France: Selected Issues

The export performance of the French economy relative to its own past and relative to a major trading partner, Germany, has deteriorated. The risk analysis indicates that French firms have seen a significant improvement in the corporate health, and seem resilient to the recent financial shock despite differences across firms. Several issues in the context of common EU tax policy formation, including carbon pricing, control problems associated with the zero-rating of intra-EU supplies, and possible movement toward a common corporate tax base need to be addressed.


The export performance of the French economy relative to its own past and relative to a major trading partner, Germany, has deteriorated. The risk analysis indicates that French firms have seen a significant improvement in the corporate health, and seem resilient to the recent financial shock despite differences across firms. Several issues in the context of common EU tax policy formation, including carbon pricing, control problems associated with the zero-rating of intra-EU supplies, and possible movement toward a common corporate tax base need to be addressed.

III. France: Reviewing The Tax System12

A. Introduction

76. France is now embarked on a wide-ranging review of the tax and social contribution system—therevue generale desprelevements obligatoires (RGPO)—with a view to initiating a program of reform around the end of 2008. There are indeed significant challenges to be faced. At around 45 percent, the tax ratio is such that careful design is needed to avoid costly distortions of economic activity. Moreover, fundamental tax innovations of the kind seen elsewhere in Europe and the wider world over recent years, largely as a response to intensifying economic integration—including dramatically reduced rates of corporation tax, fundamental rethinking of the income tax, and movement to greater tax neutrality—have not as yet been in France. Increased awareness of environmental issues, not least in relation to climate change, raises a further set of challenges—and opportunities.

77. The purpose of this paper is to set out, at this early stage in the review process, broad considerations and options for improving the French tax system drawing on wider international developments to identify key strategic considerations. Section B provides broad background, describing key features of the present system and objectives of reform. Subsequent sections look in turn at key elements of the tax system: business taxation, personal taxation, and indirect taxation. Section F concludes.

B. Context and Objectives of Reform

Tax revenues: level, composition and challenges

78. At 44.5 percent (in 2006), the tax ratio—revenue, relative to GDP—is well above the OECD and EU 15 averages (of 36.2 percent and 38.8 percent, respectively), being exceeded in the OECD by only Belgium, Sweden, and Denmark (Figure III-1). It would remain high even with a reduction to around 40 percent, to which President Sarkozy made a commitment in the 2007 presidential election. Any such reduction would need to be carefully sequenced with expenditure reduction,13 moreover, the current intention being to eliminate by 2012 a fiscal deficit (now 2.4 percent of GDP) that has led to a large build up of public debt (64 percent of GDP). Nor, it should be noted, would tax-cutting in itself greatly reduce the challenges of tax design in France: effective tax rates, and possible inefficiencies, will remain high. And identifying the areas in which any tax reductions would be most constructive is not easy.

Figure III-1.
Figure III-1.

Tax Revenues, 2006

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: OECD Revenue Statistics

79. The most striking feature of the composition of tax revenues is the heavy reliance on social contributions (37 percent of tax revenue, compared to an OECD average of 25.6 percent) and relatively low reliance on personal income taxation (Figure III-2). The latter—which includes not only the personal income tax proper (impdt sur le revenue, the IR) but also, taxes in all but name, the flat rate contribution social generalisee (CSG) and contribution au remboursement de la dette sociale (CRDS)—accounts for 17 percent of tax revenue, compared to an OECD average of 25 percent. The share of VAT in tax revenue is around the OECD average. More suggestive is that that revenue from the corporate tax (impdt sur les societes, IS) is somewhat lower than the OECD average not only as a share of tax revenue, but also relative to GDP—despite a statutory rate that, at 33.33 percent, is not low by international standards. Property taxes account for a relatively high fraction of tax revenue, exceeded among OECD members, relative to GDP, in only Canada and the U.K.

Figure III-2.
Figure III-2.

Tax Structures, 2006

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: OECD Revenue Statistics.

80. An important part of the wider tax-benefit system, is the earned income tax credit (prime pour l’emploi, PPE) introduced in 2002.14 This is a refundable tax credit against the IR for those in employment, which has been increased in generosity over the years to the point at which it is now received by nearly 9 million households: about one in four.

The development of the French tax system

81. There have been many changes to the French tax system over the last two decades or so. Many have been both creative and apparently effective. Measures to reduce social contributions at and just above the minimum wage (the Salaire minimum interprofessionelle de croissance, SMIC) since 2002, for example, are estimated to have increased employment by around 3 percentage points. Similarly, the PPE, while still undergoing improvement (most recently in accelerating payments so as to be available in times of need), has to a large degree succeeded in making employment more attractive. Measures to allow payments of minimum income support (Revenu minimum d’insertion, RMI) and other benefits available to the unemployed to be phased out rather than summarily removed on taking up employment have had similar effect. The simplification of the IR schedule, with a reduction in the top marginal rate and elimination of the abatement for wage income, were also constructive measures. And in terms of administration, the recent decision to merge the Direction general des impdts (DGI), responsible for tax assessment, with the Direction generale de la comptabilite publique (DGCP), responsible for tax collection, should generate significant efficiency gains.

