Cablegate: The Sarkozy Economic Agenda: Fiscal Adjustment

DE RUEHFR #4349/01 2981145
R 251145Z OCT 07





E.O. 12958: N/A

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

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

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.

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.


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