Authorities’ views

10. The authorities considered that from 2012 onwards the economy was set to achieve higher growth than projected by staff. They expected the current momentum to carry over in 2012, with real GDP growth increasing to 2¼ percent—above current consensus. For 2013–14, more dynamic private consumption would lift the annual growth rate to 2½ percent. Over the medium term, the authorities projected potential growth at a rate of 2 percent, mainly reflecting higher total factor productivity growth than under the staff baseline.

Fiscal Consolidation Seeks a Balance between Competing Considerations

12. A large fiscal consolidation has been set in motion. Crisis-related costs—including the fiscal stimulus, revenue losses, and financial sector support—and declining trend growth have pushed France’s government deficit and public debt to above the levels typical of other European AAA-rated countries. Aging-related spending pressures (although less than in other advanced countries) further add to sustainability concerns. While the 2010 pension reform enacted in December will improve the public debt dynamics, under current policies projected health care spending growth will push up the debt ratio in the coming years. To underpin France’s AAA-rating and to avoid that rising public debt would negatively affect growth, the government considers a large and determined fiscal consolidation as critical.

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Fiscal Indicators for European AAA Countries

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

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13. The French Stability Program strikes an appropriate balance between growth and sustainability concerns, and aims to reduce the overall fiscal deficit to 3 percent of GDP by 2013 and 2 percent of GDP by 2014. This planned fiscal adjustment is large both by historical standards and relative to that in other countries. The authorities seek to mitigate adverse effects on growth through a package of measures that: increases the efficiency of public services through implementation of the second phase of the review of public expenditures (Révision Générale des Politiques Publiques, RGPP); ensures the viability of the social security system by arresting the surge in aging-related spending; contains local government current spending through a freeze on transfers; raises public investment in innovation-related projects, including through public-private partnerships; and cuts wasteful tax expenditures. Moreover, the authorities expect the increase in the retirement age to raise potential growth through higher labor force participation. Staff observed that achieving the fiscal targets would enhance credibility and be an important down-payment towards reducing the public debt to 60 percent of GDP by the middle of the next decade.

14. Following the fiscal stimulus in 2009/10, progress is now being made in restoring fiscal sustainability. The fiscal outcome in 2010 was better than foreseen by almost ¾ percent of GDP because of higher-than-expected revenues (0.4 percent of GDP—including from real estate transaction taxes levied by local governments), lower-than-expected spending on unemployment benefits; and capital expenditure cuts at the local government level. Instead of the expected fiscal expansion, the overall deficit was reduced to 7.1 percent of GDP from 7.5 percent in 2009, implying a small negative fiscal impulse.

15. Building on this, the 2011 budget and 2011–14 multi-year fiscal framework provide for about 2.8 percent of GDP in adjustment measures over 2011–13. These measures trim the overall fiscal deficit to below 6 percent of GDP in 2011, yield a permanent reduction in spending by 1.2 percent of GDP, and expand the tax base through the elimination of 0.6 percent of GDP in tax expenditures and exemptions on social security contributions. A reform of capital taxation, which seeks to boost competitiveness, particularly in relation to Germany has been approved by parliament.¹ The reform will eliminate the first tranche of France’s annual wealth tax (Impôt sur la fortune, ISF) in 2011 and remove the ceiling on personal taxes (bouclier fiscal) in 2012.²

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Announced Fiscal Measures

(Billions of euros)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: 2011-14 multiyear budget; Conseil d’Orientation des Retraites; and IMF staff estimates and projections.1/ Over and above the announced measures already included in the staff’s baseline scenario.2/ Includes stimulus withdrawal and normalization of the tax position after the 2010 local business tax reform (both in 2011); freezing of non-interest, non-pension, expenditures of the central government; tighter health care spending norm; taxes on banking sector; and reductions in tax expenditures. Impact of spending freeze on local governments estimated relative to a counterfactual scenario based on 2006-09 average nominal expenditure growth.

