US embassy cable - 05PARIS175

UNCLAS SECTION 01 OF 03 PARIS 000175 
 
SIPDIS 
 
PASS FEDERAL RESERVE 
PASS CEA 
STATE FOR EB AND EUR 
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, PBIO 
SUBJECT: 2005 CENTRAL GOVERNMENT BUDGET, PART III: 
EPILOGUE 
 
REF:  (A) Paris 8860 ; (B) Paris 9110 ; (C) Paris 8612 
 
1. SUMMARY.  This is the last in a series of cables on the 
2005 GOF central government (CG) budget.  This cable 
analyzes the questionable assumptions upon which the budget 
bill was based, and analyzes the budget as finally passed. 
Final passage of the 2005 budget law occurred December 30 
with publication in the French Official Journal.  Despite 
expressing strong confidence in its scenario, the GOF 
nonetheless announced in January it would restrain 
spending.  In a marked shift of economic policy, the 
government has decided to subsidize job creation.  END 
SUMMARY. 
 
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Unexpected Spending Related to Oil Prices 
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2.  The 2005 French budget was signed into law and 
published in the French Official Journal on December 30. 
No significant modifications were added to the bill prior 
to passage, so details are as described ref B.  The budget 
assumptions, therefore, incorporate the biggest 
uncertainties arising at the end of the year, namely, the 
rise in value of the euro and increased oil prices.  The 
budget also assumes significant one-time receipts will be 
realized after partial privatization in 2005 of publicly 
held energy companies EDF and GDF.  EDF will transfer 7 
billion euro to the CG to pay pensions in the future for 
EDF's employees, who currently have a status similar to 
civil servants. 
 
3. In France, oil prices are exacerbated by a very high 
domestic tax on petroleum products ("Taxe interieure sur 
les produits petroliers - TIPP). Former Finance Minister 
Sarkozy promised to provide 123 million euros support to 
groups hard-pressed by high oil prices, including farmers, 
fishermen, and truck drivers.  The GOF also planned to use 
value-added tax (VAT) receipts on oil to reduce the effect 
of the TIPP due to windfall VAT receipts.  After opposition 
arose from other EU members who argued such plans should be 
coordinated within the EU to avoid threatening competition, 
Sarkozy announced the creation of a special commission to 
examine a decrease in the TIPP.  Such a decrease was not 
examined as persistent oil price increases caused a 
decrease in gas consumption, reducing expected windfall VAT 
receipts.  Eventually, the GOF decided to pay an extra 
benefit of 70 euros to retirees receiving minimum old-age 
allowance ("allocation vieillesse minimum") to help them 
pay for heating bills.  Nevertheless, these new 
expenditures did not get added to projected 2005 
expenditures since the GOF was able to fund them with the 
windfall VAT receipts. 
 
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Despite High Oil Prices and Euro, GOF Sticks to its 
Optimistic 2.5% GDP Growth 
--------------------------------------------- ------ 
 
4.   Increasing oil prices and euro both cast a shadow over 
the GOF scenario when it introduced the CG budget in 
September.  But the new situation failed to dampen the 
GOF's 2.5% GDP growth forecast.  Since September, Prime 
Minister Jean-Pierre Raffarin has kept repeating that GDP 
is growing at a 2.5% annual pace, and he has never altered 
that prediction despite poor third quarter GDP growth (ref 
C).  He acknowledged that the rise in oil prices was high, 
but argued that business confidence remains high as well. 
Recently, new Finance Minister Herve Gaymard opined "we 
have a forecast of 2.5% growth in 2005 which is realistic." 
The slide in the dollar "should not continue" and is an 
issue for U.S. and Asian monetary authorities, as well as 
European ones.  The OECD forecast a recovery in the French 
economy in 2005, but downgraded its GDP growth forecast for 
France to 2.1% from 2.6%. 
 
