FRANCE Draft Budget Law for 2018 Public deficit reduced to 2.6% of GDP

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No. 17/244 5 October 2017 FRANCE Draft Budget Law for 2018 On 27 September, the government presented its Draft Budget Law for 2018.

9% in 2017), with growth forecasts of 1.7% per year. The public debt ratio is expected to stabilise at 96.8% of GDP.

1 No. 17/244 5 October 2017 FRANCE Draft Budget Law for 2018 On 27 September, the government presented its Draft Budget Law for This budget proposal aims to meet the dual objective of reducing the deficit-to-gdp ratio and supporting growth and employment. The public deficit would reach 2.6% of GDP in 2018 (after 2.9% in 2017), with growth forecasts of 1.7% per year. The public debt ratio is expected to stabilise at 96.8% of GDP. The support measures include 10bn (net) of tax cuts and the first component of the major public investment plan. They are part of a supply-side policy and aim at a sustainable recovery of investment and employment. Significant savings on expenditures ( 15bn) enable both the funding of these measures and the reducing of the deficits. However, the reduction of the structural deficit is very moderate, and it is essentially the favourable economic situation that contributes to the fiscal consolidation. Businesses will benefit from new tax cuts and the reduced taxation of capital (overhaul of the wealth tax and implementation of the PFU). On the other hand, the net impact of this budget on households will probably be very limited, as the tax cuts are offset by tax increases and cost savings (personalised housing allowance - APL, illness spending, subsidised contracts, etc). Key points of the 2018 budget The main objectives of the 2018 Draft Budget law (DBF 2018) are as follows: Support growth and employment The new government s economic policy aims to strengthen both growth and employment in the long term. It is structured around several priorities: - A supply-side policy and a continuation of the recovery effort of the cost- and qualitycompetitiveness of French companies. - Support for innovative projects and promising sectors (digital transition, healthcare, transport of the future, environmental and energy transition, etc.) through a major public investment plan of 57bn over five years. - A reform of labour law and unemployment insurance, going towards a clearer/ flexisecurity model. - The fight against precarity and downgrading, particularly through education assistance, a reform of vocational training and apprenticeship, and various measures to support employment. In 2018, these priorities lead to a 10bn tax cut programme for businesses and households. Keep reducing public deficits The government has reaffirmed the priority of with Europe and the strengthening of the Eurozone. This requires continued reductions in public deficits. It is necessary to reduce France's debt and avoid the risk of an upward debt spiral. French public debt is very high, amounting to 96.3% of GDP in The debt/gdp ratio is now roughly stabilised. However, any bad surprises with either the long-term rates, the deficit, or growth would cause it to rise. Recall that 58% of the State's negotiable debt is held by non-residents and that France is considered a safe haven on the sovereign debt market but remains fragile.