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16. The adjustment is front-loaded and tilted toward expenditure-containment measures. Expenditure reductions account for about 56 percent of the effort through 2013.³ Moreover, the multi-year budget implies a sizeable upfront adjustment of 1.7 percent of GDP in 2011 (followed by about ½ percent of GDP per year in 2012-14). The adjustment effort is underpinned by the implementation of the 2010 pension reform, enforcement of a tighter health care spending norm, and restraint in central government spending—including through freezing the base wage for civil servants in 2011–12, the non-replacement of one-in-two retiring civil servants, and a freeze on transfers. However, staff expects GDP growth and revenue outcomes from 2012 to be weaker than those currently foreseen by the authorities and hence the deficit ratio to fall more slowly than envisaged. Under staff’s current projections, achieving the deficit target of 3 percent of GDP by 2013 requires further measures.

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France: Fiscal Developments, 1995–2010

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

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Aging-Related Spending, 1981–2016

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: French authorities; and staff estimates and projections.

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17. France cannot risk missing its medium-term fiscal targets given the need to strengthen implementation of the Stability and Growth Pact (SGP) and keep borrowing costs low by securing France’s AAA-rating. Staff’s baseline projections, based on less sanguine macroeconomic assumptions, suggest additional adjustment needs of about 0.2 percent of GDP in 2012 and 0.6 percent of GDP in 2013. The authorities’ determination to achieve their fiscal objectives would thus be supported by preparing specific contingency measures that would secure the targeted consolidation in case growth and revenue outcomes fall short of the authorities’ projections. With limited scope and desirability for raising tax rates, further efforts will need to rely mainly on limits on spending growth and a growth-oriented restructuring of the tax system. In this context, increasing the revenue yield of existing taxes through further base-broadening measures could support both cuts in the overall high labor tax wedge and provide insurance against expenditure slippages (as discussed in Section III.C).

France: Fiscal Projections, 20101–14

(in percent of GDP)

Source: French authorities and IMF staff estimates and projections.

^1/INSEE for 2010, and April 2011 Stability Program and June 2011 DOFP for 2011-14.

^2/In percent of potential GDP.

France: Fiscal Projections, 20101–14

(in percent of GDP)

	2010	2011	2012	2013	2014
Authorities’ projections 1/
General government balance	−7.1	−5.7	−4.6	−3.0	−2.0
Primary balance	−4.6	−3.1	−1.7	−0.1	1.0
Structural balance 2/	−5.1	−3.8	−2.9	−1.6	−0.9
General government gross debt	82.3	85.4	86.9	86.4	84.8
Real GDP growth	1.4	2.0	2.3	2.5	2.5
Inflation	1.2	1.8	1.8	1.8	1.8
IMF staff’s baseline
General government balance	−7.1	−5.7	−4.8	−3.8	−2.9
Primary balance	−4.6	−2.9	−1.7	−0.6	0.3
Structural balance 2/	−4.7	−4.0	−3.4	−2.7	−2.2
General government gross debt	82.3	85.2	87.2	88.1	87.8
Real GDP growth	1.4	2.1	1.9	2.0	2.1
Inflation	1.7	2.1	1.7	1.8	1.9

Source: French authorities and IMF staff estimates and projections.

^1/INSEE for 2010, and April 2011 Stability Program and June 2011 DOFP for 2011-14.

^2/In percent of potential GDP.

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France: Fiscal Projections, 20101–14

(in percent of GDP)

	2010	2011	2012	2013	2014
Authorities’ projections 1/
General government balance	−7.1	−5.7	−4.6	−3.0	−2.0
Primary balance	−4.6	−3.1	−1.7	−0.1	1.0
Structural balance 2/	−5.1	−3.8	−2.9	−1.6	−0.9
General government gross debt	82.3	85.4	86.9	86.4	84.8
Real GDP growth	1.4	2.0	2.3	2.5	2.5
Inflation	1.2	1.8	1.8	1.8	1.8
IMF staff’s baseline
General government balance	−7.1	−5.7	−4.8	−3.8	−2.9
Primary balance	−4.6	−2.9	−1.7	−0.6	0.3
Structural balance 2/	−4.7	−4.0	−3.4	−2.7	−2.2
General government gross debt	82.3	85.2	87.2	88.1	87.8
Real GDP growth	1.4	2.1	1.9	2.0	2.1
Inflation	1.7	2.1	1.7	1.8	1.9

Source: French authorities and IMF staff estimates and projections.

