French budget heavy on taxes, could hurt Hollande

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By SARAH DiLORENZO, Associated Press

PARIS (AP) — France's new budget may be the worst of both worlds. It lacks the serious spending cuts that economists say are needed to put the country on a path to growth — but also doesn't unleash the wave of stimulus that voters expected from their Socialist president, Francois Hollande.

The 2013 budget includes his infamous pledge to tax the ultra-rich at 75 percent, and it meets an important requirement: It will reduce France's deficit to 3 percent of its gross domestic product, a major Hollande campaign promise and the level that will halt the rising tide of the country's enormous debt.

But it's not making anyone happy.

French workers who are watching factories close and unemployment climb say Hollande is not doing enough to stop either event. Hollande may have spared his countrymen the massive budget cuts that neighbors Spain and Italy are enforcing, but people are still turning against him.

After a brief honeymoon following his May election, Hollande has seen his popularity slump right along with France's economy. Two polls this month, by Ifop and BVA, showed most respondents are unhappy with the job that Hollande is doing.

The reasons they gave varied widely, from those who say he's not doing enough to reform France to those who say he's not doing enough to make it a fairer place.

The budget also represents a major backtrack for Hollande, who won the presidency by campaigning against the kind of Europe-wide austerity championed by his conservative predecessor Nicolas Sarkozy and German Chancellor Angela Merkel.

On the other hand, economists say Hollande is just eking by with this budget and that drastically raising taxes does nothing to improve France's global competitiveness, which is fading fast. Business leaders complain he'll scare away both the rich and the investment the country desperately needs.

"France is sick from a model that isn't viable," said Guillaume Carou, CEO of Didaxis and president of the Club of Entrepreneurs, which represents 15,000 small businesses. "But (the government has) chosen to keep it, that's what the 2013 budget reveals."

The government's budget — which relies heavily on tax hikes to fill a €30 billion ($38.8 billion) hole and rein in the deficit a bit — also lacks any sweeping reforms of France's labor market.

Finance Minister Pierre Moscovici rejected such criticisms.

"To those who say to us, 'there are no cuts in this law,' these numbers constitute a formal denial," he told reporters. "Spending cuts assume reforms ... which take time."

The problem is that France may be running out of time.

The French economy, the second-largest among the 17 countries that use the euro, has not grown for three straight quarters, the national statistics agency confirmed Friday. Its GDP stands at €1.8 trillion ($2.2 trillion). Unemployment has been on the rise for more than a year and stands at 10.2 percent.

If France doesn't drastically reduce its debt — which is more than 90 percent of its GDP — and dramatically loosen its labor market quickly, growth will likely continue to slide. Italy, Spain and Greece — which are using the crisis to modernize their economies — could eventually pull investment away from France.

To restart growth, France needs to both dramatically reduce its spending and lower its tax burden, one of the highest in the world, economist Marc Touati said.

"Either France finds growth and modernizes its economy in order to cut unemployment, or it continues to be in denial and unemployment will explode," he said.

If investors think France isn't doing enough to clean up its act, they'll start charging the country more to lend to it.

The budget shows the perverse way in which France has benefited from the debt crisis plaguing the eurozone. Because France has been considered a relatively safe haven among the mess, its borrowing rates are historically low and dropping. And the 2013 budget made use of that: The assumption is that the average interest rate for next year will be lower than the one for this year. That netted the government around €2 billion ($2.6 billion) — for nothing.

While the budget makes €10 billion ($12.9 billion) in cuts — in everything from administrative costs to the defense budget — it actually holds next year's spending even with this year's. The cuts were necessary because spending would have automatically increased because of salary hikes and inflation.

It also levies a series of taxes, mostly on the rich and big companies.

The most famous is a 75-percent tax on income earned over €1 million ($1.3 million). At the moment the current top rate of tax is 41 percent. The measure, which will run for two years, is largely symbolic — it would only hit a tiny number of people and barely make a dent in the deficit, bringing in an estimated €100 million to €300 million a year— but it has caused fears that the rich would flee France for friendly tax climates.

There are other measures that also hit the rich and large businesses, like increases in the capital gains taxes and a bigger bite for companies that distribute profits in dividends. Many voters see these as a good thing that the well-off take a disproportionate share of the tax burden.

Companies, however, complain that these measures penalize the very people who could reduce unemployment.

Prime Minister Jean-Marc Ayrault rejected that characterization, insisting that the budget would win the battle against unemployment.

"It's a budget that aims to inspire confidence and to break the debt spiral that keeps growing and growing," he said after it was presented to the Cabinet.

The budget is built around an expectation of 0.8 percent growth for next year. If growth misses the projections, more cuts could be needed later.

Moscovici conceded that most economists predict the French economy will grow just 0.5 percent, but said if the European debt crisis stabilizes, France would meet its targets.

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Associated Press writer Angela Charlton and Sylvie Corbet contributed to this.

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