France’s tax hikes are a case study in how not to run a country

Allister Heath

MORE evidence that high and punitive tax rates are bad for tax receipts. An official report from the French audit office makes damning reading for all those who believe in hammering taxpayers to pay for their pet projects.

While French tax receipts went up for the fourth year in a row, they have dramatically underperformed forecasts, undershooting by €14.6bn. Income tax, corporate tax and VAT all brought in much less than expected.

The French audit office divides revenues into “spontaneous” receipts generated by current tax rates and rules, and those generated by changes to the rules. It argues that the “spontaneous” measure collapsed by 1.7 per cent, rather than growing by 2.6 per cent as expected, even though GDP grew by 1.4 per cent. The previous year, receipts defined on the spontaneous measure also fell – by 0.2 per cent, despite GDP growth of 1.5 per cent. By contrast, the tax hikes yielded as much as was expected last year, the Cour des comptes argues.

The big change is that the elasticity of “spontaneous” tax receipts – their responsiveness to economic growth – has collapsed to -1.3, according to the French document, a historically bad outcome and worse even that the already disastrous -0.2 seen in 2012.

So what is going on? The audit office doesn’t really know, though it is hugely concerned, but I can venture an explanation. Francois Hollande, the socialist president, was elected on 2012 and immediately attempted to implement a hard-left agenda, with the tax rate on high incomes eventually lifted to 75 per cent (albeit not quite in the way he originally wanted). This has been hugely counter-productive.

The French state has still found ways of extracting cash from its hard-pressed citizens by levying fresh taxes – but Hollande’s time in office has coincided with a collapse in the tax base. This is a major crisis for the French model, and provides intriguing evidence of what happens to overtaxed countries.

What we are seeing is a variant of the Laffer curve. When tax rates are low enough, raising them increases revenues. But there comes a certain point at which increasing tax rates actually starts to reduce revenues. The government can either grab a large slice of a small pie, or a smaller slice of a bigger pie. The full analysis is more complex than that, of course, with short and long-term effects and all sorts of other complications, and there is endless debate about the actual cut-off points.

But Hollande’s catastrophic mismanagement of the French economy has become a giant case study in what not to do.

The Lib Dems are in an even greater crisis than they realise. They have been hit by a loss of trust that mirrors what happened to the Tories in 1992. The two situations are very different – the Lib Dems went into coalition, alienating the left-wing and anti-politics parts of their base, and blatantly broke promises; the Tories saw their reputation for economic competence, their unique selling point, shattered by sterling’s forcible exit from the European Exchange Rate Mechanism (ERM). But the outcome was very similar – the Tories have still not recovered, 22 years later, and it will also take the Lib Dems decades to recover.

The data is shocking. In May 1992, the Tory party was reelected with 41.9 per cent of the vote. Four months later, the UK was hit by the ERM catastrophe and Tory opinion poll ratings collapsed, never to recover. In 1997, the Tories grabbed 30.7 per cent of the vote; in 2001, 31.7 per cent; in 2005, 32.4 per cent; in 2010 36.1 per cent; and in the latest YouGov poll 32 per cent.

Of course, the ERM was merely the event that triggered the collapse; it was then perpetuated by many other factors. But when a party loses its lustre, it becomes extremely difficult for it ever to recover. The Lib Dems are truly in trouble.
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