France: Staff Report for the 2005 Article IV Consultation Supplementary Information
Author: International Monetary Fund
Publication Date:
07 Nov 2005
eISBN:
9781451813678
Language:
English
Keywords:
ISCR; CR; spending; authority; price distortion; scenario; director; structural adjustment; volume terms; spending restraint; Nontax revenue; spending growth; high-case medium-term scenario; Social security contributions; Budget planning and preparation; Health care spending
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This 2005 Article IV Consultation highlights that the cyclical recovery of the French economy was interrupted in the first half of 2005, as previously strong domestic demand faltered and the external sector continued to exert a drag on growth. In 2004, growth was faster and more consumption-driven than in other large euro area countries. Employment growth in hours, increases in minimum wages, and some fiscal measures supported private household incomes. The 2006 draft budget targets a reduction in the general government deficit to 2.9 percent of GDP.

Abstract

This 2005 Article IV Consultation highlights that the cyclical recovery of the French economy was interrupted in the first half of 2005, as previously strong domestic demand faltered and the external sector continued to exert a drag on growth. In 2004, growth was faster and more consumption-driven than in other large euro area countries. Employment growth in hours, increases in minimum wages, and some fiscal measures supported private household incomes. The 2006 draft budget targets a reduction in the general government deficit to 2.9 percent of GDP.

Output and inflation

1. The authorities project growth to rise from 1½–2 percent in 2005 to 2–2½ percent in 2006, largely due to increasing exports. The staff has maintained its projections of the staff report at 1.5 percent and 1.8 percent for 2005 and 2006, respectively. These projections are the same as the October Consensus forecast and, for 2005, of France’s national statistics institute (INSEE) (Table 1).1 Recent data releases are consistent with a modest recovery. Consumers have become slightly more confident, increasing spending on manufactured goods, but stocks remain high. Industrial production appears to be recovering, while services to enterprises show continued growth. Employment has been edging up, which together with stricter enforcement of job search requirements allowed the unemployment rate to fall to just below 10 percent of the labor force. Oil prices boosted headline inflation to 2.4 percent in September. As a result, the staff has increased its projection of average consumer price inflation somewhat in both 2005 and 2006, while lowering the GDP deflator in 2006 in line with the authorities’ projection—reflecting a squeeze on profit margins.

Table 1.

France: Main Economic Indicators, 2001–10

(Annual percentage change; unless otherwise indicated)

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Sources: Banque de France; data provided by the authorities; and IMF staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year's GDP.

Harmonized CPI.

For 2005, year-on-year September.

In percent of labor force; harmonized index.

GDP over total employment.

Personal disposable income deflated by the implicit deflator for private consumption.

In percent of household disposable income.

In percent of potential GDP.

Index; Base 2000=100. For 2005, data available up to August.

In percent of GDP; data for 2001-02 exclude the proceeds from the sale of UMTS licenses, which amount to about 0.1 percent of GDP; data for 2005 exclude the EDF pension fund transfer (0.4 percent of GDP).

2005 Budget

2. The 2005 budget deficit target of 3 percent of GDP is within reach and achieving it would represent structural adjustment of 0.4 percentage point of GDP. The latter is more than was expected in the staff report as revenues have been stronger in relation to income, and credits equivalent to ¼ of one percentage point of GDP have been cancelled. In addition, health care spending growth is being sharply reduced compared to 2004. Income support to mitigate the impact of high oil prices appears well targeted to alleviate social hardship and will have only limited consequences on the 2005 budget and marginal implications for economic efficiency. Fiscal incentives favoring energy conservation and investment in refining have been strengthened.

2006 Budget

3. The draft 2006 budget aims to reduce the deficit marginally to 2.9 percent of GDP, which requires underlying adjustment of 0.5 percentage point of GDP to compensate for the decline in one-off revenues. In addition to relying on growth of 2¼ percent, this is to be accomplished as follows (Text Table 1):

  • On the expenditure side, general government spending is set to grow by not more than 1.6 percent in real terms. Central government spending will remain constant in volume for the fourth year in a row, though this is facilitated by moving some spending to the revenue side as negative items. The number of civil servants will decline by 9,700 (5,300 in terms of full-time equivalents).2 With additional reform measures agreed in 2004 that have yet to come into effect, nominal health care spending growth is targeted to decline from 3 ¾ percent in 2005 to 2½ percent in 2006.3

  • Revenues from taxes and social security contributions will remain stable at about 44 percent of GDP. To promote employment, the earned income tax credit (prime pour l'emploi) is being raised, and temporary incentives for job-taking by welfare recipients and long-term unemployed are being introduced. The exemption of new investment from the taxe professionnelle has been made permanent for the first two years and the amount of the tax capped at 3.5 percent of value added. On the other hand, contributions are being raised to reduce the deficit of the social security system. All revenue windfalls, except those related to higher oil prices, are intended to go to deficit reduction. A national committee has been set up to assess and propose an allocation for any revenue windfalls due to higher oil prices.

