the tax base—which would involve restructuring the tax schedule and reducing deductions. Lowering PIT rates, by reducing the taxation of capital income, would also increase savings incentives.

125. Consideration should be given to integrating the PIT and the CSG into a unified personal income tax. In principle, both taxes share broadly the same income base—although the PIT base is significantly reduced by various deductions and is based on the previous year’s income—and unification would simplify the tax system. The PIT and the CSG could be integrated into a single tax comprising a unified tax schedule, with a proportional base rate and a progressive component, and a unified tax base—preferably the broad base of the CSG. The integrated tax could be based on the current year’s income, and withheld at source. However, because the CSG is currently earmarked to financing social security, its integration with the PIT would require an overhaul of the relations between the government budget and the various social security institutions.

Improving the yield and efficiency of the VAT

126. Streamlining the VAT would greatly reduce distortions, cut compliance costs, and facilitate international trade. The French VAT is not particularly buoyant because of its reduced rates and exemptions. Best practices suggest that the VAT should be used primarily as a financing instrument and not as a means to pursue sectoral or redistributive objectives (Ebrill, Keen, Bodin, and Summers, 2001). The following measures, which would contribute to improving the yield and efficiency of the tax, should be considered:

  • Eliminating the 2.1 percent super-reduced rate;

  • Increasing the 5.5 percent reduced rate to a level closer to the standard rate (19.6 percent) while limiting its scope;

  • Narrowing the extent of exemptions;

  • Increasing the standard 19.6 percent rate, which currently is not above the average in the EU; and

  • A simplification of the cross-border VAT regime, which, however, requires agreement at the EU level.

127. Reduced rates are costly ways to achieve sectoral policy objectives, miss the mark as they are often regressive, and create additional distortions. Alternative policies such as a reduction in labor costs would be much more effective and less costly. Appropriate compensation, in the form of targeted social transfers, could mitigate the impact of the proposed measures on low-income households.

Reducing corporate and capital taxation, and improving its neutrality

128. There is scope for further reducing corporate income tax rates (e.g., from 33 percent to 25-30 percent) to align them with major economic partners and competitors, especially considering the relatively low yield of the CIT (2.8 percent of GDP in 2001). The German tax reform may be instructive in this regard, and may also prompt a review of the French imputation system to achieve greater neutrality with respect to cross-border investment flows (Keen, 2002).

129. Consideration might be given to moving toward a Nordic dual income tax system, so as to improve neutrality with respect to various incomes from capital or corporations. The dual income tax is characterized by a low tax on all capital income accompanied by a progressive tax on labor income, instead of taxing all personal income (from labor and from capital) under a unified tax (and taxing corporate income separately). To the extent that it reduces the taxation of capital income, such reform may improve incentives toward savings and promote growth. It could be considered along with the reform of the PIT mentioned earlier.

Simplifying local taxes

130. Low yielding and costly local taxes should be eliminated—specifically the local business tax and the local housing tax. The resulting revenue loss for subnational government should be compensated by other taxes in a revenue-neutral way (see below). The local business tax, since it is levied independently of actual turnover and profits, may constitute an impediment to entrepreneurship, in particular for small firms and new companies.77 The local housing tax serves no defined purpose and has become somewhat of a nuisance tax, following its gradual erosion by numerous deductions, exemptions, and reductions designed to bring its base closer to taxpayers’ ability-to-pay. Consequently, it would be better integrated with the PIT or with local property taxes.78

131. Subnational governments should be assigned simple and buoyant taxes. There are various options for local taxation, which go beyond the scope of this paper.79 To replace the eliminated local direct taxes, consideration could be given to introducing a low rate but broadly-based local surcharge on personal and corporate income taxes (or a surcharge on the CSG) specifically allocated to local governments. It could be redistributed to local governments according to the origin principle, or according to needs or equalization objectives. Rates could be set by each local government according to its own needs or preferences. Another potential source of local revenues lies in real estate taxation. Developing this source may improve the redistributive characteristics of the tax system, although it would necessitate updating real estate values and harmonizing valuation rules and rates. Finally, a local tax on businesses’ value-added, along the lines of the Italian IRAP, could be considered—although its base, which includes wages, may cause a direct increase in labor costs.80

132. Gains from a reform of local taxation may be substantial in the long run, despite the almost certain short-term political economy costs. There may be large efficiency gains to be reaped from designing local taxes on a sound and economic basis. Moreover, this may improve the transparency and simplicity of the overall tax system—possibly improving economic conditions for businesses—as well as the fiscal accountability of local governments. The political economy cost of a reform of local taxes maybe large, however, given the large number of parties involved and the complexity of the existing financing arrangements among various levels of local governments and with the central government.