^1/INSEE for 2010, and April 2011 Stability Program and June 2011 DOFP for 2011-14.

^2/In percent of potential GDP.

18. Achieving the envisaged consolidation is critical to put the public debt-to-GDP ratio on a downward path. In the staff’s baseline fiscal projections, high deficits in 2010–12 are likely to result in further increases in the public debt ratio, which would peak at about 88 percent of GDP in 2013. In a scenario where interest rates are permanently higher by one-half standard deviation, debt would peak at almost 90 percent of GDP in 2013, and if both interest rates are higher and growth is lower, debt would continue to rise to 95 percent of GDP by 2016. Under the authorities’ fiscal consolidation plan, the public debt ratio starts to fall after 2012.

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Interest Rate Shock ^1/

(Percent)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: International Monetary Fund; country desk data; and staff estimates.Note: Shaded areas represent actual data.^1/ Permanent one-half standard deviation shock to real interest rate (based on the GDP deflator).

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Combined Shock ^2/

(Percent per year)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: International Monetary Fund; country desk data; and staff estimates.Note: Shaded areas represent actual data.^2/ Permanent one-half standard deviation shocks to real interest rate and real GDP growth (equivalent to a scenario where the growth-interest differential returns to historical levels).

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19. A credible fiscal package of additional measures to achieve the necessary consolidation and lay the foundation for a more growth-friendly tax system could include:

• Curbs on local government expenditure growth, including through an extension of the RGPP to regional and local authorities and implementation of the recommendations of the Balladur Committee to rationalize responsibilities of departments, regions, and municipalities;

• Improved targeting of family, housing, and other social transfers. To enforce a tighter budget constraint on spending by social security entities, consideration could be given to replacing earmarked “social taxes” (which account for almost a third of social security resources) with subsidies. This would result in less open-ended spending mandates in the social security budget and greater ability of the central government to control the expenditure growth of social security entities and other public agencies.

• Reducing the VAT policy gap through a gradual elimination of VAT exemptions and incentives (including reduced rates). An ambitious VAT reform could yield up to 3.3 percent of GDP and be combined with the introduction of a carbon tax (Box 5), higher revenue from fuel, alcohol, and tobacco taxation, gradual hikes in recurrent inmovable property taxes, and improving the efficiency of the personal income tax while further reducing personal income tax allowances to lower the still high labor tax wedge at the average wage level.⁴

Potential Options for Additional Fiscal Adjustment Over 2012–13

(in billions of euros)

Source: From Stimulus to Consolidation; and IMF staff calculations.

^1/One-third of the impact of raising VAT C-efficiency from 0.48 to 0.55, slightly above average for the Group of Twenty countries (G20).

^2/Implementing a carbon tax gradually over 2013-15.

^3/Over and above already announced reductions.

^4/One-third of the impact of increasing revenue-to-GDP to the average of the US, UK, and Canada levels.

^5/Spending freeze on family, housing, and other transfers from 2013.

^6/Expenditure measures account for 61 percent (52 percent) of the overall adjustment under the expenditure-based (balanced) option.

Potential Options for Additional Fiscal Adjustment Over 2012–13

(in billions of euros)

		Option 6/
		Expenditure-based	Balanced
Central government measures
	Close one-third of the VAT policy gap with respect to the G-20 average 1/	-	7.5
	Introduce a carbon tax 2/	1.3	-
	Further reduce tax expenditures 3/	2.4	-
Local government measures
	Higher revenue from property taxes 4/	-	1.6
	Freeze spending in real terms in 2012, thereafter in nominal terms	11.2	-
	Freeze spending in real terms from 2012	-	6.7
Social security measures
	Improve targeting of social transfers 5/	1.0	-
Total savings		15.8	15.8

Source: From Stimulus to Consolidation; and IMF staff calculations.