82. However, tax policy changes over the years have in many cases been made on a piecemeal basis, responding to immediate pressures and priorities—and often attempting to offset policy-induced distortions—rather than reflecting a strategic vision of the tax system. Several of the changes introduced in the recent TEPA (Loi du 21 aout 2007 en faveur du travail, de l’emploi et dupouvoir d’achat), are of this kind (Box III-1). It is not clear, for example, how the introduction of a tax credit in relation to purchases of a principal residence, intended to promote owner-occupation, sits with the continued existence of a tax incentive under the IR to invest in property for rent.15 And while the tightening of the bouclier fiscal,seems largely intended to weaken the impact of the annual wealth tax (Impot sur la fortune,ISF), it does so in a way that adds to complexity and opens avoidance opportunities,16 all of which could be avoided by simply reducing the rates and/or raising the various thresholds under the ISF. Exempting overtime pay from IR and social contributions, while signaling the government’s intention to encourage work, may have only limited effects on hours worked and employment (conceivably reducing the latter), but introduce considerable additional complexity for tax administration and firms alike.

83. Piecemeal tax policy-making is not unique to France, of course. One feature that is striking, however, is that the ingenuity of several of the measures discussed above is addressed at circumventing distortions in the labor market created by the relatively high level of the SMIC,17 the 35-hour week, and other labor market restrictions. This is also true of the rebating, starting in the late 1990s, of employers’ social contributions (of 26 percent at the SMIC, phased out by earnings of 1.6 times the SMIC). Assessments of the employment effects of such measures vary, but have generally been positively evaluated—Ministry of Economy, Finance, and Industry (2007a) concludes that around 300,000 jobs have been created, at a direct revenue cost of about €10,000 each. But the remaining scope for such measures is now limited, as will be seen. This brings home increasingly starkly the point that tax policy is not the most effective device for mitigating policy-induced labor market distortions: even if they were to fully offset them, for instance, the benefit would be reduced by the distortions caused by raising the revenue to finance them. The better-targeted policy is to remove or modify the underlying labor market distortions themselves.

Central Elements of the TEPA, 2007

  • A refundable mortgage interest payment tax creditwas introduced, for new mortgages only: up to 40 percent of interest payments—capped at €3,750 for a single person household and €7,500 for a couple—will be deductible in the first year, and 20 percent in the next four.

  • Tightening the ceiling on personal taxes (bouclier fiscal). The ceiling on payments of the IR, ISF, and certain real estate taxes on the primary residence—introduced in 2007—was cut from 60 to 50 percent of income, and the CSG and CRDS added to the capped payments.

  • Elimination of taxes and social charges on overtime: personal taxes (including CSG and CRDS) and employee’s social contributions on overtime earnings are eliminated, with a small absolute reduction in employers’ contributions also provided.

  • Reduction of the inheritance and gift tax, with the exemption per direct descendent tripled and the charge eliminated for transfers to living partners.

  • A credit against the wealth tax of investments in SMEsof up to 75 percent of the investment, to a limit of €50,000.

Objectives for tax reform

84. The general aim set for the RGPO is to improve the simplicity, stability, and predictability of the tax system.18 These concerns speak directly to the need to break with the piecemeal policy-making just described, which has indeed resulted in a highly complex system. They point, moreover, to the importance of developing a strategic vision to guide the many and quite fundamental tax policy choices that will continue to arise in coming years—and a clear view of what the tax system can, and cannot, be expected to achieve.

85. Such a vision requires, not least, recognizing the challenges from intensifying globalization: meaning, in particular, increased mobility of tax bases, and likely to be especially marked in relation to capital income. This implies that the effective burden of taxation will tend to fall on less mobile factors—in which case efficiency calls for taxing them directly. Taxes on corporate income, for example, may be shifted onto immobile labor, as companies move abroad in search of higher after-tax returns, leading to a reduction in domestic labor productivity (Hassett and Mathur, 2006). It is then better to tax such labor income directly, so as to avoid distorting capital-labor ratios. The key issue is then to identify what are likely to be the most immobile bases, the natural candidates being relatively low-and, perhaps especially, high-skilled labor, consumption, and property that has location specific attractions not found elsewhere. The distributional implications of this may be unwelcome, but maintaining a high overall tax ratio inescapably means a high burden on such bases—and the problem is then how to do so in ways that are least distorting, and fairest.

C. Business Taxation

86. A wide range of taxes are formally incident on businesses, but pressures for reform are most evident for two: the corporation tax and the taxe professionelle.

Impot sur les Sociétés (IS)

87. The corporation tax has been the subject of substantial (and continuing) reform both in Europe and more widely. The most dramatic aspect has been a reduction of headline statutory rates—the OECD average falling from 41 percent in 1986 to around 27 percent now—but there has also, and perhaps ultimately more fundamentally, been significant experimentation in the structure of the tax. In France, however, although the statutory rate has also fallen (most recently with the elimination of the 3 percent surcharge in 2006) the IS has not changed as fundamentally as elsewhere.

88. The impact of any corporate tax depends not just on the statutory rate but also on the base: in particular, the generosity of depreciation allowances and the treatment of financial costs. Box III-2 describes how key aspects of the corporate tax are conventionally summarized by supplementing the headline rate with measures of marginal and average effective tax rates (METR, AETR), capturing respectively the likely impacts on the level and cross-country location of investment. Table III-1 reports estimates of all three rates, the final column reporting estimates of the implicit corporate tax base (in percent of GDP), calculated by dividing revenue from the corporation tax by its (highest, marginal) statutory rate: this is a crude estimate of revenue productivity, giving the additional revenue that would be raised—assuming unchanged behavior—by a one-point increase in the statutory rate.

Analyzing Corporate Taxes

  • The statutory rate of corporation tax directly affects firm’s decisions regarding income shifting, meaning the use of devices other than real investment—transfer pricing, financial arrangements, and so on—to shift taxable receipts from countries in which the statutory rate is high to those in which it is low, and deductible expenses in the opposite direction.

