Tuesday, July 17, 2007


Earlier this day, I came across the article published in Wall Street Journal entitled French Tax Proposal Tests Appetite For Overhaul Sarkozy Promised written by David Gauthier Villars and Marcus Walker. The core issue of the tax reform debate in France is whether to raise sales-tax to compensate for tax cuts in pension and health-care contributions which French companies pay.

Nevertheless, France has one of the broadest social-welfare programs in the world. Also, public spending on health-care and pension schemes in terms of GDP percentage, is one of the highest in the world.

There is a broad empirical evidence that exogenous government spending shocks hurt the competitiveness of the private sector as well as there is a negative correlation between high public spending rate and the rate of seasonlized GDP growth. The private sector also heavily controls exogenous shocks which affect the supply-side of the economy.

The latest proposal of French government is to reduce the contribution rates and raise the VAT. Professor Greg Mankiw gave four tentative answers with predictable scenarios of French tax reform proposals, or rather correction because the real tax reform is when the aggregate tax burden stimulates the economic activity through productivity effects.

One of the particular weaknesses of the France is a tight, lopsided, minimum-waged and heavily rigid labor market while generous pension schemes encourage the adjustment in labor supply to seek benefits such as early retirement which further hampers the overall productivity performance relative to claims and demands from interest groups. Tax cuts to unburden labor assets, of course, trigger greater elasticity of labor supply due to greater benefits from incentives to work and create value-added.

If young had greater incentives to save for the future, this could boost aggregate saving after taking the effects of consumption tax into account. However, there is also an income tax beside the value-added tax rate, which creates an additional bubble to foster the distribution on the revenue side.

One of the possible scenarios coming from tax measures in France could be the short-run macroeconomic disequilibrium in case if nominal wages grew too slow to adjust to their higher level, which could disequil the real wages and temporarily stimulate employment. Distributional effect of tax increase in value-added also varies when it comes to pension fund investment conducted by labor supply.

Cutting contribution rates on health-care and pension system, could foster the investment of the part of the residual income in various pension and investment funds which could possibly yield high returns and contribute a lot to aggregate savings.

Above all, inflexible labor market in France deserve an ambitious tax reform which will eventually realize if the aggregate tax burden is reduced.

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