France: Selected Issues Paper
Author: International Monetary Fund
Publication Date:
27 Jul 2011
eISBN:
9781462338528
Language:
English
Keywords:
ISCR; CR; France; staff calculation; financial crisis; labor force; tax wedge; tax system; welfare arrangement; OECD tax database; VAT hike
Download PDF (776 KB)

This note estimates potential output for France during 1980–2010, using three distinct approaches, and discusses long-term growth prospects. The focus on capital taxation highlights the need for a broader reform of the French tax system to address the features that hamper job growth, investment, and productivity growth. This paper analyzes the impact of Basel III capital requirements on French banks and the French economy, and proposes policy recommendations. French banks should be able to meet the new requirements through earnings retention.

Abstract

This note estimates potential output for France during 1980–2010, using three distinct approaches, and discusses long-term growth prospects. The focus on capital taxation highlights the need for a broader reform of the French tax system to address the features that hamper job growth, investment, and productivity growth. This paper analyzes the impact of Basel III capital requirements on French banks and the French economy, and proposes policy recommendations. French banks should be able to meet the new requirements through earnings retention.

II. Toward a Growth-Oriented Tax System for France1

A. Introduction

1. France’s tax system is subject to external pressure for change. Closer EU integration and globalization have increased the mobility of capital, resulting in rising pressures to reform capital and business income taxation. Recognizing these pressures, the government has proposed on May 11, 2011 (as part of its 2011 supplementary budget) a reform of capital taxation, which seeks to level the playing field and boost France’s attractiveness—particularly in relation to Germany.2 The reform would eliminate the first tranche of France’s annual wealth tax (Impôt sur la fortune, ISF), reduce the number of rates from six to only two (0.25 percent for taxable amounts between €1.3 and €3 million, and 0.5 percent for higher amounts) in 2011, and remove the ceiling on personal taxes (bouclier fiscal) in 2012.3 The proposals are expected to be approved by Parliament on July 7, 2011, and would potentially come into effect from January 1, 2012.

France: Net Wealth Tax, 2010

article image
Source: IBFD.

2. The focus on capital taxation highlights the need for a broader reform of the French tax system to address the features that hamper job growth, investment, and productivity growth. While the average tax burden may need to remain relatively high in France, reflecting a high preference for public goods, recent studies suggest that it is the tax mix that matters for growth. Tax structures conducive to growth are less reliant on corporate and personal income taxes, and more reliant on consumption and recurrent residential property taxes (OECD, 2010). Lowering the direct-to-indirect tax ratio on average by 10 percentage points could increase per capita GDP growth by 0.39 percent based on results for a panel of 116 developed, developing and transition countries over the period 1972–2005; the impact of reducing the direct-indirect tax ratio by 10 points on per capita growth is even stronger for developed countries, at 0.56 percent (Martinez-Vazquez et al., 2009).4 Other growth-oriented reforms include lowering the tax wedge on labor; tax base broadening and a reduction in marginal tax rates; and improving the extent to which taxes correct for “externalities.”

3. This paper documents key features of the present French tax system that affect employment and investment decisions and highlights possible measures to make the tax system more competitive and growth-oriented in a globalizing world economy. The main concerns include: a high labor tax wedge, due to a heavy reliance on social security contributions; a relatively high corporate tax rate; and the bias of the present system toward certain sources of finance and certain sectors, which encourages excessive financial leverage, and contributes to a dearth of equity financing for innovative projects and an inefficient allocation of resources. The analysis suggests the following directions for reform:

  • Social security contributions could be further lowered to reduce the labor tax wedge and increase employment. While past measures have been targeted at the low-wage earners, the tax wedge at the average wage level remains one of the highest in the OECD, both for singles and families.5 An analysis of participation trends and reported estimates of employment elasticities suggest that measures targeted to the high participation margins of older workers and women with school-age children in France are the most likely to yield the largest employment and investment impact. France’s corporate tax system is characterized by a high statutory rate compared to other advanced countries and a relatively narrow base. A reform that lowers the tax rate accompanied by base-broadening could improve neutrality, lower compliance costs, and reduce the current bias of the system against small firms to grow. Base-broadening achieved through limits on interest deductibility or shifting to a comprehensive business income taxs could limit incentives for excessive corporate leverage.

  • The revenue cost of such measures could be offset by a further reduction in tax expenditures and other base-broadening measures, increased reliance on recurrent taxes on inmovable property, “green” taxes, and consumption taxes which have the least damaging effect on growth. On the tax administration side, introducing mandatory withholding for the personal income tax (PIT) would improve efficiency and compliance.

  • The proposed reforms need not conflict with redistributional objectives: international experience shows that this objective is better achieved with expenditures rather than tax measures.6 Moreover, micro-level evidence suggests the VAT can be a progressive tax, if its impact is assessed on lifetime rather than annual income (Caspersen and Metcalf, 1995). Reforms will need to assess distributional issues and possible mitigating measures carefully.

B. International Comparisons and Recent Trends in French Tax Revenues

Stylized Facts

4. The tax ratio in France, at 42.8 percent of GDP (in 2008), is well above the EU-27 and EA-16 averages (of 39.3 percent and 39.7 percent, respectively). A relatively high level of taxation is required to fund France’s preference for extensive welfare arrangements. Recent empirical evidence suggests that the tax structure, more than the overall tax level, is what matters for growth (Martinez-Vazquez et al, 2010). Even without changing the overall tax burden, there is scope to improve the tax mix. France relies heavily on social security contributions (39.2 percent of tax revenue in 2009, compared to an OECD average of 26 percent) and indirect taxation (including taxes on goods and services and other taxes) yields about 28 percent of tax revenue compared to 31 percent on average in OECD countries. The corresponding ratio of direct-to-indirect taxes (at 2.5 in 2008) is higher than the OECD and EU-15 averages of 2.2.7

A02ufig19

Tax Mix, 2008

(in percent of GDP)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: OECD Tax Statistics.

