THE SARKOZY ECONOMIC AGENDA: FISCAL ADJUSTMENT

UNCLAS SECTION 01 OF 02 PARIS 004349 SIPDIS SENSITIVE SIPDIS PASS FEDERAL RESERVE PASS CEA TREASURY FOR DO/IM TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER USDOC FOR 4212/MAC/EUR/ E.O. 12958: N/A TAGS: EFIN ECON PGOV FR SUBJECT: THE SARKOZY ECONOMIC AGENDA: FISCAL ADJUSTMENT REFS: A) PARIS 03401 B) PARIS 04315 C) PARIS 04327 ¶1. (SBU) SUMMARY: President Sarkozy took office pledging to reduce France's public debt of nearly 65% of GDP and to boost growth rates by one percentage point. Annual budget deficits have moved below the Maastricht criteria of 3% of GDP as a result of increasing revenues rather than cuts to public spending (which represents over 52% of GDP). France's longer-term financing challenges include chronic deficits in its social security system (which includes health and pension costs). Faced with flagging economic growth, Sarkozy has provided fiscal stimulus through early tax cuts in hopes that his broader reform agenda will help deliver growth and bring the budget into balance by 2012. On the expenditure side the government is seeking to rationalize and reduce the footprint of the public sector. Reforms planned for 2008 would increase individuals' responsibility for health care and retirement in order to lessen the public sector burden. This is the third of three cables on economic measures introduced by President Sarkozy (see refs B and C). END SUMMARY. Tax Breaks First, Budget Balancing Later -------------- ¶2. (SBU) In one of his first moves as president, Sarkozy made waves by attending the June Euro-group meeting of finance ministers and declaring that economic growth was his first priority. Consequently, France's pledged target to balance its budget by 2010 would be pushed back to 2012. The GOF subsequently introduced a package of tax cuts "to encourage work, employment and purchasing power" (ref A) at an estimated cost of 10 - 11 billion euros (0.6% of GDP) in 2008 (and up to 13 billion euros per year once fully implemented). The package includes tax breaks for overtime work, deductibility of mortgage interest on principal residences, wealth tax credits up to 50,000 euros for investments in small businesses held for at least five years, and increased exemptions from inheritance taxes. ¶3. (U) The 2008 government budget, announced in early October, projects the overall government deficit (including central government, social security, local authorities) to decrease to 2.3 % of GDP in 2008 from 2.4 % this year. However, private sector economists believe the government's assumption of GDP growth between 2.0 and 2.5% for 2008 to be overly optimistic. Reducing the Size of the State -------------- ¶4. (U) The Sarkozy government plans to cut the size of France's civil service by not replacing one out of three retiring civil servants (trimmed from one out of two promised in the presidential campaign) in 2008, and one out of two by 2012. Some 22,800 jobs will be eliminated in 2008, representing a savings of 458 million euros. Observers say that 30,000 to 40,000 jobs would be eliminated each year by 2012, with one parliamentarian estimating that up to 300,000 jobs could be eliminated by the end of Sarkozy's five year mandate. ¶5. (U) During the campaign, Sarkozy said that he wanted to reduce the number of civil servants to free up resources for a better-trained, better-paid government service. He called for a "revolution" in the broad public service sector by 2012, and suggested introducing private sector practices, such as buy-outs, to trim the bureaucracy. Civil servants would be evaluated and compensated in line with private sector practices. Current government plans will simplify the civil service, reducing the current 500 professional categories (ranging from diplomats to nurses) to 200. On October 1 the government kicked off a broad consultative process, focusing on values, missions and the way work is organized in the civil service. Unions representing civil servants support improvements in compensation and training, but are skeptical that shrinking the public sector is in their interest. Rationalizing Social Security -------------- ¶6. (U) In order to reduce the chronic deficits in the off-budget health care system (projected to be 8.9 billion euros in 2008),the GOF is introducing measures to cut health benefits. The 2008 draft social security budget puts new limits on reimbursement rates for medical procedures and services provided by specialists. A co-payment system ensures that patients bear a (still modest) portion of the cost of treatment. In addition, system spending for generalist care will receive the smallest increase (2%) of all categories of health care. The changes are designed to save 850 million euros annually in generalist care. PARIS 00004349 002 OF 002 Continuing the Reform of Pensions -------------- ¶7. (U) The October 18 nationwide strike of transport and energy sector workers, considered the first test of the Sarkozy government's mettle, underscores the challenge of reforming the pension system. The strike followed the initiation of government/union consultations on proposals to reform the "special regimes," which allow workers in a number of once-dangerous professions to retire early and with higher pensions. The objective is to have all workers contribute to the pension system for 40 years to qualify for full pensions. The current pay-as-you-go system for special regimes has a chronic shortfall (5 billion euros in 2006). (The ratio of workers to retirees is 50% in the special regimes compared with 64% in the general pension system). ¶8. (U) The government is also looking to plug growing budgetary gaps in the pension system for private sector workers (estimated at 4.7 billion euros in 2007, 8 billion euros in 2010 and 43 billion euros in 2020). The Advisory Council for Pensions, an independent government agency, projects the pension system deficit for private sector workers will total 1.0 % of GDP in 2020 and 3.1 % in 2040. Among other measures, the government plans to eliminate compulsory retirement before the age of 65. President Sarkozy has announced that, beginning in 2008, most categories of civil service employees will have to work 40 years to qualify for full benefits instead of the 37.5 years heretofore required. Making Government More Efficient -------------- ¶9. (U) To achieve greater efficiency, the Sarkozy government is reorganizing various administrative agencies, consolidating ministries and encouraging performance-based standards in government. The Finance Ministry has taken advantage of recently-implemented rules allowing ministries to use personnel budget savings for other purposes by cutting nearly 3000 staff positions and using the resources for needed operational improvements. Although improving efficiency is hardly controversial, some measures are likely to offend well-organized constituencies. A proposal revived by the Sarkozy government to merge the two agencies that assess and collect France's taxes (and eliminate over 6000 jobs in the process) led to the resignation of the then-budget minister when first mooted in 2000. Comment: -------------- ¶10. (SBU) Although successive governments have made incremental progress on fiscal sustainability (notably on pension reform),the Sarkozy government faces critical challenges in putting France's financial house in order. The president appears willing to risk larger near-term deficits -- and the opprobrium of EU partners -- in order to build support for a reform agenda he hopes will boost growth and balance budgets over the longer term. But whether his proposals to tackle public sending will bear fruit is unclear. The special regimes pension reform is expected to be a critical first test. In contrast with the 1995 strike over similar retrenchment, the French public endorses the idea that workers in both public and private sectors will have to work longer to qualify for full pensions. The fate of other proposals, including cuts to the civil service, will depend on Sarkozy's ability to maintain political momentum. The considerable outcry over very modest proposed co-payments for medical care indicates the sensitivity of the French public to perceived cuts in public service, and the considerable challenges that lie ahead for Sarkozy. STAPLETON