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25 October 2011.
Update - France is to raise its reduced VAT rate from 5.5% to 7% in 2012.
As the Euro crisis hits another crescendo this week, all factors point towards France having to turn to taxing its consumers through a VAT rate hike - currently 19.6%. Fear of the bond markets and credit rating agencies are the latest impetus. The prospect of an internal currency devaluation and a chance to improve global competitiveness also add to the attractions. But, most of all, France has history on this subject.
Fear of the financial bond markets and credit rating agencies
France is now starting to see the same piercing focus from the nervous bond markets as Italy did over the summer. Of the six AAA-rated countries in the Euro zone, France is the most indebted. In particular, the high exposure of French banks to Greek debt it raising alarm in the markets. This leaves it exposed to a credit rating downgrade - exactly the threat that pushed Italy into raising its VAT rate by 1% in September.
So France may now have to start showing the financial markets that is has the political will to push through tough austerity measures at home. A VAT rise is one of the ways to do this.
Back door currency devaluation – the USA looks on in envy
One of the many structural rigidities that Euro countries face in the current crisis is the inability to rely on a devaluation of their currency to help reduce the price of goods abroad and so export their way out of trouble. Historically, this has been a regular fall back for fiscally errant countries, such as Greece and Italy. But the Euro has killed off this escape route as the weak countries are locked into a currency buoyed up by the relative strength of the German economy.
VAT rises offer an alternative as an internal devaluation tool. By raising consumption taxes to pay for employment tax cuts, France could simulate an external devaluation by reducing labour input costs. Also, since VAT is not charged on exports, it would give France the sort of deficit stimulus measure that is unavailable to the likes of the USA which has no major consumption tax.
French fiscal history points towards tax rises
France has not run a national budget surplus since the 1970s, nor has it reduced budgetary spending in any budget since the end of the Second World War. Its historical tendency is to tax, and maintain a strong state function. This was underlined last week as the French Assembly voted to introduce a new 3% tax on salaries above Euro 250,000, and 4% on salaries above Euro 500,000.
But the effect of such a measure is limited. A one percentage point increase in VAT would raise approximately Euro 5 billion per annum.
Lagging Europe’s lead in VAT rises
As the table below shows, many countries have already raised VAT in recent years to cope with their ballooning deficits. France's VAT rate is unchanged at 19.6% since 2000.
Ireland – 21% to 23% by Jan 2014
Hungary – 20% to 27% by Jan 2012
Italy – 20% to 21% in Sept 2011
Poland – 22% to 23% in Jan 2011
Portugal – 20% to 23% in Jan 2011
Switzerland – 7.6% to 8% in Jan 2011
UK – 17.5% to 20% in Jan 2011
Finland – 22% to 23% in July 2010
Greece – 19% to 23% in Jul 2010
Spain – 16% to 18% in Jul 2010
Romania – 19% to 24% in Jun 2010
Czech – 19% to 20% in Jan 2010
Germany – 16% to 19% in Jan 2007
Timing is everything
With France coming under close scrutiny by the financial markets who will want to see proof of its willingness to tackle the deficit, it may be that it is only a question of when, and not if, France will raise its consumption tax rate. The idea was floated in 2010 of a 2% rise to 21.6%, but came up against strong public resistance, and the inevitable rise looked to have been put back till after the 2012 Presidential elections. With the Euro crisis hitting new levels, it may be that France has lost the control over the timing.
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