Cablegate: Fuzzy Math Complicates First Semester French Budget

VZCZCXRO7769
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHFR #5622/01 2341645
ZNR UUUUU ZZH
R 221645Z AUG 06
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 0555
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

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

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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#

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