5. The revenue productivity of the main taxes (personal and corporate income taxes and VAT) is low.

  • Personal income tax revenue—which includes not only the PIT but also “social taxes” including the flat rate social security contribution (contribution sociale généralisée, CSG) and the social security debt contribution (contribution au remboursement de la dette sociale, CRDS)8—totaled 7.5 percent of GDP in 2008, compared to 9 percent in the OECD and 9.6 percent in Germany. The low yield of the PIT reflects its limited scope (it is paid by only about half of all taxpayers) and the impact of various tax credits and provisions. The highest statutory marginal PIT tax rate, at 40 percent, is lower than in Germany (45 percent), but higher than in other Euro area countries such as Spain (27.13 percent) or Finland (31.50 percent). Notwithstanding a higher tax rate, revenue raised by the PIT is only slightly above Spain’s level (of 7.1 percent of GDP) and much below Finland’s level (of 13.3 percent of GDP).

  • Revenue from the corporate income tax (CIT) at 2.9 percent of GDP in 2008 is also lower than the OECD average (of 3.5 percent of GDP) despite a statutory rate that, at 33.33 percent, is not low by international standards (Appendix, Table 1). While corporate tax revenue has remained above the EU-15 average level in the past 20 years, France recorded a decrease in receipts since 2001, in contrast to the OECD and EU-15 countries, where corporate tax revenue increased by 0.3 and 0.5 percent of GDP, respectively, in large part reflecting the base-broadening measures taken.9 The overall revenue productivity, as indicated by the implicit tax base (CIT revenue divided by the top statutory rate), is 8.7 percent of GDP, well below the OECD mean (of 15 percent of GDP) due to generous deductions and exemptions including a 15 percent rate for SMEs (see Appendix, Table 3).10

  • The share of taxes on goods and services in GDP (10.6 percent) is somewhat below the OECD average (10.8 percent)—despite a higher standard VAT rate (19.6 percent in 2010 vs. 18 percent in the OECD).

  • In contrast, property taxes account for a relatively high fraction of GDP in 2008 (3.4 percent), higher than the OECD average (1.8 percent) although below the U.K. level (4.2 percent).11

France: Social Taxes, 2010

article image
Source: IBFD.

On income from inmovable property and investment income.

A02ufig20

Corporate Tax Revenue, 1990-2008

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: OECD.

6. While past reforms have succeeded in lowering the tax wedge for low wage earners, corporate tax reforms in France have lagged those in other advanced countries. For example, Germany completed a second major CIT reform in 2008. In line with previous reforms and those in other advanced countries over the past decades, the reform broadened the tax base (particularly through limits on the deduction of interest costs in specific cases where there is evidence of borrowing from foreign subsidiaries to shift profits abroad) while lowering profit tax rates significantly from 38.9 percent to 30.2 percent.12 This leaves France with the highest rate in the EU and the third highest rate in the OECD after Japan and the U.S. (see Appendix, Table 1). Appendix, Table 1, shows that forward-looking average and marginal effective tax rates (METRs) are much lower than the headline statutory rate, reflecting generous depreciation allowances for plant and machinery (Keen and Luzio, 2008). The METRs are thus not out of line with those of other advanced countries. The average effective tax rate (AETR), however, is high by advanced country standards (as further discussed in Section C).

A02ufig21

Corporate Income Tax Rate, 1979-2010

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Sources: IFS until 2005, and OECD thereafter.

Previous Reforms

Cuts in social contributions targeted on low wage earners have been a cornerstone of France’s policies to mitigate the impact of a high tax wedge on employment and investment. Past reforms were focused on reducing social contributions at and up to 1.6 times the minimum wage and are estimated to have increased employment by around 3 percentage points (Keen and Luzio, 2008). Other measures included the introduction of the earned income tax credit (Prime pour l’Emploi, PPE) in 2002 and the introduction in July 2009 of a new earned-income supplement (Revenu de Solidarité Active, RSA) aimed at smoothing the effect of benefits thresholds to increase incentives for the low-skilled to seek employment.

Recent reforms have focused on the local business tax (taxe professionelle, TP). The TP was suppressed in 2010 and replaced by an “economic territorial contribution.” This is no longer based on the annual value of commercial and industrial equipment, but consists of a levy on the annual rental value of immovable property and a new tax of 0.4 percent (from a turnover exceeding €500,000) to 1.5 percent (from a turnover above €50 million) on the added value of the business (cotisation sur la valeur ajoutée des entreprises). The overall tax cannot exceed 3 percent of the value of the business.

Tax measures included in the 2009–10 fiscal stimulus package have further eroded the tax base. France has reduced PIT rates for low-income households and introduced reduced VAT rates as part of its stimulus measures in 2009 and 2010. The PIT was cut by two-thirds for low-income households in 2009 and a reduced VAT rate of 5.5 percent was introduced on restaurant services. Similar measures were taken in Germany over the same period.1

1Germany reduced the bottom PIT rate from 15 percent to 14 percent in 2009 and 2010, increased PIT thresholds, the basic allowance, and the tax allowance for children, and introduced a one-off payment of EUR 100 euros per child in 2009 (Kinderbonus). In 2010, Germany also introduced a reduced 7 percent VAT rate on short-term accomodation as supplied by hotels, pensions, and guesthouses.

