Wednesday, July 11, 2012

France and Francois Hollande Get Ready to Test Economic Policy – Can They Reduce their Deficit and Increase Growth at the Same Time?

Probably Not – But At Least They are Going to Try

Europe cannot catch a break, primarily because they don’t know how to put together a coherent policy.  For example, in Spain the banking system is crashing, the economy is crashing and the deficit is crushing.  So European decided to bail out the banks, but to do so by loaning money to the Spanish government to invest in the banks.  Since this increased the Spanish debt, it was self defeating.  So then Europe said no, they would invest direct in banks.  But now they are hesitating, so the interest rate on Spanish debt is up above 7%, again.

In France the voters went against the recent trend in European elections and put the Socialists in charge.  They are charged with bringing down the deficit and preserving social programs, an almost impossible task.  But France is taking a different approach. Unlike other countries who have addressed the deficit issue by cutting government spending, France’s first step is to raise taxes on the wealthy.

The Prime Minister, Jean-Marie Ayrault, who is in charge of domestic policy is doing this.

Mr Ayrault’s response for 2012, outlined on July 4th, was simply to increase taxes by €7.2 billion, mostly on business and the rich. These include extra levies on those who pay the wealth tax, higher inheritance tax, an extra 3% tax on dividends, heavier charges on stock options, higher taxes on financial transactions, banks and oil firms, and a 5% extra tax on big companies. Since his idea is to spare the middle class, he is also scrapping the previous government’s planned VAT increase. Mr Ayrault confirmed that, when he presents the 2013 budget in September, he will introduce a new top rate of income tax at 75% for households earning over €1m.

This tax the rich first policy is enraging to center right and right wing policy folks, but both economically and politically this is better policy.  On the economic front raising taxes on the rich is less destructive than cutting spending, as the rich have wealth with which to replace lost income.

 On the political front Mr. Hollande has now positioned himself to ask for support for government spending cuts.  He cans say he has already asked the well off to do their part. 

On public spending, it could be that Mr Hollande is waiting until the autumn to take the hard decisions. By then, he will have made plenty of gestures, such as taxing business and the rich, that afford him cover for broader and more painful measures. His government will also have begun what it calls “social democracy”, or talking to the trade unions about change. Even by Mr Hollande’s own calculations, he will be up against some unpleasant choices. He has promised to create 60,000 new teaching jobs without increasing the overall public-sector payroll. With job cuts in the police service, security and justice ruled out, this means much bigger cuts somewhere else.

And France does need to cut the public sector.  It is just too large a part of the economy. 

So the likely result is that both sides will turn on Mr. Hollande, the upper income groups because he is raising taxes, the middle and lower income groups because he is cutting spending and everybody because the results will probably be less growth, higher deficits and more unemployment. 

But at least this way Mr. Hollande has given himself a chance, and that’s more then could be said for Spain, Greece, Portugal etc. 

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