France’s Income Tax Furore

The French 75 is a champagne cocktail, allegedly created by World War One fighter pilot who felt that champagne lacked a little in strength. The kick was so powerful that he named it after a French 75mm howitzer artillery piece, but it might as well have been named after Francois Hollande’s proposed top tax rate, for from its very suggestion it has been met with a stinging backlash.

On Saturday the Conseil Constitutionnel rejected his plan to raise the tax rate to 75% on income above €1 million, suggesting that it breached French law by targeting individuals, rather than households, meaning that two families who earn the same income could incur different tax burdens, depending on their individual earnings.

Given the turbulence in France at the moment, it is a little surprising that the top tax rate has received so much attention. After all, it would have only affected around 1,500 people, and its revenue raising ability was not that significant; there are a host of larger austerity measures. There are also more pressing issues for France to deal with. The nation is facing a ’competitiveness shock’, anaemic growth, a high unemployment rate and social problems in the banlieues, not to mention the ongoing issues that the Eurozone crisis continues to cause.

At a glance the negative press about this seems strange. Indeed, the tax was popular with the general public; but that is perhaps indicative of France’s unique relationship towards inequality and capitalism (Indeed, in an IFOP poll in 2010, when presented with the statement ’Capitalism is a system that works well and should be preserved’, just 10% of French respondents said they agreed, compared with 55% in the USA and 65% in China).

However, even though the tax attracted a lot of criticism, the Conseil did not actually mention the high rate as a reason for its rejection, only that it was unfair because it was posed upon individuals. In his new year’s address Mr Hollande did not directly mention the Conseil’s decision, yet made a reference about ’asking more of those who have most’, which suggests that he will not back down over this issue, even though it now faces a delay of at least a year. It is not yet clear whether the scope of the tax could be changed to cover households rather than individuals. This would expand the number the tax affects to 15,000 people. Jérôme Cahuzac, the budget minister, also suggested that the tax could be applied to households with the threshold also being raised to €2m, but that would be likely to have a detrimental effect on the likely take.

Even if it is not significant in terms of revenue, the tax seems emblematic of a President and government that seem naive in their hostility towards business. Mr Hollande’s government has already been forced into a u-turn over doubling the capital-gains tax to 60% after an online revolt by 65,000 people. When he was elected, the French public saw him as a candidate who could end the ’unnecessary austerity’ that Sarkozy had put upon France; he campaigned on a promise to tax the rich at 75%, stop industrial closures and face down the ’world of finance’. Interested observers from abroad, on the other hand, hoped he could add some breadth to the debate over the direction of Eurozone policy which lies largely in the hands of Angela Merkel, who favours swingeing austerity. So far he has achieved neither.

His government has been especially prone to attacking business and wealth. This is best typified by his industry minister, Arnaud Montebourg, who was left somewhat embarrassed in attempts to stop ArcelorMittal closing 2 blast furnaces in Lorraine. His tack swung from initially boasting that France could do without the company to threatening to nationalise the firm. He has also taken to dressing up in a traditional striped Breton top to promote French made products. The Prime Minister, Jean-Marc Ayrault, suggested that those who are leaving to Belgium for tax reasons were ’greedy’ and that ’these individuals are leaving because they want to get even richer.’ These ministers are both well versed in the rhetoric of the moment in French politics – that all wealth is bad and businesses are dangerous. Even Francois Hollande famously claimed he that ’didn’t like the rich.’

Luckily, this populist sentiment has been tempered with a genuine desire to reform. Mr Hollande and Mr Ayrault have said they will adopt a lot of the proposals put forward by businessman Louis Gallois in a government sanctioned report on competitiveness. Mr Hollande has also promised 2 years of labour market reforms, which are relatively rigid compared to France’s competitors. France may also need to improve some facets of the 35 hour week to make it more business friendly, but this policy is fairly popular with the public and a key pillar of Socialist policy. It is telling that when the PM proposed that a 39 hour week might be an option French newspaper commentators suggested that Mr Ayrault might be on the ”slippery slope” taken by his earlier predecessor Edith Cresson, who was dismissed after 11 months in 1991-2 after a series of mishaps. Reforming the labour market will be crucial in tackling France’s historically problematic unemployment rate, which is currently above 10%.

All in all, the tax is ultimately more of a symbolic issue than a real idea for sorting France’s somewhat unique economy. More attention by those in power needs to be paid towards whether France can become more competitive and less reliant on the government to create growth in the long term, and not whether national hero Gérard Depardieu (who is moving to Belgium for tax reasons) is a traitor or not. Mr Hollande likes to be known as ’Mr Normal’, but he must be prepared to take more difficult and brave decisions in order to keep France away from trouble. He needs to offer a viable centre-left alternative to the problems that face both France and the Eurozone, but too often he is easily swayed by populism, and he and his cabinet lack political experience.

The Economist repeatedly suggests that the President should take his lead from Gerhard Schröder, another centre-left leader, who undertook the task of difficult reforms which ultimately left Germany with low labour costs and a strong economy. The problem is that the voters did not reward Mr Schröder with re-election after making these tough decisions. The now infamous phrase from Jean-Claude Juncker will probably resonate with Mr Hollande; ’We all know what to do, we just don’t know how to get re-elected after we’ve done it.’ Mr Hollande may have to put up with lower poll numbers if he wants to get France back on track.