  • Decisions on the level of investment in a given country depend on the marginal effective tax rate, which is a summary measure of how the statutory rate and tax allowances together affect the before-tax return that a firm must earn in order to provide investors with the after-tax return they require. If the METR is zero, for example, then the tax system has no effect on the marginal decision to invest even though it may will collect revenue by taxing the return on infra-marginal investments.

  • The choice as to the country in which to locate a given discrete investment—a factory, for example—depends on comparing the average effective marginal tax rate in each, this reflecting the present value of taxes to be paid—including on infra-marginal profits—over the life of the project. In practice, the AETR—which is a weighted average of the statutory rate and METR (Devereux and Griffith, 2003)—often tracks the statutory tax rate quite closely.

89. The most striking feature of the French corporate tax by current international standards is that the statutory rate is relatively high (Figure III-3 and Table III-1)—indeed with the reduction in Germany from the start of 2008 to an average of just under 30 percent (inclusive of the lower-level trade tax) France now has the second highest rate in the EU. It is (slightly) exceeded only by Belgium, which (see below) operates a quite different type of corporate tax, and is far higher than in the 12 new members (their average rate now being less than 20 percent). The METR and AETR do not appear so out of line, at least with the older members. This reflects what now seem to be fairly generous depreciation allowances, particularly in relation to plant and machinery (though this is an area in which the diversity of country practice makes simple comparisons difficult). More generally, the final column of Table III-1 suggests the implicit corporate tax base in France to be relatively low: while more than suggestive (reflecting, for instance, non–tax related cross-country differences in the size of the corporate sector), the implicit base has the merit of reflecting all base-reducing measures, whereas the more stylized effective tax rate calculations reflect only such generalized features as depreciation allowances.

Figure III-3.
Figure III-3.

Statutory Corporate Tax Rates, 2007

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: OECD1/ Germany reduced its tax rate to 30 percent in 2008
Table III-1.

Corporate tax rates, selected countries, 2006

(In percent)

article image
Sources: OECD Revenue Statistics, Institute for Fiscal Studies, Marini (2007)

2007, including lower-level taxes, from Marini (2007) and OECD Revenue Statistics.

Equity financed, investment in plant and machinery, rent at 10 percent.

Ratio of corporate tax revenues to top corporate tax rate.

Subsequent adoption of ACE will have reduced METR to zero.

Reform of 2007 reduced METR on equity and raised it on debt.

Statutory rate excludes the IRAP.

90. The central concern raised by these comparisons is the risk of profit-shifting from a statutory rate from France to countries offering a lower rate.19 The consequent prospect of a significant reduction in the statutory rate raises several questions.

91. One is whether a rate reduction in France is likely to trigger further reductions elsewhere, diluting any benefit derived. It seems likely that tax competition is now so pervasive that France alone can have little impact on the final outcome. But in determining an appropriate IS rate it is important to recognize that higher tax rates are more appropriate for larger countries than for small: the small domestic tax bases of the latter mean they stand to lose relatively little from cutting tax rates, but to gain a lot from inducing inward movement of tax bases from abroad. There is thus good reason to suppose that the IS rate in France should remain towards the upper end of those in industrialized countries.

92. A second question is whether any such reduction should be achieved in one-step or phased. The disadvantage of a substantial one-step adjustment is that it effectively imposes a windfall loss on the government: less revenue is collected from investments that have already occurred.20 Against this is the possibility that a phased reduction will send a weaker and perhaps less credible signal to investors of the intention to provide a more supportive tax regime. It may be, however, that signaling concerns need not be as prominent in France as they have been in the reforming countries of Eastern Europe.

93. A third and critical issue is whether the revenue cost of reducing the rate of the corporate tax can appropriately be recovered, to some degree, by expanding the base. Most rate-reducing corporate tax reforms in the OECD have indeed been accompanied by some base-broadening (particularly through scaling-back depreciation allowances). And revenues have generally held up or even increased (Devereux, Griffiths, and Klemm, 2002), though how far this reflects base-broadening rather than other developments—including an increased GDP-share of profits (especially of the financial sector), perhaps for reasons unrelated to tax reform21—remains unclear. The figures above do suggest, in any event, that the base in France has become relatively narrow. Beyond less generous depreciation, other candidates for base-broadening are the various special allowances and tax holidays, such as the holidays (and subsequent reduced rates) for investments in competitiveness centers, urban free zones, and new enterprises meeting R&D criteria. Being unrelated to either investment or employment, such measures are not well-targeted to what are presumably the underlying objectives, create avoidance opportunities—and are a particularly ineffective way of helping new companies, which are particularly unlikely to have positive taxable profits.22

94. The rationale and effectiveness of the reduced IS rate of 15 percent for SMEs—relatively generous by international standards—are also questionable. While such preferential treatment is common (though not universal—Australia, Austria, and New Zealand, for example, apply the same rate to all corporations), the weakness of their rationale is increasingly recognized (see International Tax Dialogue (2005)): the U.K., for example, recently raised the small business rate while lowering the general rate. Preferentially low rates for SMEs introduce their own distortions—even, perversely, discouraging firm growth23—and are unlikely to be the most effective way of alleviating credit market imperfections particularly affecting smaller firms. Indeed the access of SMEs to bank finance in France compares favorably to that in other EU countries (Gabrielli, 2007). That only around 60 percent of eligible enterprises derive any benefit suggests that the measure is not especially well-targeted. More generally, the wide array of measures favoring SMEs, including other tax breaks such as that introduced in the TEPA (which EU rules means apply to SMEs anywhere in the EU, not just in France) as well as non-tax measures, seems to merit review and simplification.

