Sunday, July 15, 2012

Will The French Be Able To Tax Their Way To Prosperity?

The newly elected Socialist government in France plans on taking a path that seems almost certain to fail. Increasing the tax rates on the rich and upon big businesses seems like an unlikely route to prosperity. The tax increases include extra levies on those who pay the wealth tax, a 75% rate for households earning over €1m, higher inheritance tax, an extra 3% tax on dividends, heavier charges on stock options, higher taxes on financial transactions, banks and oil firms, and a 5% extra tax on big companies. 

The increased revenue is needed in order to meet deficit reduction targets of 4.5% of GDP this year and 3% next. Yet France desperately needs to grow their economy. The unemployment rate is about 10% and trending upward and business activity is flat. Increasing taxes is almost certain to restrain job creation and economic growth.

Among the various methods of reducing the deficit, the Socialist Party is taking the most politically palatable. Given how poorly reducing spending has worked out for Greece, it is no surprise that politically unpopular austerity measures have not even been put upon the table by the new government. Increasing taxes on the middle class would be equally unpopular. Thus, while the French increases in taxes on the rich and big business are likely to send the country into recession, the new government did not have a lot of other politically palatable options for reducing the deficit.

As the demographic time bomb of aging baby boomers explodes in economically developed democracies  across the globe, voters will have to choose between:  1) continuing to run up unsustainable deficits; 2) cutting entitlements, 3) increasing taxes, or 4)  making structural changes such as increasing the work week and pushing back retirement ages. It seems unlikely that France will be the only country to choose to increase taxes on the rich and big business. Despite the fact that increasing taxes on the rich and big business will fail in France, that lesson is unlikely to be learned as deficit problem worsen in every country with generous entitlement problems for aging baby boomers.

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