French move to increase spending will raise eyebrows in Italy
New French deficit spending comes amid heated budget discussions between Brussels and Rome.
The French President, Emmanuel Macron, has responded to the “yellow vest” protests with a dose of fiscal easing, mainly by bringing forward already planned measures. The spending package has four main building blocks: a tax exemption to incentivise employers for overtime pay; a tax break on overtime pay; a EUR100 increase in the minimum monthly wage; and the cancellation of the 1.7% surcharge on pensioners earning less than EUR2000 per month. Some of the measures were already in Macron’s manifesto, and have merely been brought forward.
According to government officials, the measures announced yesterday will cost EUR8-10bn (~0.4% of GDP). This comes on the top of the elimination of the planned fuel tax hike, which is likely to cost EUR4bn (~0.2% of GDP) in lost revenues. How the gap will be filled is unclear.
Before the government’s retreat on a fuel-tax hike and yesterday’s announcement, the French budget deficit was already projected to reach 2.8% of GDP in 2019 (up from 2.6% of GDP in 2018). So, keeping everything else unchanged, including growth forecasts, the latest measures could mean a 3.4% GDP deficit in 2019 according to initial estimates. But given the accumulation of downside risks to growth, even this figure could prove too optimistic.
The increase in the French deficit comes against the backdrop of heated discussions between Rome and Brussels on budget issues. The Italian government will seek to justify its own fiscal expansion by pointing at the new French deficit spending, or denounce “double standards” if its own budget spending plans are rejected by Brussels.
But there is a large difference between the situation in Italy and France. In the latter, the 2019 budget deficit will in part be pushed higher by a one-off transformation of a tax credit for corporates into a permanent payroll tax cut of EUR20bn, so there is a good chance that France’s deficit will fall below 3% again in 2020. Moreover, structural factors in France (for example, labour productivity and demographics) are relatively more favourable than in Italy, where weak potential growth is a real issue. Some of the Italian government’s could even dampen labour supply, at a time when the Italian workforce is already declining.
However, at the end of the day, it is the markets that will deliver a verdict on the merits of the case for higher deficit spending in France and Italy.