C. The Burden of the French Tax System and a Roadmap for Reform

Labor Taxes

7. France’s welfare arrangements require a relatively high level of social security contributions and social welfare taxes, resulting in the third-highest tax wedge in the OECD. Despite the low revenue yield of the PIT, relatively high social contribution rates imply sizeable marginal tax wedges (income tax plus employer and employee social security contributions minus cash transfers) that are well above the OECD average. The labor tax wedge at the average wage level for singles is the fourth highest in the OECD. Germany’s tax wedge is also relatively high for singles, but much lower for families (although still higher than the OECD average, see Appendix, Table 2).

A02ufig22

OECD Countries: Total Tax Wedge, 2009 /1

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: OECD.1/ For a single individual without children, at the income level of the average worker.

8. Such tax wedges provide disincentives to employment and labor force participation by pushing up labor costs. Substitution away from labor puts downward pressure on the marginal product of capital, reducing investment and growth over time. Thus, lowering labor taxation could have a direct impact on competitiveness and employment. Past reforms in France, as noted earlier, have been targeted to low-wage earners, at or close to the minimum wage. The tax wedge at the average wage level remains high.

9. The empirical evidence suggests that reducing high tax wedges, along with lowering unemployment benefits, could decrease aggregate unemployment and boost employment prospects.13 Based on a panel of 14 OECD countries during 1965–95, Daveri and Tabellini (2000) find a high positive correlation between labor tax rates and unemployment in continental Europe, but not in the Anglo-Saxon or Nordic countries (where strong and centralized unions may internalize the implications of higher wage demands and moderate their wage claims, resulting in little or no effect of taxes on labor costs). Their results suggest that each 1 percent rise in the average effective labor tax rate in continental Europe leads to a rise in unemployment of about 0.3 percent, a reduction in the investment rate of about 0.2 percent, and an annual per capita growth slowdown of about 0.03 percent. Using a panel of 21 OECD countries over 1982–2003, Bassanini and Duval (2006) similarly find that a 1 point reduction in the tax wedge leads on average to a drop in the unemployment rate by about 0.3 percent.14

10. High marginal effective tax rates (due to the combination of tax and benefit systems) can also affect labor supply decisions by affecting the choice between additional work and leisure or non-market activities. In particular, labor taxes affect the labor supply response of women, possibly because the activities that women perform (child care and other household-related activities) provide a close substitute for market work. For example, Klevmarken (2000) found that the reduction in tax rates led to a higher increase in work hours for women than for men in Sweden during the 1990–91 reform. Bassanini and Duval (2006) find that each percentage point decrease in the tax wedge raises the employment rate of prime-age women by 0.5 percent, compared to an impact of 0.3 percent on the employment rate of other groups. Simulations of a tax benefit model for the U.K find that while the overall hours elasticity for the age 30–54 group (i.e., the decrease in hours worked in response to a 1 percent increase in implicit tax rates) ranges from 0.3 to 0.44, women with children of school age have higher elasticities of around 0.5 on average (Blundell, 2010). Evers et al. (2008) similarly find a higher elasticity of women’s labor supply of 0.5, compared to 0.1 for men. Empirical studies also offer support for larger elasticities regarding the decision to participate (the extensive margin) than the decision to work longer hours (the intensive margin). This latter result may also explain the relatively large elasticities at old age found by some studies.15

11. Significant labor supply dividends can thus be expected from a reform of the tax-benefit system that increases work incentives for the high supply margins, i.e. elderly workers and women with school-age children. The participation rate of male workers aged 55–64 in France is the lowest among advanced countries; and while the employment rate of prime-aged women (30–54) has increased in line with that of other OECD countries, French women’s mean hours worked have declined markedly since the late 1970s.16 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) and about 10 percent by higher hours worked of employed prime-aged women (Blundell et al., 2011).

A02ufig23

Labor Force Participation Rate, Men, Ages 55-64

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: OECD.
A02ufig24

Employment, Women, Ages 25-54

(Percent of population)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: OECD.

12. Work incentives targeted at these high labor supply margins are likely to be more effective and cost-efficient than across the board tax cuts. They can be implemented by making earned income tax credits (EITC) more generous for older workers and for women with school-aged children. For example, the Netherlands introduced in January 2009 an age-specific EITC that increases the reward to working for individuals aged between 62 and 67. This bonus is estimated to raise the participation of the 60–64 group by 0.6 percentage points, equivalent to 0.1 percent of the labor force (Euwals et al., 2009). Alternative forms of tax relief may yield similar effects on participation and employment, depending on their design. For example, employers could receive special credits for social security contributions paid for workers in these two groups. This age-specific subsidy would reduce wage costs for older workers and women with children over 5, making it more attractive for firms to employ them.17

13. While the employment impact of lower tax wedges would likely partially offset their cost in revenue terms, uncertainty over the size of the employment effect calls for concurrent revenue measures to ensure that fiscal consolidation goals are achieved. To have the least damaging effect on growth, revenue-raising measures would ideally shift the tax burden to indirect taxes. However, given the low revenue productivity of the PIT in France and in light of distributional considerations, there is also considerable scope to raise PIT revenue.18 Specifically, the following options could be considered:

  • A broadening of the VAT base through the removal of exemptions and reduced rates (see Appendix, Table 3). For example, IMF (2010) estimates that France would gain 0.36 percent of GDP by raising C-efficiency—defined as VAT revenue divided by the product of the standard rate and aggregate private consumption—from its current level of 0.48 to the average level of advanced countries examined (0.52). Raising C-efficiency to Japan’s level of 0.7 (the highest in the sample) would yield 3.5 percent of GDP.