^1/One-third of the impact of raising VAT C-efficiency from 0.48 to 0.55, slightly above average for the Group of Twenty countries (G20).

^2/Implementing a carbon tax gradually over 2013-15.

^3/Over and above already announced reductions.

^4/One-third of the impact of increasing revenue-to-GDP to the average of the US, UK, and Canada levels.

^5/Spending freeze on family, housing, and other transfers from 2013.

^6/Expenditure measures account for 61 percent (52 percent) of the overall adjustment under the expenditure-based (balanced) option.

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Potential Options for Additional Fiscal Adjustment Over 2012–13

(in billions of euros)

		Option 6/
		Expenditure-based	Balanced
Central government measures
	Close one-third of the VAT policy gap with respect to the G-20 average 1/	-	7.5
	Introduce a carbon tax 2/	1.3	-
	Further reduce tax expenditures 3/	2.4	-
Local government measures
	Higher revenue from property taxes 4/	-	1.6
	Freeze spending in real terms in 2012, thereafter in nominal terms	11.2	-
	Freeze spending in real terms from 2012	-	6.7
Social security measures
	Improve targeting of social transfers 5/	1.0	-
Total savings		15.8	15.8

Source: From Stimulus to Consolidation; and IMF staff calculations.

^1/One-third of the impact of raising VAT C-efficiency from 0.48 to 0.55, slightly above average for the Group of Twenty countries (G20).

^2/Implementing a carbon tax gradually over 2013-15.

^3/Over and above already announced reductions.

^4/One-third of the impact of increasing revenue-to-GDP to the average of the US, UK, and Canada levels.

^5/Spending freeze on family, housing, and other transfers from 2013.

^6/Expenditure measures account for 61 percent (52 percent) of the overall adjustment under the expenditure-based (balanced) option.

Institutional Reforms Can Aid Fiscal Sustainability

20. Staff encouraged the authorities to push ahead with their efforts to adopt a fiscal rule consistent with the planned EU directive. A fiscal rule this would entrench fiscal credibility and support euro area-wide efforts to boost fiscal discipline. With a second large core country adopting a fiscal rule, the credibility of the euro area’s SGP would be significantly strengthened. The authorities have prepared a draft law that envisages enshrining a fiscal rule comprising the general government in the constitution.⁵ In line with the recommendations of the Camdessus working group⁶, the draft law would provide for:

• A binding medium-term budget framework, including multi-year expenditure ceilings and minimum annual revenue measures, and restriction of new tax measures to budget laws. The 2011–14 multi-year fiscal framework already specifies objectives for budgetary aggregates, consistent with the European fiscal rules, and since June 2010 a directive of the Prime Minister ensures the monopoly of budget laws on tax policy. However, enshrining those provisions in a national fiscal rule will lend greater credibility to the fiscal targets, ensure continuity of policy across governments, and reduce the uncertainties associated with consolidation.

• A post-consolidation anchor for fiscal policies. The medium-term budget projections under the proposed fiscal rule would need to be consistent with a return to general government structural balance, ensuring that any temporary deficits are eventually corrected.⁷ Unlike Germany’s debt-brake rule, the target year for achieving budget balance would not be set in the constitution but would be implied by the consolidation path voted by parliament.