95. Fourth, the question arises as to whether more fundamental reform of the structure of the corporate tax is appropriate. The last few years have seen substantial experimentation in this area, focused on eliminating the bias towards debt finance that is implied by the deductibility of interest costs but not of the return to shareholders—a bias that is evident from the negative METRs for debt finance in Table III-1, and is exacerbated by financial innovation in constructing instruments that have many of the properties of equity but are treated as debt for tax purposes (Auerbach, 2006). There are broadly two ways of doing this. One is by curtailing interest deductibility—moving towards a comprehensive business income tax (CBIT), as has been done in Denmark and Germany.24 The other is by providing more generous treatment for equity costs: as Estonia has done by eliminating corporate tax on undistributed profits, and as can also be achieved by allowing a tax deduction for an imputed cost of equity finance—an allowance for corporate equity (ACE). The latter route has been adopted in Belgium since 2006, to some degree in Brazil and (formerly) Italy and Croatia. Both approaches substantially level the playing field across sources of finance. A key difference is that the base is wider under the German approach, so that the revenue- neutral statutory rate is correspondingly lower—and hence pressure from profit-shifting likely to be less. The ACE approach, while it appears to have worked well in Croatia (see Keen and King (2002), and Klemm (2007) for a broader review of the ACE experience) has also proved potentially vulnerable to avoidance devices (Quaghebeur, 2007). Against this, however, a reform along German lines would tend to increase METR for equity finance (Klemm and Danninger, 2006) whereas movement to an ACE would them 25 There may be no immediate need for fundamental structural corporate tax reform in France—just as there may be no immediate need for a substantial rate cut—but in shaping the medium-term prospects for the IS it will be important to recognize that the challenges go far beyond those concerning the headline rate, and to learn from the experiences of innovations elsewhere in Europe.

Taxe professionelle (TP)

96. The taxe professionelle is a cumbersome charge on assets in business use. Revenue and rate-setting powers are allocated (within bounds) to regions, departments and communes; and the tax has been eroded by exemptions (covering around 25 percent of businesses), the cost of which is covered by central government (so distorting tax-setting incentives at lower level and eroding the local accountability that is a key reason for giving tax-setting powers to lower-level governments (Jamet, 2007b). The TP has been subject to many changes (most recently an exemption for new investment), and its future long debated. A lasting solution to these difficulties is likely to be found only in a broad review of the architecture of fiscal relations between levels of government, including the desirability of the increasing importance over recent years of vertical transfers from the center. There may, in particular, be quite different types of lower-level finance that would be less distortionary and simpler, such as an add-on to the IR or CSG. Many countries do, however, find a charge on businesses that is related not to profitability but to some broad measures of activity appealing, as a rough form of user charge for locally-provided services.

97. In that respect a strong case can be made—as the Conseil des impostdid as far back as 1989—for converting the TP into a tax on value added; not on the invoice-credit and destination-basis of the TVA, but an accounts- and origin-basis. Such a tax (the imposta regionala sulle attivita produttive, IRAP) has operated, with success, in Italy, the regions being allowed to vary the rate (and to some degree the base) within centrally specified limits: see for instance Keen (2003). Recent decisions have confirmed the consistency of the IRAP with EU law. Moreover, the TP is already largely of this form: around 45 percent of payments are by firms for which the constraint that payments not exceed 3.5–4.0 percent of value added (depending on turnover) bites. Explicit movement in this direction—which would need to be accompanied by some adjustment in vertical transfers—offers scope for both simplification and improved coherence. There appears, however, to have been strong resistance to the idea of an IRAP, largely because of a reluctance to impose additional taxes on labor. But EU rules (precluding local sales taxes), the difficulties of taxing capital income, and the already-heavy use of property taxes, leave few options.

D. Taxes and Charges on Personal Income

98. The treatment of personal income in France has several distinctive features. One is the limited scope and revenue yield of the IR itself, the IR: paid by only about half of all taxpayers, it raises only about 6.5 percent of all tax revenue (almost three-quarters paid by just 10 percent of taxpayers). While the IR is thus quite progressive, in the sense that payments are concentrated largely amongst the better-off, its limited yield means that the equalizing effect on the distribution of after-tax income is relatively modest. Also notable features of the IR are the use of mandatory joint taxation and the absence of mandatory withholding: in the OECD, the former is now found only in Greece and Luxembourg, and the latter only in Switzerland. Largely offsetting the relative weakness of the IR are the broad reaching and flat rate CSG (at 7.5 percent for wage income, 8.2 percent for capital income and 6.6 percent for pensions) and CRDS (at 0.5 percent). Withheld at source, with payments (earmarked to finance social benefits but carrying no benefit entitlement, making them—as noted earlier—effectively taxes), these raise almost twice as much as the IR. Less distinctive, but critical to the overall structure of the system, is the PPE, a refundable credit against the IR (paid on earnings at marginal rates, for full-time workers, of 14.2 percent and then 7.7 percent before being withdrawn beyond the SMIC level; and equivalent in amount, at the SMIC, to working a thirteenth month).

99. Interest income is fully taxable under the IR, but with an option for final withholding at a flat rate of 27 percent (16 percent for the IR, plus CSG, CRDS and prélèvement socialsumming to 11 percent). Exemptions are available for livret A accounts and longer-term equity and pension savings. Personal capital gains above threshold, and other than from principal residences (which are exempt), are also typically subject to a flat 29 percent. Since removal of the avoir fiscal, under which credit was given for underlying corporation tax, only 60 percent of dividends are included in taxable income (with, in addition, a modest tax credit), but with an option for taxation at a flat 29 percent.


100. The relatively high social contribution rates, in particular, imply marginal tax wedges—the gap between the gross cost to the employer of increasing the wage and the amount received by the worker—that are also relatively high, being somewhat above OECD average: Figure III-4.