  • Improving the efficiency of tax collection, including for fuel, alcohol, and tobacco excises. Revenue from alcohol excises in 2007 was only 0.05 percent of GDP in France, compared to 0.14 percent of GDP in Germany and an average of 0.18 percent of GDP in other advanced countries (IMF, 2010). This is despite an alcohol excise tax somewhat above Germany’s. Similarly, revenue from tobacco excises in France, at 0.52 percent of GDP, is lower than in Germany (at 0.58 percent of GDP), despite a more than double excise rate. Motor fuel tax revenues are also lower in France by about ½ percentage point of GDP relative to Germany, despite broadly similar levels of fuel taxation.

  • Raising recurrent inmovable property taxes, on which France relies to a lesser extent than the U.S., Canada, Japan, or the U.K. Increasing the revenue from recurrent inmovable property taxes—the least damaging for growth—to yield the average ratio to GDP in the U.S., Canada, and the U.K., would yield 1 percent of GDP (IMF, 2010).19

  • Increasing environmental taxes, which are relatively less important in France than in other advanced countries (OECD, 2011). For example, the introduction of a carbon tax along the lines of the EU’s April 2011 proposal would provide annual revenue of about 0.2 percent of GDP.

  • Finally, raising PIT revenue through the removal of exemptions and improved tax administration and compliance. A range of exemptions and deductions is available under the PIT, which do not apply under the CSG. These include not only a relatively high threshold, but special treatments such as the tax credits for salaries of domestic staff, investments in improved energy efficiency, investments in residential properties for letting, and the mortgage interest credit (Keen and Luzio, 2008). On the administration and compliance side, elimination of tax breaks could enable significant simplification and, together with the introduction of mandatory withholding, improve compliance and reduce both taxpayers’ compliance costs and the authorities’ costs of administration.20

Taxation of Alcohol, Tobacco, and Motor Fuel, 2007 1/

article image
Source: OECD Tax Database.

EUR per hectolitre, unless otherwise specified.

in percent of retail selling price.

14. To further encourage increased labor supply by prime-age women, complementary reforms could include a shift to an independent system of family taxation. The current joint taxation system implies high marginal tax rates on secondary earners entering work. While these effects may currently be muted in France by the relatively narrow scope of the IR, they could become more significant following a reform that broadens the base and increases the revenue yield of personal income taxation.

15. In the case of senior participation, complementary reforms could focus on increasing further the statutory retirement age at which full benefits can be collected to increase incentives for senior workers to remain in the labor market. Bassanini and Duval (2006) estimate that, for the average OECD country, a one-year increase in the standard retirement age would raise the employment rate of older workers by 0.6 percent. Estimates for the Netherlands suggest broadly similar effects of delaying the standard retirement: increasing the retirement age from 65 to 68 years could raise the total employment rate (including 65 and over) by 1.6 percent and the labor supply among workers below 65 (20–64 years) by 0.8 percent in a central scenario, where a one-year increase in the official retirement age at which benefits can be collected causes an increase in the actual retirement age by 0.5 years (Euwals et al., 2009).

Corporate Taxes

16. Key features of France’s corporate tax system from a growth perspective are: (1) a relatively high statutory and average effective tax rate (AETR), which could adversely affect firms’ location decisions; and (2) non-neutrality, resulting in distorted incentives to invest with potential negative consequences for the efficiency of investment decisions and total factor productivity (TFP) growth.

17. A relatively high AETR can impact firms’ investment and location decisions (i.e., domicile competitiveness) and encourage profit-shifting. High average taxes, for example, could discourage multinational companies from incorporating in France and/or encourage operation through subsidiaries located in low-tax foreign countries, or inversions (reincorporations in low-tax countries).21 Empirical studies of international investment responses yield substantial effects, both via marginal investments and especially via discrete location decisions. Specifically, reported estimates of semi-elasticities in de Mooij and Everdeen (2009) suggest that each 1 percentage point increase in the AETR (METR) has an aggregate effect on the tax base of −0.65 (−0.4).

18. While the impact of tax on the cost of capital and thus marginal investment does not seem out of line in France compared to other advanced countries, the average effective tax rate is relatively high, suggesting that it could affect discrete investment decisions. France’s marginal effective tax rate (METR) on new investment is broadly in line with the OECD average for equity-financed investments in the manufacturing sector, and below average for debt-financed investments (Appendix, Table 2). However, METRs affect the quantity of investment, whereas AETRs affect discrete investment choices (i.e, the decision whether to invest). The decline in the AETR in France over the last 15 years has been less pronounced than in other advanced countries (amounting to 4 percentage points, compared to 8.3 percentage points for the comparator sample).22 Thus, for 2009 (the most recent year available), France had the second highest current effective tax rate in a sample of 11 countries and regions for which estimates were available in both years. Moreover, METRs and AETRs vary by industry. The services sector—in particular, financial firms—face higher effective tax rates in France (as discussed below).

A02ufig25

Effective Tax Rates, 2009 vs 1996

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: Markle and Shakelford (2011).Notes: Current tax expense. Multinationals and domestic companies, pooled. Estimates controlling for industry and firm size differences across countries.