21. To enhance its credibility, the multi-year budget should be based on independent macroeconomic forecasts and be backed by contingency spending and revenue plans. EU experience suggests that the impact of fiscal rules on budgetary outcomes depends on the strength of enforcement mechanisms (Box 6). Staff encouraged the authorities to establish an independent public institution or fiscal council to provide forecasts that would be mandatory for budget preparation and medium-term planning. Alternatively, the council could review ex ante government projections of macro-economic variables and tax revenues to ensure their realism and credibility; however, this option would enhance policy credibility only to the extent that mechanisms are in place to enforce the council’s recommendations.⁸ The same institution could also assess the long-term sustainability of public finances on a regular basis, to increase public awareness of fiscal challenges.

^{Box 6}.

Numerical Fiscal Rules in the EU

Fiscal rules have become a wide-spread policy tool across EU member states. In 2008, 67 national fiscal rules were in place, up from less than 20 in 1990. About half of the total number of rules applied to the general and central governments in 2008, up from a quarter in 1990. More than a third of the existing fiscal rules in the EU countries are budget balance rules (including golden rules) while expenditure and debt rules represent about a quarter each. Revenue rules (that pre-define the allocation of windfall revenues) account for the remainder. Expenditure rules apply more often to the central government and social security funds, and are evenly distributed between nominal ceilings and targeted growth rates. Local governments are more often subject to budget balance and debt limits according to repayment capacity.

The strength of fiscal rules depends to a large extent on its institutional features. To capture the influence of these features, the European Commission has developed a fiscal rule strength index, which is based on: (i) the statutory base of the rule; (ii) room for setting or revising its objectives; (iii) the body in charge of monitoring implementation of the rule; (iv) the enforcement mechanisms relating to the rule; and (v) the media visibility of the rule. Strong rules (with a value of the fiscal rule strength index above the median) are in place in Denmark, Finland, Germany, the Netherlands, Spain, Sweden, and the U.K. Weak rules apply in Austria, Belgium, France, Greece, Ireland, Italy, and Portugal.

Only few EU rules include independent monitoring and enforcement mechanisms in case of non-compliance. Strong rules, enshrined in law or constitution, with broad coverage, and supported by pre-defined enforcement mechanisms, seem to have a larger impact on borrowing costs than weak rules, suggesting that market participants favorably discount the effect of the rules on fiscal discipline. Strong rules are also associated with more favorable budgetary outcomes.

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Average Yield and the Strength of Fiscal Rules

(2008M9=100)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: Bloomberg; European Commission; and staff calculations.

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Primary Cyclically Adjusted Balance and the Strength of Fiscal Rules

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: WEO; European Commission; and staff calculations.

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22. Securing long-term fiscal sustainability will require deeper reforms of key pension and health care parameters.

• On the pension side, further increasing the legal retirement age in the future in line with life expectancy would prevent continued fiscal pressures from increases in time spent in retirement as medical advances continue to lengthen life spans.⁹ With the tenth-highest worldwide life expectancy and one of the lowest effective retirement ages in the OECD, French workers spend the longest time in retirement among advanced countries. Further efforts to increase senior workers’ labor force participation rate, including through targeted tax incentives, would also help moderate the fiscal and growth consequences of aging (as discussed in Section III.C). Another evaluation of the long-term financial viability of the pension system is planned for 2013.

• On the health care front, the rise in living standards and technical progress will continue to put pressure on public expenditures, which is already higher in per capita terms than predicted by France’s income levels. Continued efficiency gains are necessary to prevent an unsustainable rise in health and long-term care spending, while at the same time maintaining France’s OECD best performer status on amenable mortality and the high quality of its health services. A planned reform of long-term care would be initiated in 2012.

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Public Expenditure on Health and GDP Per Capita, 2007

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: OECD; WEO; and IMF staff estimates.