Figure III-4.
Figure III-4.

Marginal rate of income tax including social contributions 1/

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: OECD1/ For single worker in manufacturing sector earning gross wage.

101. The likely employment impact of such tax wedges depends on the nature of wage bargaining, being least if it is either fully centralized (so that their effects are fully recognized in the bargaining) or fully decentralized (so that the labor market clears at any tax rate). While France is generally reckoned to occupy an intermediate position in this respect, pointing to stronger effects than elsewhere, it seems likely that a general reduction in income tax or social contribution rates would need to be quite large—and hence costly in revenue terms—to have any very marked impact on employment (see, for example, Nickell, 2006).

102. Stronger employment effects might be realized from cuts targeted on the lower paid. This though is an area in which France has already shown considerable ingenuity and achieved much, with the substantial reduction in employers’ social contributions at lower incomes and operation of the PPE. One consequence is relatively high marginal effective tax rates as earnings rise above the SMIC (reflecting withdrawal of the PPE, rebates to employer’s social contributions, and other benefits): Figure III-5. To some degree this is inevitable, in that moderate support for those in work requires relatively high marginal tax rates somewhere in the lower part of the distribution in order to limit the revenue cost. Revenue needs permitting, it would in principle be possible to go further than at present either by eliminating some remaining contributions (discussed further below), eliminating other contributions up to a somewhat higher income level, or introducing a wage subsidy. Minimizing distortions points to smoothing the increase in the marginal effective rate by taking the second of these options; but just as the relative thickness of the income distribution where the marginal effective peaks suggests that these distortions may be a significant concern, so it indicates that the revenue cost of such a restructuring is likely to be relatively high. Ultimately, tax policy instruments are inherently an expensive way of dealing with the labor market distortions created by the SMIC, best addressed by letting it fall in real terms.

Figure III-5.
Figure III-5.

Effective Marginal Tax rate, 2004

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: Ministry of Finance.1/ One-earner housholds with two children.

103. Much has also been done to improve the attractions of work relative to inactivity, largely by the extension in 1998 of the period for which unemployment benefit and the RMI can continue to be enjoyed after returning to work. This is another relatively expensive device—compared to reducing the real value of out-of-work benefits—but one for which there has apparently been a social consensus. Experiments are underway towards combining the PPE and a series of benefits, including for housing and single parents, into an integrated income-related schedule, the revenu de solidarite active (RSA). Given the potential usefulness of providing some benefits in kind rather than cash—easing incentive constraints insofar as these benefits are more valuable to those with genuinely low earning ability—full income-relation may not be entirely desirable. Nevertheless, these experiments offer the prospect of further simplification and more complete assurance of marginal effective tax rates on entering employment of under 100 percent—and are a potentially important example of the careful project evaluation enabled by a constitutional reform in 2003.

Base-broadening and simplification

104. Recent years have seen significant reduction in the number (from seven to five) and, more important, the rates of the IR: the top marginal rate has been reduced from 48.1 to 40 percent, now being broadly in line with those elsewhere in Western and Northern Europe (though far above the flat rates of Eastern Europe). This has been facilitated by some base- broadening (notably the elimination of the 20 percent abatement for earned income). There remain, however, a range of exemptions and deductions under the IR (most of which noticeably do not apply under the CSG) whose elimination could enable further rate reduction—likely to be especially appropriate if the IS rate is lowered, in order to limit tax biases towards incorporation—and significant simplification. These include not only a relatively high threshold, but such special treatments as the tax credits for salaries of domestic staff, investments in improved energy efficiency (there being no obvious reason why these should be restricted to those with high enough incomes to pay the IR), and investments in residential properties for letting. For the longer term, the new mortgage interest credit also merits reconsideration: not only does it sit uneasily with the incentive for letting, but the benefits are likely to be largely capitalized in house prices and so simply convey a benefit to existing owners. Experience elsewhere suggests that the increase in home ownership—presumably a key objective of the reform—could be modest: Glaeser and Shapiro (2002), for instance, find this to have been the case in the U.S. Removing this tax break can be difficult (because it means windfall capital losses for homeowners), though France did succeed in removing a similar measure in 1995. It would seem prudent, at the least, to keep the upper limits fixed in nominal terms and so allow the benefit to erode over time, as was done, for example, in the U.K.

105. The distinctive quotient system for family taxation26 has potentially powerful efficiency and distributional effects. It creates a tax incentive to marriage—though at lower incomes the family nature of the PPE acts in the opposite direction (Legendre and Thibault, 2007)—and is parameterized so as to provide strongly favorable treatment of children. Joint taxation also implies high marginal tax rates on secondary earners entering work (because they have no allowance to set against that income): O’Donoghue and Sutherland (1999) show, for example, that moving the U.K. population from a largely independent system to one akin to the French would have increased the average marginal tax rate on wives by about 4 points, and reduced that on husbands by somewhat less. And the Irish experience, at least, suggests that the impact on labor supply could be noticeable (Callan, van Soest, and Walsh, 2007). Concern with these effects has led almost all other countries towards independent taxation: the Czech Republic, for example, recently returned to independent taxation after a brief experiment with joint. These effects may be muted in France by the relatively limited scope of the IR—certainly female participation rates do not appear especially low relative to male (though both are low overall). But that also means that the benefits are concentrated among the better-off, reducing the progressivity of the overall tax system. Further limiting the effect is an explicit cap on the benefit of the quotient system to families with children; though this is a source of significant complexity.27

106. There are no simple rules on how best to tax members of a family,28 and some degree of joint treatment is widely recognized as proper for the PPE (so as to avoid subsidizing partners of high income individuals). But moving away from the strongly constraining structure of current quotient arrangements, building on the existing family allowance system, could provide both some simplification and more effectively-targeted child support.

