Buyer’s remorse

In a recent post (in French) on the Telos web site,  Professor Elie Cohen complains that he finds President Hollande’s policies disappointing. According to him, Hollande is putting the country into jeopardy by postponing any serious structural reform or fiscal adjustment. The risk is that markets eventually corner France in a similar situation as its Southern neighbours, with harsh austerity measures having to be rapidly implemented in exchange for the IMF/German manna.

One year ago, Professor Cohen, along with a number of prominent French economists,  signed a vocal petition in French newspaper Le Monde asking people to vote for Hollande. So it must be that the policies that have been followed come as a surprise to Prof. Cohen.

Well they hardly come as a surprise to me. The course of action followed by the French government during the last year was totally predictable. Historically the French socialist party represents civil servants and various beneficiaries of the welfare state. Reducing public expenditure is simply in contradiction with its ideology. With its Keynesian twist it is also reluctant to engage in austerity and would thus be happy to indefinitely postpone a reduction in deficits. However those deficits are bordering 5 % of GDP and public debt is increasing fast, while markets and Brussels are watching. (The French should be prepared for  a quality of public service at the level of Italy or Belgium for years to come. This is what excess public debt does to your economy and it’s the poorest who will suffer the most from it.)

So something has to be done to appease Brussels and the markets, that is, one must raise taxes. Then the ideology dictates that one should tax “capital” and hit on the groups who are least likely to vote for the socialist party.

The problem is that, contrary to what the signers of the petition pretended to believe, capital was actually taxed quite a bit to begin with. Furthermore the presumption that capital should be taxed as much as labor, now popular in France, makes little economic sense. Capital is money that has already been taxed in the past, and you tax it again when it earns its return. Relative to a consumption tax this is a big intertemporal distortion. This means that savings and wealth accumulation are discouraged by capital taxation.

Recent fiscal moves amount to taxing high incomes and capital income of a rather small fraction of the population. If you want any money out of such a scheme, you have to increase the tax rate by a lot. We are not talking about people paying 4 % more of their income in taxes relative to last year. We are talking about people paying 20,30,40 % more of their income relative to last year.

For example, an individual firm owner paying dividends to himself faces a 33% corporate tax rate, plus a 15.5 % extra social security tax, and now a 40 % levy on dividends, and has to pay personal income tax on what is left. This is not taxation, it is expropriation of the Lenin kind. To avoid that, the entrepreneur has to do some convoluted contorsions to convert his profits into something different from dividends–or just pack and go elsewhere.

Given that the new taxes are especially hitting those people most likely to create jobs in the future, hopes that “growth” will bootstrap the French economy out of its self-inflicted path to gradual extinction sound ludicrous.

Again none of those developments are remotely surprising. 2+2 = 4, meaning either one reduces public expenditures or one raises taxes. The preceding government was not great at reducing expenditures, but at least it tried. It was kicked out of power by the French, a majority of whom seem content with another round of inflating the welfare state,  despite that it is one of the heaviest in the world.

How about the elusive “structural reforms”? The word was not written in the Hollande programme, nor in the petition signed by Prof. Cohen, so why is he surprised that we do not see them coming? The socialist party has traditionally implemented measures that were most harmful to the competitiveness of French companies: the 35 hour workweek, reductions in the age of retirement, repeated raises in the minimum wage, and so forth.

To implement structural reforms you have to believe that they work. That is, you have to believe in the market economy — that more competition and more contractual freedom mean more mutually profitable transactions and more prosperity down the road. If you think you can get away with taxing firm owners and executives at 80 % then it’s unlikely that you believe in the market economy. Instead you are more likely to believe that wealth just “happens” and sits there to be taxed, not that it actually belongs to somebody else who created and accumulated it.

Many of my left-wing colleagues believe that the Left is more likely to implement product market reforms than the Right. Besides the fact that such reforms won’t help much if at the same time you keep raising labor costs and kicking talent out of the country, there is no evidence that the Left has ever been interested in them. It is true that the lobbies in favor of such regulations are more right-wing than  those in favor of labor market regulation. But product market regulation generally protects a set of incumbent firms at the expense of potential entrants and this benefits both employers and employees in the incumbent firms. Both Left and Right see no electoral gains in a product market deregulation. The gains to consumers are diffused and hard to identify, the losses to incumbent workers are clear, at least if they share part of the rents thus generated.


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