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Authorities’ views

23. The authorities reaffirmed their full commitment to the fiscal adjustment path outlined in France’s Stability Program. They considered that growth could surprise on the upside and noted that their macroeconomic forecasts in recent years had proven realistic. Strong revenue performance on the back of the increasing employment could result in a slightly better-than-expected budgetary outcome in 2011. Should downside risks materialize, there was room for contingency measures (including further cuts in tax expenditures). The authorities agreed in principle on the desirability of “green taxes”, including a carbon tax, but viewed the scope for raising consumption taxes as limited in light of the potential negative impact on demand and inflation. They were confident that the 2010 reform of the local business tax and the legislated freeze in transfers would limit local government spending growth. Social security finances would benefit from the positive impact of the recent and previous pension reforms, the labor market recovery, and cost containment measures under way in health care. Although current borrowing costs were still exceptionally low from an historical perspective, the authorities considered the current spreads versus Germany to be higher than warranted by France’s credit fundamentals, and expected tighter spreads as the crisis is resolved.

24. The authorities highlighted the recent advances made in strengthening the medium-term budgetary framework. In the near term, they considered that the current fiscal framework—including the approval of the Stability Program by parliament, the “golden rule” at local government level, and strictly enforced spending rules for the central government (along with the pension reform and the tightened health care spending growth norm)—provided strong safeguards against the risk of fiscal slippages. They noted the broad support for the proposed fiscal rule. It is nevertheless uncertain whether the required super-majority for a constitutional change will be secured ahead of the presidential elections in 2012.

Authorities’ views

40. The authorities supported improving global and European regulatory standards. They stressed that the Basel III capital standards constitute a significant advance that harmonizes the definition of regulatory capital and strengthens the prudential framework for banks, thereby helping to avoid the significant costs of financial crises. However, they also emphasized the key role of supervisory arrangements, the importance of an internationally level playing field, and the need for sufficient phase-in time to allow systems to adapt without excessive economic costs. Regarding globally systemically important financial institutions, they remain actively involved in the ongoing international discussions.

41. The authorities agreed that house prices were relatively high but stressed that the risk of negative fallout from a correction in the property market were low, given sound lending practices and intrusive banking supervision. They noted that the systemic risk board (Conseil de Régulation Financière et du Risque Systémique) is a useful forum for all relevant supervisors and government bodies to continue monitoring property market developments, and consider tools, including macro prudential ones, to manage associated risks.

Strengthening competitiveness

43. Strengthening the competitiveness of the French economy is an important ingredient in a growth strategy. Like most advanced economies, France has experienced a decline in foreign market shares over the last decade as emerging market economies have expanded their presence on world markets. However, French export performance over last decade also lagged compared to its main competitors while relatively few new products gain market share. The overall exchange rate assessment based on CGER methodologies suggests that there may indeed be some real effective exchange rate overvaluation. This is driven in part by the dynamics of euro, but it also indicates the need for wage moderation and cost containment. In addition, non-price factors have been significant in explaining French export performance until the crisis when demand factors became dominant. Restoring competitiveness along these dimensions calls for promoting innovation and creating favorable conditions for business to better penetrate growth markets and sectors.

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Real Export Growth, 2001-05 to 2006-10 ^1/

(Percent)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: IMF WEO; and staff calculations.^1/ Period averages.

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Contributions of Factors Other than Foreign Demand and REER

(Price)

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

Sources: IMF WEO; and staff calculations.

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Estimates Applying the CGER Methodology ^1/

Source: IMF staff estimates.

^1/Positive number indicates that REER is above equilibrium.

Estimates Applying the CGER Methodology ^1/

	France			Euro area	Germany	Italy
	Current	Previous	Previous	Current	Current	Current
	Estimate	Article IV	Article IV	Estimate	Estimate	Estimate
	(April, 2011)	(April, 2010)	(April, 2009)	(April, 2011)	(April, 2011)	(April, 2011)
Current account norm (macro balance)	5	−7	−6	4	1	10
Equilibrium exchange rate (ERER)	4	7	4	5	−8	8
NFA stabilizing (external sustainability)	9	1	9	1	−6	7
Average	6	0	2	3	−5	9

Source: IMF staff estimates.

^1/Positive number indicates that REER is above equilibrium.