Withholding and integration of the CGS and IR

107. With both the IR and the CSG/CRDS serving as taxes on personal income, some simplification could be achieved by integrating the two into a single charge, with the further benefit of extending to the IR employer withholding on wage income. There is some risk in doing so, however, that political pressures will undermine the integrity of the CSG—one of the main strengths of the French tax system—by extending to it the range of allowances and exemptions available under the IR. The inclusion of the CSG in the bouclier fiscal, introduced in the TEPA, is perhaps a warning of the potential risk to the CSG.

108. Extending mandatory wage withholding to the IR does not, in any event, require combining the two sets of charges (though there would be evident advantages in integrating their administration). The potential advantages of withholding are substantial. It would reduce taxpayers’ compliance costs (potentially eliminating the need, depending on the form of withholding and the rate structure of the IR, for many to file returns), reduce the authorities’ costs of administration (by enabling them to focus monitoring on withholders, far fewer in number than recipients), and could be expected also to improve compliance. It is hard to gauge the potential revenue gain (which will be mitigated in that some taxpayers already opt for withholding). Experience from the introduction of withholding in the U.S. states, with a long-run gain of around 22 percent of revenue (Dusek, 2002)—this in addition to the one-off timing effect, and at unchanged tax rates—suggests that it could be noticeable. Plans for mandatory withholding have indeed long been mooted in France, one outstanding issue being how to deal with the transition: with taxes currently paid in the year following that in which they arise, but concurrently under withholding, moving from the former to the latter can imply paying two years’ taxes—and consequent liquidity problems—in the first year. Almost all countries, however, have found ways around this difficulty: Box III-3. The adoption of withholding is perhaps best delayed until the merger of the DGI and DGCP is complete, but preparing for it should be a core element of this structural redesign.

Moving to Withholding

There are broadly two ways in which the impact on taxpayers of moving to withholding can be reduced (both, by the same token, reducing the increased present value of tax revenue otherwise resulting from the acceleration of payments):

  • Liability over some period can be waived: Denmark, for instance, forgave taxes for the six months prior to the introduction of withholding in 1967. If pre-announced, such a ‘holiday’ can have beneficial incentive effects—marginal tax rates in that period are zero—but also creates opportunities for avoidance by, shifting income into the tax-free period.

  • Payment periods in respect of liabilities arising before the introduction of withholding may be lengthened. This was the approach taken in Australia at the introduction of withholding in 2000, for example, payments being spread over 5-6 years.

To assure horizontal equity, the ‘holiday’ approach would need in France also to apply to those who already opt for withholding. Extended payment may offer a better compromise between safeguarding revenue and minimizing disruption to taxpayers.

Taxation of capital income

109. The tax treatment of personal income in France is far from the textbook notion of a progressive individual-based tax on a comprehensively-defined income. Instead, the present architecture is in many respects similar to a dual income tax (DIT) of the kind found in Nordic countries: it combines a relatively low flat tax uniform across all forms of capital income with a progressive tax on labor income (operating at lower levels through the PPE, and marked also at higher levels). And the level of that flat tax rate, around 29 percent, is broadly the same as in the Nordic countries. Such a system has much to recommend it, given the difficulty of taxing increasingly mobile capital income at marginal rates close to those at which it is typically desired to tax labor income. Movement to a full DIT would require significant change in the treatment of individual entrepreneurs and close companies (more able than most to shift reported income between capital and labor): some form of mandatory income splitting would likely be required, and not easy to implement. Even without going so far, however, systematic adoption of uniform flat rate taxation of financial capital income could enable simplification, reduced inefficiencies, and provide a coherent framework for dealing with pressures from globalization.

110. A full assessment of capital income taxation would require addressing a wide range of issues, including wider objectives in the tax treatment of savings. With interest and personal capital gains already largely taxed at the same flat rate, the most substantial change in moving closer to a DIT would be shifting to mandatory taxation of dividends at the same flat rate. At current rates, the flat rate option for dividend taxation is generally attractive only to those in the highest IR bracket (and not subject to the bouclier). While mandatory flat taxation mandatory would reduce the marginal rate currently faced by such taxpayers, the more marked effect would be to raise that faced by those on lower incomes; but it is not clear why, as now, they should be encouraged to hold equity rather than debt (and, if desired, they could be protected by exempting some small amount of dividend receipts). Perhaps no less important than the change in dividend taxation, however, is the need to review the preferential treatment of housing investment, which is likely to prove of doubtful merit.

E. Indirect Taxation

111. This section considers two central issues of indirect tax design in France: the structure of the VAT, and a strengthening of environmental taxes.

The value added tax

112. A mainstay of the wider tax system, the VAT raises around 16 percent of all tax revenue. It is marked by a standard rate which, at 19.6 percent, is somewhat above the OECD average (17.6 percent in 2006,Figure III-6). Still more striking is the extensive rate differentiation. As noted in Ministry of Economy, Finance, and Industry (2007b), France makes quite full use of the possibilities for reduced rates within EU rules, with rates of 5.5 percent (including for most foodstuffs, public transport, social housing, housing renovation) and 2.1 percent (on, for example, reimbursable medication, books and newspapers). A consequence of this is that the VAT has relatively low productivity: C-efficiency—VAT revenue divided by the product of consumption and the standard rate (which would be 100 percent if the standard rate applied to all consumption)—is well below the OECD average (Figure III-6).

Figure III-6.
Figure III-6.