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Left and Part of Center-right Criticize the Budget 
--------------------------------------------- ----- 
 
5.  Communists highlighted "insufficiencies of a budget 
that is far from addressing emergencies and needs related 
to rising unemployment and poverty."  Former Socialist 
Finance Minister Dominique Strauss-Kahn described the 2005 
CG budget as a budget with no economic strategy, based on 
an unrealistic 2.5% GDP growth forecast.  His guess is that 
GDP growth will not be higher than 2 percent in 2005 as oil 
prices will be closer to USD 45 per barrel than USD 36.5, 
the assumption of the GOF forecast.  He also stated that 
the purchasing power of the French would fall in any case 
since social taxes will be increased by 6 billion euros 
(the social security deficit will be reported separately). 
He also warned against a net decrease in youth job 
creation, and no social progress since inheritance taxes 
will benefit less than 20 percent of the population and be 
costly (600 million euros).  Socialists and Communists 
criticized inheritance taxes and a 50 percent increase in 
the tax relief for employing domestic help, as gifts to the 
GOF's electorate.  In a letter to Le Monde newspaper, 
Sarkozy denied that the reform of inheritance taxes would 
only benefit the rich, arguing that 70 percent of the 
public approved the change.  "The tax cut stems from the 
need not to penalize initiative, not to discourage 
individual effort, and it responds to the concern of many 
people that the fruit of their work should be handed on to 
their heirs." 
 
6. To respond to the criticism from the left, the 
Conservative majority made its "Social Cohesion" plans a 
priority, backtracking from its liberal (in the French 
sense) strategy of no longer subsidizing job creation to 
fight unemployment. 
 
7.  The center-right Democratic Union party (UDF) announced 
it would abstain on the budget if the zero-interest loan 
scheme to home-buyers ("PTZ") was eliminated, the increase 
in the tax relief for employing domestic help did not take 
into account the size of families, and if the GOF 
maintained its reform of rights to pensions paid to 
surviving spouses of retirees ("pension de reversion"). 
This new reform was planned as part of the 2005 social 
security budget.  Eventually, UDF passed the budget as the 
GOF backtracked on the pension issue, and listened to UDF's 
concerns about PTZ and the tax relief for employing 
domestic help. 
 
8.  Deputies contested several technical provisions, 
resorting to the Constitutional Council, which can review 
bills and strike unconstitutional clauses before their 
passage.  The Council suppressed a clause in the budget 
bill limiting the effect of measures designed to prevent 
job outsourcing.  As a result, all companies (not only 
companies located in certain zones) can benefit from 
professional tax deductions if they do not move jobs 
overseas.  The Constitutional Council also removed an 
article on the role of the Tax Council ("Conseil des 
Impots"), deeming that it was not a budget issue.  The 
initial idea proposed by former center-right minister Jean 
Arthuis was to transform the Tax Council into a "Conseil 
des Prelevements obligatoires" that could examine the 
spectrum of all taxes including social contributions (44% 
of GDP), and how taxes at large affect taxpayers.  The Tax 
Council is administratively related to the Cour des Comptes 
(roughly equivalent to the GAO). 
 
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COMMENT 
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9.  The main problem with the budget is that the GOF 2005 
GDP growth forecast is too optimistic.  Even if the French 
economy grows at 2.5 percent, the resulting higher tax 
receipts might not be sufficient to reduce the budget 
deficit if even just a few budget expenditures are 
undervalued.  2005 CG expenditures amount to 242.7 billion 
euros, setting the deficit at 45.2 billion euros.  The 2005 
CG budget deficit could even deteriorate in absolute terms 
compared to 2004, since the 2004 CG deficit was revised to 
49.3 billion euros (ref D), and eventually adjusted to 49.5 
billion euros by the Parliament.  The GOF announced in 
January 2005 it is limiting spending by 4 billion euros to 
ensure stability in expenditure growth. 
 
10. Another troubling aspect of the budget bill is the 
reliance on one-time budget boosts.  There is nothing wrong 
with the one-off payment from EDF and GDF, which is a 
financial transfer similar to the 1997 transfer from France 
Telecom, but it cannot be repeated every year, nor resolve 
the structural budget deficit associated with the sheer 
size of the GOF. 
LEACH