19. Effective tax rates in France vary considerably across industries and firms, reflecting widespread use of tax incentives for special sectors and regions, and the bias toward debt financing. Industry results in Markle and Shakelford (2011) suggest that France has relatively more industry-specific provisions than other industrial countries: the spread of estimated effective tax rates by industry (for pooled multinational and domestic firms), measured by the coefficient of variation, is 0.25 in France, higher than in Germany (0.14) or the U.K. (0.17), albeit lower than in the U.S. (0.33). Calculations of effective tax rates in Partouche and Olivier (2011) confirm these results, showing that (nonfinancial) services firms face an effective CIT rate of 30½ percent compared to 25 percent for manufacturing firms. Firm-level results in Partouche and Olivier (2011) also show that the tax subsidy for debt-financed investments in France disproportionately benefits large firms (5,000 or more employees), contributing to a 14 percentage points reduction in their CIT rate against 3–4 points for small firms (249 employees or less). The reduced statutory rate of 15 percent for SMEs in France is not sufficient to offset the bias related to interest deductibility provisions, as the same study finds that its contribution to lowering the effective CIT rate is 11.5 points for the smallest firms (9 or less employees) and 2 points for larger SMEs.

A02ufig26

Dispersion of Effective Tax Rates by Industry, 2005-09 1/

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Sources: Markle and Shackelford (2011); and IMF staff estimates.1/ Coefficient of variation of estimated industry-specific effective tax rates.

20. A corporate tax reform that reduces the statutory rate along with broadening the base would mitigate the revenue cost, make the system fairer and simpler and thus less biased toward small firms, and deter profit- and investment-shifting. As noted earlier, OECD corporate tax revenues have increased over the past 20 years, notwithstanding a move toward lower statutory rates. This suggests that base-broadening—along with other factors, such as a rising GDP-share of profits—has largely offset the revenue costs of statutory tax cuts.23 Beyond less generous depreciation allowances, base-broadening achieved through the removal of reduced rates and tax incentives would reduce the complexities of the current system and distortions resulting from the heterogeneity of tax burdens across firms and sectors.24 Such measures are not well-targeted to what are presumably the underlying objectives—investment or employment—and tend to benefit larger companies which can achieve a lower tax burden through tax planning and fiscal engineering, and which may also have easier access to debt-financing. Reducing the bias toward small firms in the current system would also raise TFP growth by increasing the potential for economies of scale through firm growth.

21. Finally, the bias toward debt over equity financing or retained earnings may encourage excessive leverage, particularly by financial firms which face a high effective tax rate in France compared to other advanced countries.25 Debt-financed investments received a 36 percent subsidy at the margin in 2005, higher than in other advanced countries (Appendix, Table 1). A number of countries have implemented policy measures to mitigate the debt bias, including limits on interest deductibility. These measures, however, can complicate corporate tax regimes. More comprehensive reforms involve a comprehensive business income tax, which disallows the exemption of interest, or an allowance for corporate equity—as adopted in Belgium since 2006, and to some degree in Brazil, Croatia, and Latvia—which grants firms a deduction for a notional return on equity or notional cost of equity finance (de Mooij, 2011).

A02ufig27

Effective CIT Rate, Finance Industry, 2005-09

(Percent)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A002

Source: Markle and Shackelford (2011).Note: Current tax expense. Multinationals and domestics pooled.

22. Quantitatively, empirical studies suggest that the effect of removing the debt-equity discrimination on firms’ financial policy (i.e., the reported semi-elasticity for financial leverage) is significant, but relatively less important than the impact of tax rates on profit shifting, incentives to incorporate, and the decision to invest (de Mooij and Ederveen, 2009). An extensive analysis of elasticity estimates based on a meta analysis in de Mooij (2011) suggest that a 10 percentage points increase in the corporate tax rate raises the debt-to-asset ratio at the margin by 2.8 percent. Thus, lowering France’s 34.4 percent combined CIT rate by 6 points to the OECD average of 28.3 percent (ignoring personal taxes) would reduce the debt-to-equity ratio by almost 4 percentage points to about 49 percent.26 Tax effects on the debt-to-equity ratio of French financial firms could be even larger, in light of the higher effective CIT rate faced by the finance industry. In the case of banks, implementing an ACE would be equivalent to granting a deduction for a notional return on Tier 1 capital, and would have the advantage of eliminating the current tax penalty on the accumulation of capital reserves (Keen et al., 2010).

23. Preferential tax treatment of debt can also in principle provide an implicit subsidy to household borrowing that, in turn, may contribute to froth in the housing market. In particular, mortgage interest deductibility and other tax features can substantially reduce the user cost of housing—by about a fifth according to estimates for the U.S. (Keen et al., 2010). For France, however, there is little evidence of tax-induced distorsions. Keen et al. (2010) find that France (along with Spain and Denmark) has one of the highest effective average tax rates on owner-occupied housing, despite experiencing the second strongest price increase since 1998, suggesting that taxation was not the main driver of house price developments over the last decade.27 While mortgage interest relief and other tax advantages (e.g., the Scellier law applied to rental investments made between January 1, 2009 and December 31, 2012) may have encouraged the strong build-up of residential mortgage debt since 1990, mortgage debt outstanding in France remains one of the lowest among the OECD countries (Cardarelli et al., 2008; Centre d’Analyse Stratégique, 2011).28

Impact of Tax Reform on Employment and Growth: An Illustrative Scenario

24. The empirical results can be used to illustrate the potential macro-economic impact of various policy reforms. While the estimates of the effects of labor and profit tax cuts discussed below do not take into account the possible negative impact of offsetting measures—and thus could over-estimate the net impact of the reforms—they still provide a useful benchmark for comparison of different measures.29 Four main scenarios were examined. These were (1) a broad restructuring of the tax mix that lessens the burden of direct taxation and increases the burden of indirect taxes to bring the tax mix in line with EU and OECD average levels; (2) a lowering of the average labor tax wedge, both without and with a concurrent reduction in benefit duration, that brings it in line with the EU mean; (3) targeted cuts in the labor tax wedge for the high labor supply margins, calibrated to replicate roughly the estimated impact of similar reforms in the U.K. and the Netherlands30; and (4) a decrease in the effective CIT rate by 5 points to 20 percent (one percentage point above the AETR level in Germany of 19 percent).