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Estimates Applying the CGER Methodology ^1/

	France			Euro area	Germany	Italy
	Current	Previous	Previous	Current	Current	Current
	Estimate	Article IV	Article IV	Estimate	Estimate	Estimate
	(April, 2011)	(April, 2010)	(April, 2009)	(April, 2011)	(April, 2011)	(April, 2011)
Current account norm (macro balance)	5	−7	−6	4	1	10
Equilibrium exchange rate (ERER)	4	7	4	5	−8	8
NFA stabilizing (external sustainability)	9	1	9	1	−6	7
Average	6	0	2	3	−5	9

Source: IMF staff estimates.

^1/Positive number indicates that REER is above equilibrium.

44. Efforts to foster innovation should be pursued in a cost-effective manner. The tax credit for research and development activities (Crédit Impôt Recherche) provides generous incentives and the Grand Emprunt supports a variety of university-based and other research efforts. While spurring innovation has the potential to increase competitiveness and growth, the cost effectiveness of these measures needs to be evaluated within an appropriate time frame. In addition, other obstacles to innovation should be evaluated, such as those possibly arising from the relative paucity of medium-sized firms.

45. Restoring competitiveness and achieving higher potential growth will also require policies to improve competition, notably in the service sector. Welcome steps have been taken to increase competition in the electricity, telecommunications, and retail sectors but the regulation of product and services markets remains more restrictive in France than in many other countries.¹³ Notably, professional services have become more regulated over the past decade, in contrast with the deregulation of this sector in most other advanced countries. France is transposing the EU services directive into national law, but has—like other European countries—not yet fully done so. The activities of the Competition Authority should be focused on areas where progress has so far been limited. Increasing competition in the services sector, in particular professional services, would contribute significantly to productivity growth in the whole economy and to job creation. Empirical studies estimate that if France aligned its regulation to best practices in the OECD, the long-run employment rate would increase by 1.2 percentage point and multifactor productivity would increase by between 0.2 and 0.6 percent per year over the medium term.¹⁴

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France: Competitiveness and External Performance

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

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Tax Reform

46. Closer EU integration and globalization have led to pressures to reform France’s labor and business income taxation. Last year’s reform of the local business tax (taxe professionnelle) is an important first step but staff noted that a more comprehensive tax overhaul to improve incentives for employment and growth is warranted. The main concerns include: (i) a still high labor tax wedge at the average wage level, due to a heavy reliance on social security contributions, which hampers job creation and participation; (ii) a relatively high corporate tax rate faced by firms which do not benefit from special allowances and incentives; and (iii) the bias of the present system toward certain sources of finance and sectors, which is prone to encourage excessive financial leverage, contribute to a dearth of equity financing for innovative projects, and discourage firms’ growth. A reform that offsets tax cuts by base broadening and improved compliance, including through the removal of the least efficient tax expenditures, would ensure that growth-friendly tax reforms support fiscal consolidation.¹⁵

47. Reducing high tax wedges could decrease aggregate unemployment and boost employment prospects. France’s welfare arrangements require a relatively high level of social security contributions and social welfare taxes, resulting in the fourth-highest tax wedge for singles in the OECD. Empirical studies for EU countries find that a high tax wedge increases unemployment by reducing incentives for formal sector employment and by inducing higher wage claims by unions.¹⁶ A reduction in labor taxes by 1 percentage point could lower unemployment by 0.3 percentage points. The impact of the tax wedge on unemployment is even higher when high and long-lasting unemployment benefits—as present in France—further reduce incentives for job search.