Simplifying income taxes and reducing tax administration costs

133. The compliance costs for taxpayers and the tax administration could be reduced significantly by introducing withholding at source for the PIT and by rationalizing tax administration. Introducing generalized withholding of income taxes at source, following the successful model of the CSG, would greatly simplify the collection of direct taxes, reduce costs for taxpayers and for the tax administration, and improve compliance, eventually increasing revenues. Furthermore, the necessity of mandatory filing for all taxpayers under the PIT should be reconsidered. At the very least, systematic advance payment of taxes would reduce the burden of the tax administration in verifying millions of annual declarations. Finally, rationalizing the various administrations dealing with assessment and collection of taxes and social security contributions would entail significant savings for the public sector and for taxpayers.

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47

Prepared by Eric Mottu. Helpful comments (without endorsement) were received from Bcnoit Bohnert, Luc Everaert, Wim Fonteyne, Guy Gilbert, Michael Keen, Henri Lamotte, Herve Le Floc’h-Louboutin, Alessandro Leipold, Sandy MacKenzie, Laurent Menard, Francisco Nadal de Simone, Janet Stotsky, and Howell Zee.

48

According to these authors, reducing the tax wedge in France to that of the United States would increase welfare by 19 percent (in terms of consumption), through an increase in the labor factor and its impact on capital accumulation.

49

Thakur, Keen, Horvath, and Cerra (2003) note that these results may be biased by the emphasis on one side of the government’s budget constraint only.

50

Progressive labor income taxation may also discourage investment in human capital, by taxing the returns more heavily than the deductible implicit costs (reduced wages during education).

51

While the authors admit that their theoretical formulation of consumption taxes is rather simplistic, they verify empirically that consumption taxes did not affect employment and growth in 14 major OECD countries between 1965-95.

52

This is the least favorable simulation, whereby unemployed workers and other transfer recipients would be compensated for the increase in consumer prices. Without such compensation, GDP would rise by close to 0.7 percent. Moreover, a reduction in labor taxation by 1 percent of GDP without compensating increase in other taxes would yield an increase in GDP of 0.8 percent after 10 years.

53

In the case of the United Kingdom, Fund staff estimated that only 11.5 percent of the implicit transfer induced by the zero-rating of food benefited the poorest 20 percent of the population, while 29 percent benefited the 20 percent of highest income earners (IMF, 2002b).

54

Bourguignon and Bureau (1999), Conseil des Impôts (2001). The impact on employment of such VAT cuts is only indirect, via the demand effect of the price reduction for the selected goods and services. In contrast, targeted reductions in social security contributions would have, in addition to the indirect effect, a direct impact on factor prices leading to a substitution from capital into labor, and they would be less costly to the budget. An evaluation of country experiments confirmed these views (European Commission, 2003).

55

The transitional VAT regime for cross-border trade, implemented since the elimination of customs controls between EU countries, is complex and applied non-uniformly across countries (for details, see Joumard, 2002, and Conseil des Impôts, 2001).

56

Finland, Norway, and Sweden.

57

See also Sorensen (1994) and Cnossen (2000). On Finland, see Joumard and Suyker (2002). The main drawback cited against the dual income tax relate to the tax treatment of self-employed, for which it is difficult to distinguish between labor income and the return on capital.

58

In comparing tax burdens across countries, it should be noted that a higher tax burden usually reflects greater public provision of goods and services or larger transfers. In France, state-provided social security services are relatively high.

59

In the OECD classification, the CSG is considered a direct tax on households, not a social security contribution, presumably because its base is broader than only wages.

60

Effective tax rate calculations are subject to methodological differences, which may lead to differing results, ha particular, the definition of effective tax rates is not settled in the literature, and their calculation faces various data limitations and practical problems, such as the difficulty to attribute some tax categories to the labor and capital factors. This paper considers mainly the comprehensive and recent calculations published by the European Commission (2000) and Martinez-Mongay (2000) on one hand, and Carey and Rabesona (2002) from the OECD Secretariat on the other hand. Earlier studies include Mendoza, Razin, and Tesar (1994), Carey and Tchilinguirian (2000), and OECD (2001a).