25. The estimates derived from empirical elasticities for advanced countries suggest sizeable growth, employment, and participation effects. Under the first scenario, bringing the tax structure more in line with the average among EU and OECD countries could raise per capita growth by about ½ percent annually. A reduction of the labor tax wedge across the board by eight points (scenario 2) could reduce unemployment by almost 1 million—lowering the unemployment rate by about 2½ percentage points—and increase the investment rate and per capita growth by 1½ percent and ¼ percent, respectively.31 Simulations for the third scenario—reducing the tax wedge for prime-age women (aged 30–54) and older workers (aged 60-64) by 1 point and 2 points, respectively—point to an addition to employment and participation of over 50,000 for women (equivalent to a 0.1 percent increase in employment) and 25,000 for older workers (equivalent to a 0.1 percent increase in participation), respectively. Finally, under the fourth scenario, simulation results based on consensus empirical estimates of the elasticity of investment at the extensive margin (0.65) to the effective tax rate suggest that a reduction of 5 points in the AETR could raise total investment by 3¼ percent.

France: Estimated Impact of Tax and Benefit Reforms 1/

article image
Sources: Bassanini and Duval (2006); Daveri and Tabellini (2000); de Mooij and Ederveen (2008); Evers et al. (2008); OECD (2005); Martinez-Vazquez et al. (2009); and IMF staff calculations. Based on OECD population, employment, and labor force data as of end-2009.

Estimates do not account for the potential negative employment and growth effects of offsetting revenue measures, which could lower the net impact.

Property taxes classified as direct taxes for the purpose of calculating the ratio.

Assuming an unchanged first-year replacement rate.

26. Model simulations for France suggest that an exclusive reliance on a VAT hike to finance cuts in social contributions would partly erase the employment gains of the reform, due to the expected inflationnary effects of the VAT hike.32 Such a proposal was put forward in 2007 by the newly elected President Sarkozy and subsequently abandoned due to concerns about the short-run inflationary impact—even though simulation results confirmed that the employment impact of a higher VAT would be limited, and would not fully offset the positive effects of reduced labor taxes. For example, Gauthier (2008) finds that a shift in tax bases of around 1 percent of GDP would lead to 50,000-250,000 extra jobs depending on whether the decrease in payroll taxes is uniform or targeted to low wages. Besson (2007) similarly finds that the employment impact of financing cuts in social contributions through a VAT hike is higher for cuts targeted to minimum wage earners, with each 2 points of cuts yielding 35,000-350,000 extra jobs. Gadenne (2008) finds that a cut of 2.1 points in social security contributions would create more than 60,000 jobs, and about 30,000-40,000 jobs if social transfers are preserved in real terms through a larger VAT hike. Simulation results from the Conseil d’Orientation pour l’Emploi (2006) suggest a net impact on employment of a 2 points cut of social security contributions of 28,000 jobs after two years, in line with the lower range of Gadenne’s and Besson’s estimates.

27. In light of the possible inflationary and distributional effects of a VAT hike, consideration could be given to implementing the proposed shift in tax bases not just by raising VAT but also other consumption taxes, environmental taxes, and/or recurrent inmovable property taxes (as discussed earlier in this section). There is also scope in France to limit the need for offsetting hikes in the standard VAT rate through improvements in efficiency. Given the size of the labor tax base in France, the 8 points reduction in labor tax rates needed to bring France’s average tax wedge in line with the EU implies a revenue loss of about 3 percent of GDP. To offset this revenue loss, estimates of the scope for policy and administrative improvements to the VAT suggest that raising the VAT efficiency would be far more effective than even quite large increases in the standard VAT rate (IMF, 2010). In France, a one point increase in the standard rate would raise 0.4 percent of GDP; but increasing VAT efficiency (of about 0.5) to the same level as Japan (of about 0.7) would raise 3½ percent of GDP.33 In France’s context of fiscal consolidation, measures to close the VAT compliance and policy gap, as well as other “growth-friendly” measures such as higher reliance on environmental and recurrent inmovable property taxes, could be implemented over time and the revenue gains used to reduce labor taxes as they materialize, rather than implementing the cuts in social security contributions upfront.

D. Conclusions

28. The analysis of labor taxation indicates the scope for expanding employment and participation at the extensive margin (for older workers) and at the intensive margin (for women with school-age children), through reduction of the tax wedge. This can be achieved in a revenue-neutral manner through targeted measures, such as age-specific tax credits, combined with a further reduction of personal income allowances and other tax expenditures to offset the revenue cost of the reforms. A more ambitious reform of labor taxation could be combined with VAT reform and increases in recurrent inmovable property taxes, environmental taxes, and/or excises on alcohol and tobacco to shift the tax mix to a more growth-friendly one, reduce labor costs more broadly, and encourage both higher employment and investment.

