FUZZY MATH COMPLICATES FIRST SEMESTER FRENCH BUDGET

UNCLAS SECTION 01 OF 02 PARIS 005622 SIPDIS SIPDIS PASS FEDERAL RESERVE PASS CEA STATE FOR EB and EUR/WE TREASURY FOR DO/IM TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER USDOC FOR 4212/MAC/EUR/OEURA E.O. 12958: N/A TAGS: EFIN ECON PGOV FR SUBJECT: FUZZY MATH COMPLICATES FIRST SEMESTER FRENCH BUDGET ANALYSIS ¶1. SUMMARY: The central government budget deficit declined nearly 25 percent at the end of the first semester compared with the same period last year. However, the decrease was largely artificial, owing more to recent cosmetic reforms to the French finance law than to cuts in spending. Strong tax receipts do mean that the GOF is likely to reach its fiscal target for an overall budget deficit of 2.8 percent of GDP in 2006. Finance Minister Thierry Breton has downplayed the budget figures, however, since France still has a huge public debt. Nevertheless, the GOF temptation to spend may grow, given the current health of the budget and the imminent start of the electoral campaign season. END SUMMARY. The Declining Deficit -------------- ¶2. On August 9, the GOF announced that the French central government (CG) deficit stood at 26.9 billion euros (USD 34.4 billion) at the end of the first semester - a significant decrease from the 35.7 billion euros (USD 45.7 billion) registered at the close of the first semester 2005. CG budget spending decreased by 16.4 billion euros (USD 12.8 billion) to 131.9 billion euros (USD 103.1 billion). However, the drop-off is not exactly the result of reduced spending but rather the reflection of modifications in budgetary procedures. Under the new finance law (Loi Organique Relative aux Lois de Finance - "LOLF") implemented this year: -- an independent pension account for state employees was established, and its expenses are calculated separately. -- cuts in payroll taxes on low wage positions are no longer considered CG expenses, but now are incorporated into the social security accounts. -- some spending outlays including transfers to local authorities will not occur until the second semester due to calendar changes in the new government finance law. Taking this into account and holding everything else constant, spending decreased only 2.3 billion euros (USD 2.9 billion) between the first semester 2005 and the first semester 2006. Even this, according to the GOF, was an anomaly; officials have assured observers that "spending will get back to its annual rate of progression based on a 1.8 percent inflation rate" in the coming months. Taxes surprise, continue to provide strong revenue -------------- -------------- ¶3. The same budget reforms have had equally misleading effects on tax revenue. CG receipts amounted to 117.4 billion euros (USD 150.2 billion) at the end of the first semester 2006, which represents a drop of 6.6 billion euros (USD 8.4 billion) over first semester levels from last year. Again holding everything constant, however, tax revenue actually appears to have increased 6.7 percent. Earnings from TVA, the largest source for CG tax receipts, driven by exceptionally high domestic consumption, rose 5.7 percent (versus 3 percent in the 2006 budget bill). At the same time, the solidarity wealth tax brought in 3.45 billion euros (USD 4.4 billion),a 15 percent increase, and receipts from the tax on business jumped by 11.6 percent (versus a 1.5 percent increase in the 2006 budget bill). The tax on business was originally expected to produce a 500 million euro surplus over the course of 2006, but already it has managed to amass 2.5 billion (USD 3.2 billion). Income tax receipts increased 3.9 percent, apparently due to more people using the internet to pay their taxes. Most important, in terms of the long term effect on revenue flows, more French are choosing to pay their income taxes on a monthly basis. To date, rising oil prices have not resulted in higher tax receipts. Companies reduced consumption of petroleum products to reduce operating costs. All in all, Budget Minister Jean-Francois Cope announced that 2006 CG tax receipts could be 1 to 3 billion euros higher than expected. Breton holds the line -------------- ¶4. Given such solid tax revenue, some analysts think the GOF is likely to end the year awash with unexpected (and unspent) cash flows. The sharks in Parliament smell blood in the water; there is already enormous pressure on Finance Minister Thierry Breton to officially scale up estimates of CG budget receipts. Fearing a "nest egg" effect among lawmakers, however, he has refused to stray from original estimates. He has pointed out that figures from the first semester of 2006 "were exceptionally low" and should not be used to extrapolate future results. For his part, in the economic newspaper Les Echos on August 14, Cope said that the 2006 overall budget deficit (including central government, social security, and local authorities) was likely to be close to the 2.8 percent of GDP target (well below the 3 percent of GDP target set by the EU). However, Cope also warned about "the long road toward eliminating PARIS 00005622 002 OF 002 public debt." Comment -------------- ¶5. With the beginning of the French electoral campaign, political pressure to increase government spending is sure to mount. For the moment, however, the GOF appears determined to reign in expectations, and continue to use any extra tax revenues to pay down its considerable public debt. HOFMANN#