61

The LETR is the ratio of employers’ and employees’ social security contributions (and other payroll taxes) and personal income taxes on labor income over total labor income, as calculated in European Commission (2000) and Martinez-Mongay (2000).

63

The tax rate on consumption (CITR) is the ratio of indirect taxes over final private and public consumption (excluding government wages).

64

The effective tax rate on capital is the ratio of corporate and property taxes, as well as the share of personal income taxes attributable to capital, over the adjusted gross operating surplus, as calculated in EC (2000) and Martinez-Mongay (2000). Interestingly, the tax burden on capital income is not very different across OECD countries, presumably because of competition over capital taxation resulting from international capital mobility. Similarly, consumption taxes have tended to converge within the EU, probably caused by VAT harmonization efforts (Martinez-Mongay, 2000).

65

Piketty (1999), however, finds a low tax-elasticity of labor supply for very high income earners, although empirical estimates are subject to considerable limitations.

66

Bourguignon and Bureau (1999) found METRs of over 100 percent for households around the minimum wage (SMIC) in 1994.

67

Crcpon and Desplatz (2001) find that the policy of lowering social security contributions for low-earning workers, initiated in 1993, increased employment by 2.6 percent annually in the industrial sector and by 3.4 percent in the tertiary sector, corresponding to about 460,000 jobs created or maintained between 1994-97.

68

France applies an imputation system that avoids double taxation of distributed profits, with a view to reducing the bias against equity financing of corporate investment. In this system, dividend recipients are granted a tax credit corresponding to the corporate tax on distributed profits. This does not, however, ensure full neutrality with respect to cross-border investment flows, since imputation credits are not systematically transferable abroad (OECD, 2001b; Zee, 2002). Moreover, Germany, Italy, and the United Kingdom recently abandoned the imputation system for a reduction in both corporate and personal income tax rates on dividends (Keen, 2002 and 2003).

69

The VAT efficiency ratio is calculated here as the ratio of VAT revenue-to-GDP over the normal VAT rate. It indicates how much 1 point of VAT rate yields as a percentage of 1 point of GDP. A ratio of 100 percent could be interpreted as the VAT fully taxing its GDP base, but could also mean that inefficient tax cascading is increasing the yield of the tax. Since consumption is the base of the VAT, total consumption could be used instead of GDP, but results for France would be similar (see OECD, 2001b).

70

For earlier reforms, see Mahfouz (2000) and OECD (2001c).

71

This deduction results from the combination of a 10 percent lump-sum deduction for employment expenses (deduction forfaitaire) and a 20 percent supplemental deduction (abattemeni).

72

Ministry of Economy and Finance, Economic and Financial Report 2002.

74

Ministry of Economy and Finance, Economic Perspectives 2003-04, March 2003.

75

This would partially sever the link between social security benefits and direct contributions, which may be seen as insurance rather than taxation. However, in a system with pay-as-you-go pension contributions with defined benefits and health care contributions dependant on income, that link is already tenuous as best.

76

The positive impact of rebalancing the tax structure on growth could be reduced in case of full indexation of wages and social benefits to price increases induced by the VAT raises. Considerable indexation mechanisms exist in France, even if they come into play with a lag, in particular for civil servant wages and for pension benefits.

77

The Conseil des Impôts (1997) proposed a complete overhaul of the local business tax, with a view to reducing its burden and transforming it into a national tax to be distributed to municipalities in such a way as to better match local resources and needs, and introduce some equalization.

78

The elimination of the local housing tax was suggested by the Conseil des Impôts (2000), which, for direct taxation of individuals, proposed to focus only on two taxes: the CSG, which is broad-based and proportional, to finance social security; and the PIT, which is progressive.

79

For a survey, see Norregaard (1997).

80

The Italian Imposta regionala sulle activita produttive (IRAP) is a regional tax, collected by the central government, payable by businesses on their sales minus material purchases and depreciation—essentially their value-added or the sum of wages and profits. As with the VAT, the tax is meant to be passed on to consumers. The central rate is currently 4.25 percent, but regions can vary the rate by 1 percentage point in either direction and differentiate by economic sector. Revenue from the IRAP is substantial, at about 2.5 percent of GDP (Keen, 2003).