2 Government debt by holders Q our own forecasts, which are 1.7% for 2017 and 1.6% for Our 2018 forecasts are very similar on household consumption (+1.5%), corporate investment (+4%), and exports (+3.9%) % GDP France: Public balance f orecasts -2 Non-residents French banks Others (French) French insurances French UCITS -4-6 However, the deficit-to-gdp ratio remains high (3.4% in 2016), the highest in the Eurozone after Spain, and continues to fuel the increase in the debt ratio. A deficit below 2.3% of GDP in 2017 would be necessary to change the direction of this debt ratio. A gradual reduction of the public deficit is expected, towards 0.2% in In the trajectory, the deficit, estimated at 2.9% of GDP in 2017, would be reduced to 2.6% in After a slight upturn in 2019 to 3%, linked to the shift from the CICE to lower charges, the deficit ratio would be reduced to 1.5% in 2020, 0.9% in 2021, and 0.2% in To finance the support measures according to this trajectory, significant savings on expenditures are put in place, supplemented by an increase in green taxation. A more favourable economic environment The growth forecasts underlying the DBL 2018 are 1.7% in 2017 and 1.7% in The business climate remains better than its longterm average in all sectors. France is benefiting from moderate oil prices, very low interest rates, and a favourable global environment. Its global demand is expected to be up 4% in 2018 as in Exports are expected to be up 3.9% in 2018, despite the rise of the euro. Corporate investment (excluding construction) is recovering quite sharply at 4.1%, linked to the recovery of profits, very low interest rates, and a capacity utilisation rate a little higher than normal. Construction is starting to pick back up. On the other hand, consumption is relatively moderate at +1.4%, despite the recovery of employment (160,000 jobs created in the commercial sector). This is related to a slight slowdown in real wages and social benefits. The savings rate is stable. These forecasts are relatively conservative and in line with the consensus of economists and Public balance Structural balance Cyclical balance Sources: MinFin, CASA. A look back at the 2017 public deficit The public deficit for 2017 is estimated at 2.9% of GDP, after 3.4% in The 3% threshold has therefore been passed, for the first time since In terms of trends, in the light of the audit of the Cour des comptes, this deficit was close to 3.2% of GDP. It is reduced to 2.9% of GDP thanks to new expenditure savings (4 billion euros) and the effect of an economic situation that is better than expected on tax revenue. The deficit reduction is substantial at 0.5 points of GDP over one year and permitted by an improvement in both the cyclical and structural components. The cyclical balance improves from 0.8% to -0.6% of GDP. This balance reflects the effect of the economic cycle on the deficit, particularly on revenues, and is approximated by 0.50 x (GDP potential GDP) / potential GDP, or 0.50 x output gap. With GDP growth of 1.7% in volume and potential growth of 1.25% in volume, the output gap is reduced by about 0.4%, and the cyclical deficit is cut by 0.2%. The structural balance improves moderately, by 0.3 points of GDP, from -2.5% to -2.2% of GDP. A further effort on expenditures was put in place this year through a rather moderate increase in spending of 0.8% in volume and 1.8% in value. The calculation of the spending effort is described in the box below. The increase in potential GDP in value is approximately 2%, therefore fairly close to the increase in spending of 1.8%, and the spending effort is quite limited at 0.1% of GDP. No. 17/244 5 October

3 The new revenue measures take into account a number of tax cuts as part of the responsibility and solidarity pact, which are offset in part, but which decrease the structural deficit by 0.1%. Taking into account the effects of tax revenue elasticity to growth (good dynamics of VAT revenue and taxes on the transfer of properties in particular) and the consideration of tax credits, there is a 0.3% reduction of the structural balance. (as % of GDP) Real GDP Real potential GDP Public balance Cyclical balance Structural balance One-offs Public debt Source: Ministry of the Economy and Finance The spending effort is one of the two components of the structural effort, with the new compulsory levy measures. It is calculated as follows: D GDP pot ( D D GDP pot GDP pot ) where D refers to public spending (excluding unemployment spending, which is highly cyclical and included in the cyclical balance) and GDPpot,potential GDP. The ratio of D/GDPpot is approximately 55%. The spending effort is obtained when spending rises less than potential growth. The 2018 public deficit The 2018 public deficit is again reduced quite significantly to 2.6% of GDP. The cyclical balance further improves from - 0.6% to -0.4% of GDP. As in 2017, GDP growth, expected to be 1.7% in volume, is greater than potential growth at 1.25%. The structural balance will only weakly improve by only 0.1 points of GDP from -2.2% to -2.1% of GDP. A very significant spending effort is in place, but largely offset by a massive tax cut plan. The spending effort is substantial (0.4 points of GDP) and obtained by a very moderate increase in spending (0.5% in volume, 1.5% in value), slightly lower than the increase in potential GDP (1.25% in volume). Details of the main measures are described below. In terms of revenue, the tax cuts total 14bn in 2018 (see below). Taking into account measures to increase levies, the new revenue measures effect decreases the structural deficit by 0.3%. Lastly, the elasticity of tax revenues to growth is estimated to be 1 in Growth support measures The measures to decrease levies total (in net terms) 10 billion euros. Approximately 8bn in tax cuts for households Overhaul of the Wealth Tax, which becomes the IFI, a tax on real estate wealth. Levied only on real estate assets, it will be based on the same liability threshold ( 1.3 M), the same scale, and the same rules (30% allowance on the primary residence) than the current ISF. It would therefore affect a smaller number of owners. Cost: 3.2bn. Housing tax exemption for 80% of households. First exemption phase in Cost: 3bn Decrease in taxation of capital income, with a Flat Tax on capital income (PFU) of 30%, which applies to all investments, with the exception of Livret A accounts and equivalent vehicles. This PFU includes the CSG, which increases from 15.5% to 17.2%. Cost: 1.3bn Expansion of the tax credit for employment of home workers. Cost: 1bn Also noteworthy is the decrease in employee contributions for unemployment (2.4%) and illness (0.75%), funded by an increase in the CSG by 1.7 points (on a broader basis). The overall effect is neutral. It is a transfer of approximately 22bn, with a gain for employees and a loss for pensioners and savers. Given that the contributions will be decreased in two stages, in January and October, this measure, eventually neutral, will generate a surplus of 3.7bn in No. 17/244 5 October

