Can Macron’s fiscal plan deliver on all fronts?
The French 5-year budget plan currently under review in the French Parliament deserves careful attention because it is the first one under President Macron and a unique opportunity to address some of the structural weaknesses of the Eurozone’s second largest economy: a high level of taxes and public spending, a competitiveness problem and high unemployment.
In the Institute’s November Review, we simulated the main measures of the plan and analysed their macroeconomic impact. We find that this plan strikes a fine balance between improving the French economy’s medium-term growth prospects, returning public finances to a more sustainable path and not damaging short-term GDP growth. However, the quantitative objectives set forth in the plan of reducing public deficit by 2 per cent of GDP and debt by 5 per cent of GDP by 2022 appear too optimistic.
The budget plan can be summarised in three broad measures: reduction in taxes by 1 per cent of GDP, reduction in public spending by 3 per cent of GDP within 5 years. The tax cuts, which would benefit both households and companies, are designed to encourage investment in productive capital and raise the economy’s competitiveness. They would be partly offset by an increase in ‘green’ taxes, mainly carbon and diesel taxes, which we expect to push up domestic prices. In order to spur future growth, there would also be an increase in public investments of around €50 billion over five years, to reverse the 12 per cent decline in public investment between 2009 and 2016.
Our analysis suggests that the fiscal package has the potential to stimulate the supply side of the economy (via corporate tax cuts) much more than the demand side (via tax cuts targeted on households). By 2022, real GDP would be only a quarter of a per cent higher than it would otherwise have been as the negative effect of the reduction in public spending almost completely offset the positive effect of tax cuts and increased investments (figure 1). But the structural shift towards lower taxes and lower public expenditure would significantly improve growth prospects in the medium term, once the fiscal consolidation is over.
While the ambitious reduction in public spending by 3 per cent of GDP would clearly lead to a consolidation of the government’s budget, the other measures would dampen this effect. The front loading of the tax cuts and the initially moderate spending cuts mean that fiscal policy would actually be expansionary in the first year (figure 2). Interestingly, the French government has just revised up its deficit forecast for 2018. In the following years, as the reduction of public spending becomes broader, the budget deficit would be reduced by up to 1.3 percentage points of GDP in 2022. Even though it goes some way towards achieving fiscal sustainability, it is still less than the 2 per cent in the government’s plan for several reasons. First, the increase in government investment weighs on the deficit. Secondly, the scale of the tax cuts naturally reduces the fiscal consolidation effort. This can be seen in the public debt ratio, which would decline by 2.9 percentage points of GDP, much less than the 5 per cent in the budget plan.
One risk that we highlighted is the timing of the public sector cut. In his term, President Hollande promised a growth of public spending of 0.5 per cent per annum in volume, but could only achieve 0.9 in 3 years (2013-2016). By assigning a large majority of the reduction in public sector expenditure to the second half of the 5-year term, President Macron risks not having enough political capital left to enforce an unpopular measure at the end of his term, when he might be running for re-election and the economy might be in a less favourable part of the business cycle. A smaller reduction in public spending would be positive for GDP and negative for the budget balance.