VAT Standard Rate and C-Efficiency,

Citation: IMF Staff Country Reports 2008, 074; 10.5089/9781451813708.002.A003

Source: OECD

113. This low C-efficiency suggests significant benefits from moving to a more uniform rate structure. Achieving the same C-efficiency as New Zealand—widely regarded as having one of the best-designed VATs—would enable the same revenue to be raised with a single rate of around 8 percent. Even moving to the OECD average would allow the standard rate to be cut by nearly 3 points. Unification would have the further benefit of reducing compliance costs of taxpayers and administration costs of the authorities, including through a lesser likelihood of refunds being due and less need to deal with borderlines (chocolate bars being taxed differently depending on whether they contain nuts, for example).

114. Against this, two benefits might be claimed for the present rate differentiation. One is that it mitigates the distributional impact of the VAT, to the extent that lower rates are applied to items consumed disproportionately by those with lower-incomes. That is indeed the case (Besson, 2007), though the effect will be less marked if assessed relative to aggregate consumption rather than current income (the former arguably being a better indicator of lifetime well-being, correcting to some degree for simple variation of income over the life-cycle). The critical point, however, is that rate differentiation is likely to be a poorly-targeted way of pursuing distributional objectives: even if the less well-off spend a larger proportion of their budget on, for example, food, it is likely that the better-off spend a larger absolute amount and so derive the greater part of the subsidy implicit in a reduced tax rate. Better instruments—the PPE, for instance—are available to achieve equity objectives. A second reason given for rate differentiation is to encourage employment, by setting low rates on labor-intensive commodities (under the terms of an experiment currently approved within the EU until 2010). Views differ on the likely effectiveness of such measures: Commission of the European Communities (2003), for example, is skeptical, estimating the cost of each job created by such measures in France to be at least €60,000. There seems, in any event, little reason to direct labor into these particular occupations: once again, tax policy is being asked to serve a role for which it is not well-suited.

115. There is thus a strong case for moving towards a more uniform rate structure—and a notable feature of the most recently-introduced and modern VATs is a tendency to charge a single rate (International Tax Dialogue, 2005). This might be done initially by moving selected items from the lower taxed categories to the standard rate (or, subject to EU approval, a new but higher intermediate rate), paving the way for a reduction in the standard rate, without any risk to—indeed possibly increasing—overall VAT revenue.29

116. There has also been much discussion of the possibility of a TVA sociale, meaning increasing VAT revenue in order to finance a cut in social contributions. The emerging consensus appears to be that the employment effects of this are likely to be limited by adjustments in transfer payments and wages to reflect increased consumer prices—the former reducing the amount available to reduce employers’ wage costs, the latter tending to counteract the direct reduction in those costs—and, moreover, are likely to be modest unless the contribution reductions are focused on the lower-paid. Ministry of Economy, Finance, and Industry (2007), for example, estimates that a 1.5 percent increase in the standard VAT rate would enable employment to be increased by 300,000 if the reduction in labor costs is focused at the SMIC, but only 30,000 if applied generally. The extent of previous reductions in employers’ social contributions is such that it is now difficult to further reduce labor costs at the SMIC without providing a wage subsidy,30 which would raise its own practical difficulties (Besson, 2007), though a further strengthening of the PPE might have similar effects. The alternative is to lengthen the earnings interval over which the near-complete elimination of social contributions applies.

117. It is important to recognize that there is a strong case for reform of the VAT irrespective of any potential link with employment creation. The arguments above suggest substantial scope for gain even from revenue-neutral reform of the VAT, and there may well be other beneficial uses to be made from any increase in VAT revenue—best achieved not by raising the standard rate (which could, for instance, increase evasion and informality) but by unifying the rates at a moderate level—such as reducing the rate of the IS or (as suggested by Cette (2007)) the TP.

Environmental taxation

118. The mandate for the RGPO includes a welcome emphasis on environmental taxation—an area in which France has been less aggressive than others (with revenue yield somewhat below the EU average: see for instance Marini (2007))—with a particular stress on dealing with climate change. This will require attention to the excises on fuel, including the continued preferential treatment of diesel: environmental considerations continue to suggest that diesel should bear a higher charge.31 Allocating revenue from the taxe interieure sur les produits petroliers, TIPP) to lower-level governments while retaining rate-setting powers at the center also merits reconsideration: since the state then takes the political pain of increasing excises but obtains no direct benefit, it may create a downward bias in tax rates (which, through lower-level tax competition, would likely be exacerbated if, as some have suggested, rate-setting powers were also decentralized).

119. Carbon pricing developments will be shaped in the wider context of negotiations towards a successor to the Kyoto protocol and improvement of the Emissions Trading System of the European Union. Eventual movement to full auctioning of rights has significant potential for the public finances of France, as for other EU members. One more immediate issue is the possibility of reducing the impact of more forceful carbon pricing on international competitiveness, and the risk that emissions will simply shift elsewhere, by adopting some form of border tax adjustment (BTA): remitting domestic carbon prices on exports and imposing countervailing tariffs on imports. This can indeed be to the advantage of those imposing carbon pricing, supporting a policy of uniform taxation and so avoiding the distortions that might otherwise arise from more favorable treatment of energy-intensive sectors. Moreover, BTA may be one of the few credible devices for encouraging non- participating countries to adopt some degree of carbon pricing. Against this, the WTO-consistency of such measures remains unclear (OECD, 2006)—the risk of implicit protection is clear—and the practical challenges of implementation are considerable: what credit should be given for carbon prices implicit in permits that were given away free, for example? The BTA issue is a difficult one—and likely to come increasingly to the fore as climate negotiations intensify over the coming months.

