Economic Survey of France 2005: Making the fiscal system sustainable and more efficient

 

The following OECD assessment and recommendations summarise Chapter 2 of the  Economic Survey of France 2005 published on 16 June 2005.

What should be done about the budget deficit?

The public sector deficit was reduced from 4.2% of GDP in 2003 to 3.6% of GDP in 2004 and the French authorities' objective is to bring it below 3% in 2005. A large part of the likely fall in 2005 is due to a transfer from the public owned electricity company EDF of some 0.5% of GDP, which will not generate a sustained improvement of public finances. The deficit may nevertheless remain over 3% of GDP this year and any reduction in 2006 is likely to be small. Current OECD projections suggest that the deficit will not be under 3% of GDP in 2006. Without further measures, the deficit is likely to diverge from the government's latest stability programme which was itself not very ambitious in its target for the debt ratio, now around 65% of GDP and unlikely to fall rapidly in the near future. France thus risks being inadequately prepared for the long-term pressures on health and pension spending that ageing will generate, despite important recent reforms. To make room to deal with these spending pressures, it is essential that the ratio of public debt to GDP decline strongly in the medium term.

In 2004 the government introduced measures that it hopes will produce substantial savings in public expenditure, mostly as from 2006. These included a reform of the public health care insurance and delivery schemes, as well as certain measures to reduce public sector employment. In fact, although the health reform has the potential to improve overall health care, it is not clear that it will generate as many savings in public expenditure as expected, in the short-term; meanwhile, implementation of an earlier reform of the hospital system, also intended to control public expenditure and to improve efficiency, is turning out to be slower than planned. Following through on these is particularly important because, as the experience of other industrialised countries shows, strong upward pressure on health spending will continue in the long term. As for public sector employment, despite some first steps to reduce numbers, the government has not yet taken sufficient measures for a progressive reduction in employment levels in the medium term, and increases in public sector salaries decided recently limit the ability to control the wage bill. Given the growing pressure for age-related spending, tight control of direct government expenditure, including cuts in employment that should take advantage of the large number of civil servants currently retiring, and restraint on wages and salaries, are needed.

What public spending reforms may make a difference?

The framework law on finance laws (Loi organique relative aux lois de finances, or LOLF) is to come into full effect in the finance law for 2006, whose preparation has already begun. The LOLF will allow improvements in the transparency of public sector accounts, improve the ability of the authorities to set spending priorities and increase the sense of responsibility among public managers by promoting a results based outlook. Its implementation should reinforce control of central government expenditure. The health sector reform introduced measures aimed at reinforcing the sense of responsibility of patients and health sector workers, tools for promoting best practice, and a deep reform of management of access to health care. This reform, to be complemented by the forthcoming framework law on the financing of social insurance, includes provision for mid year corrections if the early-warning committee (Comité d'alerte) observes expenditure overruns; for this to work, the government must be ready to impose unpopular cuts in the prices of health services and goods or in health service entitlements at short notice if increases in contributions are ultimately to be avoided. The government will also have to ensure that the tighter control mechanism is not accompanied by a relaxation in the annual expenditure targets.

Central government expenditure has grown less than that of local and regional governments. This is only partly due to the government passing some responsibilities to lower levels, since there has also been underlying growth in local expenditure. Tight controls on borrowing by local government have not prevented this: some of the expenditure restraint that borrowing restrictions should generate has been undermined by the fact that central government has increasingly subsidised the apparent burden of local business taxation (the taxe professionnelle) by paying a substantial part of the notional tax to sub-national governments from central government revenues, with rates set by the local and regional governments themselves. The reform of the taxe professionnelle must meet its objective of ensuring that the central State government no longer pays local taxes on behalf of enterprises.

Some transfers of spending responsibilities to sub-national government have in recent years been accompanied by the transfer of equivalent amounts of certain specific taxes, or parts of them. However, some programmes transferred have centrally-determined characteristics, such as using part of the petroleum tax to cover the cost of certain in-work benefits. These methods, although respecting a compensation principle which reasserts the financial autonomy of subnational government, run the risk of not creating an appropriate matching of resources to needs in the long run; centrally mandated programmes whose administration, but not design, is decentralised should be financed by direct transfers financed out of general taxation. As far as local and regional governments own spending programmes are concerned, local taxes provide the main share of their resources. The proposed reform of the taxe professionnelle should improve the distribution of the tax burden between firms and better reflect the impact of economic activity on local government costs. It should also ensure that central government no longer pays local taxes for and on behalf of companies, as it does at the moment.

General government spending by level of government
As per cent of GDP


 


1. Central government plus ODAC.
2. Excluding current transfers between public administations (D73) and capital transfers (D9 exc. D91, D995).
Source: INSEE, Comptes nationaux, Rapport sur les comptes de la Nation 2003.

What tax reforms are needed?

The system of taxation in France is characterised by its high visible rates, the still large number of specific taxes, the number of institutions involved in calculating, collecting and allocating revenues, and the additional complexity engendered by the large number exemptions and allowances for certain activities, sectors or agents. This also shows up in internationally high administrative costs even though they have diminished since the mid 90s. Some rationalisation and measures to reduce the burden on taxpayers have been undertaken in recent years, but a more fundamental reform of the entire system of taxation seems called for.


Tax to GDP ratio in OECD countries
2003

1. Tax revenues from OECD National Accounts are not fully comparable with the information found in OECD Revenue Statistics. The divergences are due to a variety of general and country specific factors. The most important  are the following: i) differences in accounting periods and methods; ii) voluntary social security contributions, which are fairly large for some countries (including Germany), are included as tax  revenues in the National Accounts but not in the Revenue Statistics; so are the employer social security contributions for government employees; iii) imputed government contributions are not included in the Revenue Statistics; iv) inheritance and gift taxes are not considered as taxes in the National Accounts while they are included in the Revenue Statistics; v) for EU countries, VAT and customs revenues are shown net of the amounts transferred to the European Commission in the  National Accounts while the Revenue Statistics show gross data.
Source: OECD National Accounts; OECD Revenue Statistics, 1965-2003.

To start with, it is necessary to continue efforts to reduce the number of agencies involved in calculating and collecting taxes and charges and to reduce administrative costs to taxpayers. The introduction of deduction at source for income tax would work in this direction though there would be short-term transition problems. Some otherwise useful reform measures may be prevented by the separation between social security finance and central government finance, even though this separation is not always strictly respected (the CSG is an income tax used for social security finance). In the long-term, nevertheless, merging the collection of social security contributions, the CSG and personal income tax could produce significant cost savings.

Reducing the use of tax expenditures would also produce cost savings, both directly for tax administration and indirectly through increased transparency of the system for tax payers. The government should significantly reduce the use of tax expenditures, along the lines suggested by the Conseil des Impôts in 2003. The government intends that tax expenditures be limited in time by using five-year sunset clauses. Further steps could be to restrict the introduction of such measures to finance laws, subject to the Constitutional Council's opinion, to improve initial estimates of their effects on revenues and behaviour and to ensure systematic ex post evaluation. Special measures such as tax credits or deductions for specific types of company expenditure should be limited to areas where there is a strong and demonstrable benefit for society. This is true for both the national corporate tax and for the local taxe professionnelle; eliminating such tax breaks would allow lower basic tax rates, stimulating entrepreneurial activity in general and reducing the need for companies (especially small ones) to devote resources to tax accounting in order to minimise their liabilities. Tax distortions between different sources of financing can also constrain the expansion of newly-created enterprises who need to raise new capital; notably, the remaining asymmetry between the treatment of dividend and interest payments in the interaction between the corporate and personal income tax systems should be reduced.

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A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.

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