4 Approximately 6bn in tax cuts for businesses Rise of the CICE with an increase in the tax credit rate from 6% to 7% of payroll. Cost: 4bn Corporate tax rate reduced from 33.3% to 28% for up to 500,000 in profits. Cost: 1.2bn Tax credit on payroll tax. Cost: 0.6bn Increase in tax revenue of 4bn Further increase in the price of tobacco (gain of 0.5bn). Merger of diesel and gasoline taxes and increase in the carbon tax (gain of 3.7bn). Cost-saving measures The cost savings are pronounced in The increase in public spending is 0.5% in volume, a very moderate pace, significantly below its longterm trend (2% in volume per year in ). The share of public spending in GDP would thus decrease by 0.7 points to 53.9%. In the reverse direction, certain expenditures are increased as part of the major public investment plan, such as support for professional training for the unemployed in particular. The objective is to train 1 million unemployed people and 1 million lowskilled youth in five years. In addition, certain basic welfare benefits are raised ( prime d activité minimum old-age pension, disabled adult allowance). Stabilisation of the public debt ratio At 96.3% of GDP in 2016, the public debt ratio would be more or less stabilised or even very slightly down as of It is expected to reach 96.8% in 2017 and 2018, climb a little to 97.1% in 2019, and fall to 96.1% in It is calculated by taking into account the financial support for Eurozone States. This quasi-stabilisation of the public debt ratio is explained by the reduction of deficits and a higher nominal GDP growth. The gap is increasingly limited between the effective government deficit and the debt-stabilizing budget deficit (-2.3% of GDP in 2017). The debt ratio would be reduced more significantly in 2021 and 2022, to 94.2% and 91.4%, thanks to very reduced deficit levels and relatively sustained growth. Approximately 15bn in new cost savings Reduction of 1,600 positions in the national civil service. Measures on housing spending (- 1.7bn): structural reform of personalised housing allowance and freezing of rents in social housing. Measures on unemployment spending: reduction of the number of new subsidised contracts to 200,000 compared with 320,000 in 2017 (- 1.5bn); expected effects of the labour law and unemployment insurance reforms on the decrease in the unemployment rate. Healthcare spending: target of 2.3% over year of health insurance spending maintained, a pace significantly slower than its upward trend (-4.2bn). Expenditures of territorial authorities: decline in operating spending (- 2.6bn) (but no reduction in the State s allocation). In addition, the debt burden would be more or less stabilised at a low level of 41bn per year. Comments The 2018 draft budget law and, more generally, the multi-year programme strive to meet two objectives that are theoretically contradictory: cut deficits and support growth and employment. They manage to achieve these objectives thanks to a clear slowdown in public spending. This approach seems desirable to us. Deficits and debt must be reduced, but growth and employment must also be strengthened for the long term. In addition, to fund these priorities, the preference given to the spending effort and not to increases in levies is a positive point. Spending adjustments are generally less unfavourable in the medium term to growth than tax increases. Also, the proportion of public spending in GDP and the tax and social contribution rate are very high, at 55% and 44.4% respectively in 2016, and higher than the European average. It is therefore logical to reduce them at the same time. The support measures should support the ongoing recovery. They are part of a supply-side policy and aim at a sustainable recovery of investment and employment. In 2018, the tax measures on businesses, amounting to 6 billion euros, plus the No. 17/244 5 October