F. Concluding Remarks

120. A full review of the tax system would need to address many design issues not considered here. One is the proper role and nature of the annual wealth tax, which relatively few countries still impose (Sweden, for instance, having recently abolished it). Another is the possibility of basing property taxes more closely on current market values. Several issues will need to be addressed in the context of common EU tax policy formation, including carbon pricing, the control problems associated with the zero-rating of intra-EU supplies (which the increase in refund claims reported in Marini (2007) suggest may be of increasing importance in France) and possible movement towards a common corporate tax base.

121. Nevertheless, several core strategic design challenges are evident, and summarized in Box III-4. More important than the specific points there, however, is the importance of taking the opportunity that the RGPO offers to move away from the long-established tendency in France to piecemeal tax policy-making, and to establish a coherent structure well-attuned to the likely challenges of the coming years.

Strategic Issues for the RGPO

  • Key issues for the corporation tax are:

    • Responding to pressures to reduce the statutory rate—perhaps phasing this in order to limit the windfall revenue loss, and further cushioning the revenue impact (as well as eliminating distortions and avoidance opportunities) by scaling back tax holidays and other special treatments, including for SMEs.

    • Whether, and if so how, to follow others in reducing the tax bias to debt finance.

  • The personal income tax offers scope for considerable simplification, and possible further rate reduction, by reviewing allowances, perhaps moving towards independent taxation, and achieving greater neutrality in the taxation of different forms of capital income—particularly in relation to housing.

  • The value added tax is currently not well-designed to do what it does best—raise revenue. Improving its effectiveness requires less rate differentiation, not more.

  • The debate on the TVA sociale stresses that tax policy measures to reduce labor costs are ultimately not the best response to policy-induced labor market distortions.

  • While there is a strong case for replacing the taxe professionelle by an IRAP-type tax on value added, a lasting solution is likely to be found only in a wider review of fiscal federal relations, touching such issues as the allocation of revenue from the TIPP.


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Prepared by Michael Keen and Rodolfo Luzio.


Public spending is also currently the subject of a broad review, the Révision Générale des Politique Publiques (RGPP).


PPE credits that do not eliminate liability are reported as reductions in IR revenue; payments to households are reported as expenditure.


In similar spirit, Leibfritz and O’Brien (2005) give the example of a tax credit for consumption loans being given in 2004 at the same time as substantial tax incentives for saving.


By, for instance, creating a potential incentive to induce more variability in income receipts, so as to engineer years in which the bouclier can be used.


France has the highest minimum-to-median relative wage in the OECD (Jamet, 2007a).


The use in France of a territorial rather than worldwide system potentially amplifies exposure to such risk, in that tax on active foreign income is not merely deferred but escaped.


A pre-announced reduction in the statutory tax rate may also cause a temporary increase in investment, as this is brought forward to take depreciation and other allowances at the higher rate. The desirability or otherwise of this will naturally depend on the cyclical position


Other possibilities include tax-induced shifting of activity into the corporate sector (De Mooij and Nicodeme, 2006), growth of the financial sector (Devereux, Griffiths, and Klemm, 2004) and, given imperfect loss offset provisions, increased volatility of corporate profits (Auerbach, 2006).


The need for R&D treatment as generous as at present—a tax credit for 30 percent of all spending up to a ceiling and 5 percent on the excess—is also questionable. While there is evidence that tax breaks can increase measured R&D (Bloom, Griffith, and van Reenen, 2002), it is not clear how much of this generates public rather than private benefit. And while these provisions may serve to attract especially mobile international investments, a reduction in the general IS rate would reduce the need for such measures. Nevertheless, stability argues against immediate change to a regime that was reformed and substantially simplified in 2007.


Eligibility ceases once turnover exceeds €7.63 million, implying a large jump in tax liability at that point€ and hence a potential incentive to remain below it.


In Germany, for instance, deductible interest is now limited (above some minimum amount) to 30 percent of taxable earnings before interest, taxes and depreciation.


Since the METR for debt-financed investments currently tends to be negative, an increase in the IS rate would tend to discourage such investment, which would be a reduction in tax-induced distortions.


Under a quotient system, aggregate family liability on an aggregate family income of Y is NT(Y / N), where the quotient N reflects household composition and the schedule T (.) is the same for all household types.


It is also unclear why, as a matter of policy, a tax benefit associated with children should be available only to those sufficiently well-off to pay the IR and then increase with their income, but only up to some limit.


Kleven, Kreiver and Saez (2006) find—leaving aside the marriage bias issue—that it is typically optimal for the marginal rates on primary and secondary earners to be negatively related: precisely the opposite occurs under joint taxation, since higher income of one partner then increases the marginal tax rate faced by both.


Quite to the contrary, however, suggestions have been made of adopting still more differentiation, exploring the possibility of doing do so on items not subject to intra-EU trade. Such measures hold little prospect of improving the coherence and effectiveness of the tax system—unless used as staging posts towards phasing out the reduced rates.


Although social contributions carrying no benefit entitlement have been eliminated, since 2007, at the SMIC level for enterprises with less than 20 employees, there remain some charges that function like taxes to such a degree that their elimination could be considered. These include the 2.1 percent charge that remains for larger enterprises (there being no obvious reason why employment in smaller enterprises should be favored) and charges, summing to around 6 percent, related to training and transport. The implications of this for social fund arrangements are discussed in Besson (2007).


That diesel is more fuel efficient than gasoline is not in itself an argument for taxing it less heavily: the carbon content per gallon is no lower, and indeed since each gallon used will thus be associated with a greater distance traveled, the appropriate charge for other road use-related externalities will be higher.

France: Selected Issues
Author: International Monetary Fund