48. To maximize labor supply dividends, a reform of the tax-benefit system could target work incentives for elderly workers and women with school-age children. The participation rate of workers aged 55–64 years in France is the lowest among advanced countries; and while the employment rate of prime-aged women (30–54 years) has increased in line with that of other OECD countries, French women’s mean hours worked have declined markedly since the late 1970s. The U.S. experience illustrates the scope for a supply response, with almost a quarter of the increase in hours worked between 1977 and 2007 explained by higher participation of older workers (55–74 years) and about 10 percent by higher hours worked of employed prime-aged women.¹⁷ Work incentives targeted at these high labor supply margins are likely to be most effective and cost-efficient.¹⁸ They can be implemented by making earned income tax credits more generous for older workers (as in the Netherlands) and for women with school-aged children. Alternatively, employers could receive special credits for social security contributions paid for these categories of workers. Based on the experience of other EU countries, further increases in the retirement age to ensure long-term equilibrium of the pension system could also have a favorable impact on labor force participation.¹⁹

49. A corporate tax reform that reduces the statutory rate along with base broadening would make the system fairer and simpler, and deter profit- and investment-shifting. Staff noted that the relatively large elasticity of profit shifting offers an argument in favor of harmonization and, in this context, welcomed the authorities’ intention to seek convergence with Germany.²⁰ A lower statutory rate across the board would reduce the need for special rates and tax treatment, e.g. for SMEs and innovative firms, and reduced complexity would make the system less biased against small firms which do not have the resources to engage in extensive tax planning and fiscal engineering. Reducing the debt bias from interest deductibility would facilitate banks’ deleveraging and promote greater reliance on equity finance (which could ultimately boost innovative investments).

Labor Market Reforms

50. Labor market policies should focus on re-absorbing the unemployed and on increasing labor force participation.

• Further strengthening activation policies and the unified job placement agency (Pôle Emploi) would better support the unemployed in their job search and broaden training opportunities, and should be accompanied by strict enforcement of job-search requirements. Efforts to foster apprenticeship programs are well placed. In addition to reducing the labor-tax wedge, consideration should be given to easing the high employment protection, in order to entice firms to create more jobs.²¹ Reducing the comparatively long duration of unemployment benefits or a lowering of the benefit level over time could strengthen incentives for job search and increase the effective labor supply.

• Policies to draw young and low-skilled workers into the labor force should be stepped up. The high minimum wage (SMIC)²² bars especially young and low-skilled workers from employment. Tax relief and reduced social contributions have lowered the labor cost for low-skilled workers and halted the decline in their share in total employment. Also, over the past 5 years, the authorities have not granted discretionary increases in the SMIC (coup de pouce), thereby increasing the distance between minimum and median wages. Because the SMIC is indexed on inflation, the progress achieved could be jeopardized by current inflationary pressures, especially in light of an overall wage moderation led by the wage freeze for civil servants. Hence, the indexation formula of the SMIC should be reviewed.

• The phasing out of pre-retirement benefits, relaxation of constraints on combining employment and retirement benefits, and pension reform have succeeded in lifting the labor force participation of seniors, despite the crisis. However, the participation rate of seniors remains one of the lowest in Europe and efforts in this area should continue.²³

Authorities’ views

51. The authorities broadly agreed with the need for structural reform to boost competitiveness and growth but cautioned that the political environment is not always conducive. They were convinced of the large growth potential of measures to stimulate innovation and agreed that the cost effectiveness of current policies will need to be evaluated. The authorities reiterated their commitment to transpose the EU Services Directive into French law, indicating that the sectoral approach taken requires time and that liberalization of regulated services can be politically challenging. Although there are signs that labor market reforms are starting to bear fruit, it is difficult to assess their contribution to the rebound in employment during the recovery. While acknowledging the need for reforming unemployment benefit schemes, the authorities stressed the political difficulties in doing so.

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France: Labor Market Indicators

Citation: IMF Staff Country Reports 2011, 211; 10.5089/9781462338535.002.A001

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52. The authorities concurred with the need to modernize the tax system, although they were cautious on the timing of a broad-based reform in the midst of fiscal consolidation. They also noted the limited scope for further decreasing the tax wedge for low-wage earners, and were doubtful that a reduced tax wedge for mostly higher-earning workers would have a large impact on employment and growth. However, they reaffirmed their commitment to lifting tax obstacles to competitiveness, in particular through seeking increased harmonization of the corporate tax base and statutory tax rates with Germany and other European countries.