France's €60 billion "belt-tightening" budget battle: why is the deficit filling plan so controversial?

The growth of Germany, the largest economy in the eurozone, is weak, and France, the second largest economy, is also unsustainable?

Recently, the restructured France government unveiled a draft budget for 2025, known as "tightening the belt", which plans to raise taxes and cut spending for a total of about 60.6 billion euros, hoping to reduce the fiscal deficit to 5% to solve the country's huge deficit.

France Prime Minister Barnier described the huge hole in public finances as a "sword of Damocles" that could "push France, the eurozone's second-largest economy, "to the edge of a cliff."

The draft caused an uproar when it was launched, and it is expected to be hotly debated in the France parliament in the coming weeks. Why is France running such a large deficit? To whom are such large spending cuts going to be "cut"? Will it be successful?

Zhao Yongsheng, a researcher at the National Institute of Opening up at the University of International Business and Economics and a doctoral supervisor at the Sorbonne University in Paris, is conducting research in France. He told CBN that France's high level of public spending is mainly driven by generous social welfare programs, health care and education, and the heavy tax burden is not enough to cover these expenses. Coupled with the economic slowdown caused by the previous epidemic, France's debt has increased significantly.

He told reporters that looking at the current thinking of the new France government, there is a lack of participation in how to integrate into the global green environmental protection and artificial intelligence technology revolution, and the current budget plan is "tightening the belt" on the one hand, and taxation on the other hand, but this is not a way to make the cake bigger, but is still solving the problem of how to distribute in the same cake, "What should be considered more is how to stimulate the France economy and face the problem of technological competition and challenges from the world." ”

Why is France running such a large deficit?

For more than two decades, France has struggled to keep its deficit below the EU's target of 3 percent of gross domestic product.

But France's deficit in 2024 is expected to reach at least 5.6 percent of its gross domestic product (GDP), up from the original target of 5.1 percent and slightly higher than last year's 5.5 percent. Last year, France's fiscal deficit reached 154 billion euros.

At the same time, if nothing is done to control the public sector budget, France's public deficit will reach 6.2% of France's GDP in 2025, which would significantly exceed the EU's requirement of a 3% deficit cap for member states.

The European Union, for its part, has included France in the so-called "excessive deficit" procedure and asked France to provide a plan to reduce the deficit in the coming years.

The reason for the above problems in France is that, on the basis of the high level of public spending, the France government continued to overspend the budget in order to stabilize the economy during the epidemic, but the tax revenue was lower than expected: in 2023, France suffered an unforeseen tax gap of 21 billion euros.

Data released by the National Institute of Statistics and Economic Research of France show that the main reason for the larger-than-expected deficit is that the increase in state revenues has significantly decreased in 2023: by 7.4% in 2022 and by only 2% in 2023. The reasons for this are, first, the slowdown of France's economy; Second, the implementation of the new tax measures has led to a delay in the collection of taxes by the state, that is, after the implementation of the new tax measures, the increase in tax revenue in France in 2023 is only 0.3%, compared to 7.9% in 2022.

Previously, the international credit rating agency Standard & Poor's (S&P) downgraded France's sovereign credit rating from "AA" to "AA-", but this did not have a significant impact on France's borrowing costs, and France bonds have long been seen as an alternative to Germany's government bonds, the safest asset in the region.

This has changed recently, as investor confidence has been hit by the pending political turmoil in the France parliament at the same time as the budget deficit has worsened, and France has found itself the poster child for fiscal imbalances, with debt yields now on par with Spain and moving closer to Italy.

The collapse in France's bonds has now raised the premium of the country's 10-year debt to Germany from less than 50 basis points before the early vote in the France parliament to nearly 80 basis points.

In short, the current situation has affected France's credibility in financial markets, causing its borrowing costs to soar. France also had to make budget cuts in order to continue its development.

France Bank Governor Villeroy said France is in a situation where it is struggling to make ends meet, "so France must spend less and increase revenue a little." First of all, we need to control our spending, because when you compare France to our European neighbors, we have the same social model, the same model of public services, but we spend much more. We need everyone's effort. ”

How is Barnier's prescription

In response to France's current high debt situation, Barnier's "prescription" is that the France government will cut fiscal spending by about 40 billion euros in 2025, mainly including reducing the expenditure of various government departments and the social security system. At the same time, the government will increase fiscal revenue by nearly 20 billion euros by raising taxes on big business and the affluent and raising green taxes. It is reported that the budget is based on the forecast of 1.1% GDP growth in France next year.

For example, the France government sector is expected to cut spending by nearly 20 billion euros in the fiscal spending plan, which accounts for nearly two-thirds of the fiscal spending cuts, mainly by reducing the staffing of the public sector.

At the same time, it will also cut spending on the social security system by 15 billion euros. For example, inflation-linked pension increases will be delayed by six months, and support for apprenticeships and subsidized contracts will be reduced.

In terms of tax increases, the draft shows that more than 400 large companies with an annual turnover of more than 1 billion euros will be subject to a 20% corporate tax, a move that is expected to bring in 8 billion euros in revenue by 2025.

In terms of the controversial "tax on the rich", the draft is expected to impose a temporary surtax on 65,000 "wealthy households" (0.3% of the total) with an annual income of more than 250,000 euros, which is expected to generate 2 billion euros in tax revenue over the next three years.

Zhao Yongsheng told the first financial reporter that this is to tax the richest people, but he doubts that it can be implemented, "If these people are forced to leave France, it will lead to capital outflow, and such a policy is contradictory." ”

At the same time, France will also increase taxes on highly polluting transport sectors, such as the maritime sector, as well as on airlines. However, France's defense budget is expected to be retained.

As mentioned earlier, fiscal cuts and tax hikes have sparked discontent from both the left and the right.

Left-wing opposition lawmakers and unions have criticized the "austerity budget" as unfair, saying it could severely affect millions of low-income families, apprentices, retirees and small businesses. Even the more moderate left-wing union, the Democratic Union of Labor of France (CFDT), criticized Barnier's plan and warned that "public services such as education will deteriorate seriously and our health care system will be further weakened".

Employers' unions have also warned about the potential impact of tax increases on businesses, including the potential job losses. The Confederation of Small and Medium-sized Enterprises (CPME) said the government's plan "will lead to a sharp rise in costs for businesses". The centrists in President Emmanuel Macron's coalition are also very unhappy about this, arguing that tax cuts are a key requirement to keep France competitive in the world.

The budget bill now needs to be approved by the end of the year. Considering that Macron's ruling coalition has lost its majority in the France parliament, the storm that this draft will cause has only just begun. Macron's government could also use the special powers granted by the constitution to pass the budget without a vote, but this could also trigger a motion of no confidence in parliament, the outcome of which is difficult to predict. Fitch downgraded France's rating outlook to "negative" from "stable" on the 11th.

At the same time, France will soon face "rulings" from other credit rating companies. Moody's will release its report on October 25, and S&P will release it a month later.

The challenge for Mr. Barnier is not how to gain outright support, but how to find a balance that will allow the far right to accept these measures and avoid forming an alliance with the left to overthrow the government, Mr. Zhao said.

(This article is from Yicai)