A Flawed Strategy
Jan 05, 2006
Eric Chaney (from Amsterdam)
During his seasonal greetings to the press, President Chirac revealed that he had asked the cabinet to review the tax base of employers' social contributions. Currently, employers' contributions are based on gross wages. These contributions are funding various welfare funds (healthcare — pensions — family), which, taken together, absorb a larger share of GDP than the central government itself (24.6% of GDP vs. 22.9%). Mr. Chirac wants to shift the tax base from gross wages to value added (a concept close to earnings before interest, taxes, depreciation and amortization, or EBITDA), in order to boost employment and, it is hoped, to prevent companies from moving jobs offshore. Although most details of this major tax change are still unknown — Mr. Chirac should be more explicit in his greetings to other constituencies in the following days, but the relevant details are likely to come much later on — the idea of a value-added based contribution is not new. I believe that the economics behind this proposition are deeply flawed and that, sadly, it may destroy good jobs in the future, instead of protecting French workers.
The change in the tax base would increase the taxation of profits and reduce the taxation of labour Although neutral for the overall tax burden by definition, this change would move the cursor from a purely labour-based tax to a mixed one. Since total compensation takes roughly two-thirds of value added (67.6% was the exact number in 2004) and profits (as measured by the gross operating surplus) one third, the arithmetic for the average company is relatively straightforward. In short: Ø A €1 tax on payrolls would be replaced by a 66 cents tax on payrolls and 33 cents on gross operating surplus (operating profits). Ø The average value-added based contribution rate should be 17.4% (on my own estimate). Ø The implicit corporate tax rate (based on gross operating surplus) would rise from 13.6% to 31.0% (my own estimate). Ø The implicit employers' payroll tax rate would be cut from 25.8% to 17.4% (my own estimate). Note that the average (or implicit) employers' payroll tax rate is lower than the headline rate (25.8% vs. 28.5%) because various tax breaks are applied to low wages. The reform may penalize capital intensive industries relatively to labour-intensive ones. The 2/3 vs. 1/3 breakdown between compensation and profits holds for the mythical average company only. In the real corporate world, companies are more or less labour intensive. For capital-intensive companies and sectors, the relative shares of capital and labour are likely to be more evenly distributed. Hence, the overall tax burden may rise for these sectors while, conversely, labour intensive companies may benefit from a lighter tax burden. The logic of the reform is political and short sighted. If implemented, it would backfire in the long term In the short term, fixed capital is less mobile than labour: although laying off workers in France is difficult and costly, it is nevertheless easier and less costly than to shut down plants and offices in order to relocate elsewhere. Accordingly, moving the tax cursor from labour to capital may be positive for employment in the short term, in theory at least. However, in the medium to long term, capital is more mobile than employment. Hence a higher profit tax will result in capital outflows (foreign direct investment). In my view, by reducing the stock of producing capital in France, this policy may eventually harm employment, especially in capital-intensive industries, which also happen to be the most innovative. A surprising political move, at odds with globalization As I see it, President Chirac's surprising burst in the economic policy arena, normally a job for the Prime Minister or the Minister of Finances, may give a clue about his personal ambitions regarding the 2007 presidential election, after last year’s political debacles (the rejection of the EU Treaty and the riots). Either Mr. Chirac might be considering running for a third mandate, or he might want to smooth the ground for his protégé Dominique de Villepin. The value-added-based social contribution was seriously considered by previous left-wing cabinets and is part of the socialist platform. Because it fits with an old socialist mantra "taxing capital creates jobs", this move may be aimed at luring left leaning voters. The problem is that it is unlikely to be effective even in the short run, because of regulatory impediments to job creation in labour intensive industries (such as retail trade for instance) and, in the end, will simply result into capital outflows. Globalization is still about capital mobility above all, labour mobility coming as a very distant issue. I am afraid that penalizing capital to keep jobs at home is a hopeless strategy.
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