5 CICE and the responsibility pact, will improve margins and cost competitiveness. The increase in public investment will foster innovation, the sectors of the future, and better training for young people and the unemployed. Hence a gradual recovery of quality competitiveness. The lower taxation of capital (overhaul of the ISF and implementation of the flat tax on capital income) should encourage investments in financial assets and strengthen corporate financing. All this will promote investment spending. Employment is the other essential objective of economic policy. It will benefit from the expected effects of lower levies on growth (and therefore on hiring). It should eventually be favoured by the effects of labour law reform. In addition, in the programming act, a series of mechanisms specifically targets lower unemployment: support for professional training, for the unemployed in particular, conversion of the CICE into a reduction of employer social contributions by 6 points (and up to 10 points for the minimum wage SMIC), unemployment insurance reform, return-toemployment incentives, etc. However, most of these measures are planned for 2019 and beyond. The impact of the 2018 budget law on market sector employment will therefore be moderate. The increase in job creations will be significant (160,000) but less than in 2017 (235,000) due to the mitigation of the effects of the CICE and the responsibility pact and the end of the recruitment bonus. Households benefit from cuts to taxes and social contributions, but their total net impact will remain limited. For all households, the reductions of levies (8 billion euros) are offset in part by 4 billion euros in tax increases and, temporarily, by the lag between the increase in CSG and the decrease in social contributions. Market sector employment will continue to grow. In the opposite direction, in terms of social benefits, households will suffer from the announced cost savings (APL, healthcare expenditure, subsidised jobs, etc.). The total effect of fiscal measures on household incomes and consumption is therefore probably very limited. In general, the expenditure saving measures will negatively affect growth. Spending adjustments have a more pronounced short-term effect on activity than tax measures. A decrease in consumption or investment of public administrations has an immediate effect on the GDP. However, the effect of a tax cut is less immediate and offset by a possible increase in savings for households, tradeoffs between different expenditures for businesses (for example, debt reduction or increased dividends at the expense of investment) and the import content of demand. The 2018 budget balance seems feasible to us, with credible growth assumptions. Note that the reduction of the structural deficit is very moderate (0.1 points of GDP) and that the decline in the deficit is largely achieved by the improvement of the economic situation. However, this point should be qualified. Potential growth has been revised from 1.5% to 1.25%, which reduces the spending effort, and therefore the structural balance, and improves the cyclical balance. Ultimately, this finance bill should achieve its dual objective of reducing deficits and supporting growth and employment. Investment and employment are primarily favoured, which will permit a more robust, more sustainable recovery. However, the magnitude of the spending measures will mitigate the expected positive effects on growth, at least in the short term. Crédit Agricole S.A. Group Economic Research 12 place des États-Unis Montrouge Cedex Publication manager: Isabelle Job-Bazille Chief Editor: Armelle Sarda Information centre: Dominique Petit - Statistics: Robin Mourier Sub-editor: Fabienne Pesty Contact: publication.eco@credit-agricole-sa.fr Consult Economic Research website and subscribe to our free online publications: Website: ipad : Etudes ECO application available on App store platform Android : Etudes ECO application available on Google Play platform This publication reflects the opinion of Crédit Agricole S.A. on the date of publication, unless otherwise specified (in the case of outside contributors). Such opinion is subject to change without notice. This publication is provided for informational purposes only. The information and analyses contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crédit Agricole S.A. and its affiliates shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crédit Agricole does not warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based, although such sources of information are considered reliable. Crédit Agricole S.A. or its affiliates therefore shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising from the disclosure or use of the information contained in this publication. No. 17/244 5 October

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