29. The corporate tax analysis demonstrates the need to improve the attractiveness of France as an investment destination by reducing the average corporate tax burden. Empirical results suggest sizeable effects of a lower AETR on investment at the extensive margin (discrete investment choices). Achieving this in a revenue-neutral manner will require base-broadening measures, including less generous depreciation allowances and the removal of special rates and incentives. Such reforms would simplify the tax system, lower compliance costs, and improve tax neutrality across industries, thus contributing to more efficient investment decisions and higher TFP growth. Reduced compliance costs and lesser potential for international tax planning would remove the bias of the current system toward SMEs, thus increasing the scope for realizing economies of scale through firm growth. Finally, eliminating or reducing the “debt bias” by moving to a comprehensive business income tax would both contribute to broadening the tax base and encourage increased reliance on equity financing for more innovation-oriented investments.

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Appendix

Table 1.

Selected Countries: Corporate Income Tax Rates, 2010

(Percent)

article image
Sources: OECD Revenue Statistics, Institute for Fiscal Studies, and IMF staff estimates.

Based on manufacturing tax rate, for an investment in plant and machinery. Taxation at shareholder level not included.

CIT revenue to GDP divided by the combined CIT rate.

The standard statutory tax rate of 33.33 percent is increased by a 3.3 percent surcharge (Contribution Sociale sur les Benefices) for companies with a turnover above EUR 7.63 billion on the part of their liable tax payments in excess of EUR 763,000 - resulting in an effective tax rate of 34.43 percent on companies with profits above EUR 2.289 billion.

Table 2.

Comparison of Total Tax Wedge by Family Type

(Percent of labour costs) 1/

article image
Source: OECD.Note: Countries ranked by decreasing tax wedge.

Figures shown for the average worker single without children and one earned married couple with two children.

Table 3.

France and Germany: Main Features of the Tax System (January 2011) 1/

article image
article image
article image
article image
Source: IBFD, as of 15 January 2011.

Taxes are administered and levied by the Central government, unless otherwise specified.

1

Prepared by Hélène Poirson.

2

A report of the Court of Accounts (Cour des Comptes) in March 2011 highlights that the burden of wealth taxation in France is much higher than the EU or OECD average, which in turn is higher than in Germany (Cour des Comptes, 2011). The report finds that the difference relates mostly to the taxation of real assets (land and property), rather than of financial assets. The report more broadly identifies potential opportunities for convergence with Germany, including harmonization of the corporate tax base.

3

Payments of personal taxes, the ISF, and certain real estate taxes on the primary residence are capped at 50 percent of income since 2007. The net revenue loss of the reform (estimated at €1.1 billion) is expected to be offset by higher inheritance taxes, a 19 percent “exit tax” on sale of assets within 8 years of relocation, and higher taxes on whole life insurance savings plans.

4

For the developing countries sub-sample, the coefficient on the tax mix variable remains negative, but not statistically significant.

5

France has successfully implemented since the late 1990’s measures targeted at low-wage earners to circumvent distortions in the labor market created by the relatively high level of the minimum wage and the 35-hours work week (see Box 1). However, the remaining scope for such measures is now limited. Better targeted policies would need to remove or modify the underlying labor market distortions themselves (Keen and Luzio, 2008).

7

However, if property taxes are included as indirect taxes, France’s direct-to-indirect tax ratio (of 1.6) would be broadly in line with the average in advanced countries (of 1.7). Property taxes which may be adjusted for the characteristics of individual owners, such as taxes on owner-occupied housing, would be classified as direct taxes, while other property taxes which are levied irrespective of circumstances (e.g., on commercial buildings, motor vehicles, etc.) would be classified as indirect taxes. Martinez-Vazquez et al. (2000) find that the trends and the empirical results on the impact of tax mix on growth are not affected by the choice of classification.

8

Unlike the PIT, for which a range of exemptions and allowances are available, the CSG applies to all types of income unless expressly exempt. The CRDS is levied, in general, on the same base as the CSG. It also applies to certain types of income that are exempt from the CSG, e.g. gains on precious metals. While the CSG is partially deductible, the CRDS and the social levy are not deductible for income tax purposes.

9

See Norregaard and Khan (2007) for an overview of tax policy trends over the last twenty years.

10

The implicit base has the merit of reflecting all base-reducing measures, whereas the forward-looking effective tax rates reflect only common features such as depreciation allowances.

11

The bulk of property taxes relates to recurrent inmovable property taxes (two-thirds of total property taxes in France), with property/capital transfer taxes accounting for about 17 percent.

12

See Klemm and Danninger (2006) for a comprehensive assessment of the preliminary reform proposal, published on July 12, 2006 by the German Ministry of Finance.

13

While both the initial replacement rate and the duration of benefits are relatively high in France compared to the average for the OECD countries, the experience of Nordic countries—where the first-year replacement rate is also high—suggests that reducing the duration of benefits while keeping initial replacement rates unchanged is preferable from the perspective of labor market efficiency to reducing the initial replacement rate.

14

The empirical findings suggest that the impact of a lower tax wedge on unemployment is higher when accompanied by a concurrent reduction in benefits: each 1 percentage point reduction in unemployment benefits further decreases unemployment by about 0.1 percent on average, with an especially high elasticity of the unemployment impact to benefit duration.

15

See for a comprehensive review Euwals et al. (2009).

16

According to INSEE’s 2009 labor force survey, employed French women work on average 34 hours a week, compared to 41 hours for men. The under-employment rate for women aged 30-49 is almost 8 percent, compared to 2½ percent for men.