  • A tax reform is being implemented, which will have no effect on the 2006 cash budget but will lower revenues in 2007 by about 0.3 percentage point of GDP. It improves efficiency and transparency by reducing the number of income brackets and simplifying the tax rate structure. Statutory marginal tax rates are being lowered, but marginal effective tax rates change little, as rate reductions are largely being paid for by eliminating a 20 percent across-the-board tax exemption.

  • Nontax revenues are maintained at above trend levels in 2006 through dividend payments by state-owned energy utilities, Banque de France, and a savings bank (Caisse des dépôts), and a transfer of pension fund assets of the post office against equivalent future liabilities.

Text Table 1.

France: Impact of New Measures on 2006 Deficit

(In percent of GDP)

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Sources: Projet de loi de finances 2006; and IMF staff calculations.

This includes exemption of taxe professionnelle for new investments, a decrease in the corporate income tax rate, housing subsidies, and deductions on the inheritance tax.

This is due to the wage bill—the tax base for social security contributions—increasing at a more dynamic rate than nominal GDP, and some other dynamic tax bases.

This assumes spending at various levels of government continues to increase at the same rate as in 2005.

Essentially exceptional dividends from state-owned enterprises.

New measures on medicines and medical visits are expected to bring health care spending growth from 3 ¾ percent in 2005 to 2½ percent in 2006.

Medium-term fiscal outlook

4. Over the medium term (2007-09), the authorities intend to pursue expenditure restraint to achieve underlying adjustment, while reducing the tax burden slightly. In the authorities’ low-case medium-term scenario, growth is set to continue at 2¼ percent per year, while real general government spending growth would fall from 1.2 percent in 2007 to 0.6 percent by 2009 (Text Table 2). This will require a decline in real central government spending by 1 percentage point per year during 2007-09 and a durable reduction in nominal health care spending growth to 2.4 percent per year. This scenario would result in a structural adjustment of 1.1 percentage points of GDP over three years. In the staff’s view, taking only explicit measures into account, real general government spending would continue to increase at about 1.4 percent per year. Consequently, the staff projects only a marginal improvement in the structural balance by 2009. The authorities also present a high-case medium-term scenario with higher annual economic growth of 3 percent due to structural reforms and additional spending restraint, mainly at the local level, yielding a further decline in real general government expenditure growth to 0.3 percent. As a result, structural adjustment would reach 2.1 percentage points of GDP over three years.

Text Table 2.

France: 2006 Budget and Medium-Term Fiscal Plans

(In percent of GDP)

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Sources: Projet de loi de finances 2006; and IMF staff calculations.

The medium-term plans correspond to the “lower scenario” in the authorities' draft budget.

Differs from the authorities in 2005 and 2006 because of differences in projected inflation.

Excluding the EDF pension transfer in 2005.

The authorities count on an increase in nontax revenue over 2007-09, which the staff does not incorporate.

Conclusion

5. The execution of the 2005 budget is likely to deliver more fiscal adjustment than anticipated, and fiscal discipline is set to continue, but the 2006 draft budget falls short of staff recommendations. Better revenue performance and additional fiscal measures have brought the 2005 budget deficit target of 3 percent of GDP within reach. For 2006, maintaining central government expenditure constant in volume terms is welcome while ongoing health care reforms will also contribute to spending control. Nonetheless, achieving the modest reduction in the deficit in 2006 relies on higher-than-consensus growth projections, increases in social security contributions, and further nontax revenue measures. Underlying fiscal adjustment, in particular excluding one-offs, is well below ½ of one percentage point of GDP and less than in 2005. The proposed tax reform increases efficiency, though its attendant revenue loss, which will affect the 2007 budget, runs ahead of the identification of specific expenditure cuts. The policy response to high oil prices is welcome, but most of the income support measures will need to be subject to a sunset clause to prevent permanent price distortions.

6. For the medium term, additional structural reforms and a considerable reduction in spending as a share of GDP in line with the authorities’ high-case scenario are needed to deal with the consequences of aging. On current policies, the staff projects the structural balance to remain in a deficit of about 2 percent of GDP over the medium term. Implementation of the authorities’ low-case scenario would still leave the budget in a structural deficit, providing insufficient consolidation to address the costs of aging. Reducing real central government spending and sharply curbing local spending growth as in the authorities’ high-case scenario would eliminate the structural deficit over the medium term, an appropriate response to the challenge of aging. Given the magnitude of the required adjustment, it will be important to identify early on durable expenditure measures to underpin the credibility of this scenario. Among these, greater advantage will need to be taken of the wave of civil servant retirements to realize the desired efficiency gains.4

1

INSEE projects only two quarters ahead and thus has no forecast for 2006.

2

There are about 2.5 million civil servants.

3

Reimbursements of medical consultations that avoid the use of a doctor-gatekeeper (médecin de référence), will be limited, and coverage of copayments by supplementary individual health insurances will also be limited.

4

Current plans foresee a reduction in the number of civil servants equivalent to 15 percent of retirements.

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Cover IMF Staff Country Reports
France: Staff Report for the 2005 Article IV Consultation
Author: International Monetary Fund
Volume/Issue:
Volume 2005: Issue 399
Publisher:
International Monetary Fund
ISBN:
9781451813678
ISSN:
1934-7685
Pages:
62
DOI:
https://doi.org/10.5089/9781451813678.002