17

Employers who hire a worker aged over 45 under an apprenticeship program (contrat de professionalisation) already benefit since May 16, 2011, from a targeted subsidy of €2,000.

18

See Landais et al. (2008) for a comprehensive assessment of the tax system’s progressivity in France. On the expenditure side, a reform of social transfers (e.g., for housing) and/or a reduction in the relatively high duration of unemployment benefits could be considered. The latter could have the added benefit of helping to increase employment. See Schindler (2011) for evidence that the 2005 Hartz IV reforms contributed to the recent downward trend in actual and structural unemployment in Germany by reducing the value of not being employed and contributing to better matching efficiency.

19

Johansson et al. (2008) find that corporate taxes are the most harmful for growth, followed by personal income taxes, while consumption taxes and recurrent taxes on inmovable property appear to have the least damaging effect on growth.

20

France is the only other OECD country (with Switzerland) not to have introduced mandatory withholding for the PIT (Keen and Luzio, 2008). Experience from the introduction of withholding in the U.S. suggests a long-run gain of around 22 percent of revenue (Dusek, 2006).

21

See, for example, Devereux and Griffith (2003) and Markle and Shakelford (2011).

22

Based on a sample that does not include R&D firms (which benefit from a preferential tax treatment in France).

23

On March 16, 2011, the European Commission (EC) proposed a Common Consolidated Corporate Tax Base (CCCTB) for businesses operating in the EU. If approved, the CCCTB would create a uniform base, ensuring that competition takes place on the effective tax rate, rather than on potentially hidden elements in different bases. The EC estimates that the CCCTB could lead to a further broadening of EU tax bases by 7.9 percent on average.

24

In particular, the rationale and the effectiveness of the holidays for investments in competitiveness centers and urban-free zones, the R&D treatment, and the reduced rate for SMEs—both relatively generous by international standards—are questionable (Keen and Luzio, 2008). While these provisions may serve to attract especially mobile international investments and to reduce discrimination against smaller firms built-in the current system, a reduction in the statutory rate would reduce the need for such measures.

25

Major French banks remain less capitalized than their European peers, with a core Tier 1 ratio of 8.8 percent in 2010 compared to an average of 10 percent for peer European banks (Sy, 2011).

26

The median debt-to-equity ratio of listed French non financial firms was 53 percent in 2007 (see Xiao, 2008).

27

Based on market indicators (i.e., price-to-rent and price-to-income), the extent of overvaluation of French housing prices is nearly 20 percent, the highest among other European countries (Standard and Poors, 2010).

28

Mortgage interest deductibility was eliminated from January 1, 2011 and replaced by an updated version of the 2010 zero interest rate loan (pret à taux zéro) for purchase of a primary residence. Unlike the 2010 version, the 2011 pret à taux zéro has no income restrictions and the amounts borrowed can be higher in higher-priced regions and when the dwelling purchased meets certain energy standards.

29

Raising consumption taxes for example could negatively affect growth and employment in the short- to medium-run, if it leads to higher inflation and wages. The empirical evidence for OECD countries on the impact of consumption taxes on unemployment is inconclusive. While Daveri and Tabellini (2000) find that the consumption tax rate has no independent impact on unemployment once the labor-related tax wedge is accounted for, the results in Bassanini and Duval (2006) suggest that a 1 point rise in the consumption tax rate raises unemployment by 0.2 percent—similar to a 1 point rise in the labor tax rate. The net impact of a shift in tax bases on unemployment is likely to negative overall, so long as the consumption tax base is larger than the wage bill. Simulation results for France suggest that the employment impact of higher consumption taxes would indeed be limited (Gauthier, 2008). The impact on inflation depends on country-specific factors, such as the existence of indexation mechanisms and the strength of competition in the retail sector. Price increases in 2007 from Germany’s 3 percentage points increase in the VAT rate for example were more modest than feared due to competitive pressures in the retail sector (Carare and Danninger, 2008).

30

See Euwals et al. (2009) for the Netherlands and Blundell (2010) for the U.K.

31

An overall reduction of the tax wedge of eight points, combined with reduced maximum benefit duration by one-third (to 25 months), could further lower the unemployment rate by 0.7 percent, bringing the total impact of the reform to above 3 percent. Lowering the maximum duration of unemployment benefits to 25 months would bring benefit duration closer to the level of many other OECD countries, including Germany, Finland, and Sweden where maximum benefit duration is below 20 months (Euwals et al., 2009).

32

Direct inflationary effects for example result from prevailing indexation mechanisms in France for the minimum wage and social transfers (e.g., pensions and family allowances).

33

VAT efficiency (or C-efficiency) is defined as the ratio of VAT revenue to the product of the standard rate and consumption.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
France: Selected Issues Paper
Author: International Monetary Fund
Volume/Issue:
Volume 2011: Issue 212
Publisher:
International Monetary Fund
ISBN:
9781462338528
ISSN:
1934-7685
Pages:
60
DOI:
https://doi.org/10.5089/9781462338528.002

Tax Mix, 2008

(in percent of GDP)

Corporate Tax Revenue, 1990-2008

(Percent of GDP)

Corporate Income Tax Rate, 1979-2010

(Percent)

OECD Countries: Total Tax Wedge, 2009 /1

(Percent)

Labor Force Participation Rate, Men, Ages 55-64

(Percent)

Employment, Women, Ages 25-54

(Percent of population)

Effective Tax Rates, 2009 vs 1996

(Percent)

Dispersion of Effective Tax Rates by Industry, 2005-09 1/

(Percent)

Effective CIT Rate, Finance Industry, 2005-09

(Percent)