loifinances2

Finance Law 2013: debugging the French economic software - 1

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It is now one month since the "pigeons" sling against the 2013 Finance Bill. A rebellion that is original to say the least because it has succeeded in seriously undermining the government's plans... without blocking anything in the economy. All this while relying for the most part on the relay of digital and social media. The starting point was the plan to align the taxation of capital income with that of labour. This FDP has generated a largely justified bronca from entrepreneurs and investors but still requires reading between the lines. Indeed, as we shall see, this FDP is more dangerous because of its complexity than because of its basic principle, which in practice would affect only a very small number of entrepreneurs.

geonpi2I am putting this debate on pigeons into perspective in the context of France's cultural exception in terms of the economy. This exception has become a real ball and chain that is blocking the economy in this country and particularly its competitiveness. It is a source of despair for many economic agents.

The big question is: what could make a difference? I've heard that we have to wait until the economic crisis is even more violent for things to change. It would be very wise to act a little before then!

The origin of FDP 2013

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The capital/labour alignment of income taxation is essentially based on the thesis of a book by economists Thomas Piketty, Camille Landais and Emmanuel Saez published in January 2011: "For a fiscal revolution".

This book advocated greater progressivity of taxation according to income. It is associated with a website well-researched and well-argued. He denounced a marginal tax rate that fell as income increased, due to the increasing weight of capital income in the income of the better-off households. This rate, which approaches 50% in the middle of the curve below, can be explained by employer and employee social security contributions which weigh on work much more than income tax. It also includes the impact of VAT, which weighs more heavily on households that consume than on those that save.

The solution was obvious: to align the taxation of capital income with that of labour. This had become the ABC of the tax revolution for the Dutch candidate. The program was clearly announced by the candidate during the presidential election, the latter announcing not only an alignment of the taxation of capital on that of labour, but also some key measures such as the taxation of 75% of income above €1m per year and the return to the former wealth tax. In short, the programme was well known in advance! What happened next was not at all a surprise!

On the downside: Piketty's thesis - who is the figurehead of the book's authors - was essentially based on a quantified argument about the progressiveness of taxation. He disregarded three key points:

The international benchmark and the effects of a tax change in an open economic world.

Tax incentive systems for job-creating investment. It is well known that they serve to compensate for their low profitability in France. It would be good to do without them, but the virtuous circle is difficult to set in motion.

The time dimension of taxation

No innovative SMEs and entrepreneurs in Piketty's book, nor integration of the notion of risk in the different forms of investment! In other words, it was a "quanti" and not a "quali" study. And which reasoned as if the French economy was operating in a closed vase.

At the time of the publication of "Pour une révolution fiscale", there were reactions, in particular an article by Elie Cohen and Philippe Aghion. They noted that "such a system can discourage innovation and growth if it targets the most enterprising and encourages brain drain. This reservation was quickly challenged by the authors on their website, which relayed this article. But entrepreneurs did not react to this real fiscal time bomb, not even really during the presidential debates.

This is partly because the vast majority of entrepreneurs have tried to avoid participating in political divisions. It was clear that they were right ahead of the game because the pigeon revolt was quickly denounced as a manipulation of the right-wing opposition, which it was not! Some entrepreneurs of the movement even claimed to be left-wing. But in the minds of some on the left, to be an entrepreneur is to adopt the position of social traitor from the outset!

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However, jobs are mainly created by entrepreneurs, whether they come from start-ups or large groups, and in all sectors of activity. Not by public authorities! And capital is one of the driving forces behind this creation! We cannot, on the one hand, denounce the financialisation of the economy and, on the other hand, overtax the part of the capital that is allocated to job creation! Otherwise, in the end, we will have neither capitalists, nor entrepreneurs... nor jobs.

A rational and emotional debate

Strikes by railway workers or the RATP do not always originate only from wages, but also from a lack of social dialogue and recognition. The story of the pigeons is in the same vein. There was certainly the FDP 2013 and its potentially disastrous consequences. But these only concern a very small proportion of successful entrepreneurs (and investors). It was in fact the economic success that was symbolically nipped in the bud by this FDP 2013 and other government actions. The government's setbacks make up for this symbolism only marginally.

One can even have the unpleasant impression of going back to the revocation of the Edict of Nantes by the Sun King in 1685, whose long-term impact was more economic than religious in France!

It must be said that the emotional dimension of the economy is very poorly understood by our governments and even our economists! Or rather, it is well understood when it comes to getting elected, but not when it comes to boosting the economy. François Hollande had thus symbolically driven the nail in by throwing in the bud with the taxation at 75% of incomes higher than 1m€, during a debate on TF1 before the presidential election. This electoral tactic has especially trapped his main opponent, who fell into the trap of contesting a tax that affected only a minority of super-rich, and therefore indefensible! The trick worked very well. All the more so as Holland said it wanted to do this as an example because the measure would bring in very little money, around 200m€. And this estimate did not take into account the loss of income that the measure would generate: fewer high-income executives living in France, especially in large multinational companies, and probably more tax exiles.

It was in the image of the SIW created in 1981 and recreated in 1989 after the short and confused Chiraquian alternation of 1986-1988: an apparently socially just but economically destructive idea. An unmanageable dilemma, even for Nicolas Sarkozy, who only applied a tactic of discreet demolition of the SIW. A tactic that did not work well for him since he was in any case accused of being the president of the rich during his entire term of office. As long as he was dragging a ball and chain, he could have been braver!

lotteryTo top it all off, in this country the best way to avoid being taxed on high incomes is to win at gambling! Chance is better valued than work and entrepreneurship in this country! Gambling winnings are just subject to about 5% of CSG. They are certainly taxed upstream at the level of the distribution of the earnings of the Française des Jeux. Some people argue that the winnings are already labour income which is taxed upstream. But this is the case for all economic flows! What you spend is taxed anyway as many times as money changes hands! Here again, the symbolism, rarely evoked, leaves one pensive.

The history of pigeons started with Jean-David Chamboredon's article of September 29th in The Tribune. A good soap opera continued with various positions, such as those of Pierre Chappaz and Jean-Louis Gassée. We've also had those of Patrick Robin playing on the recognition of entrepreneurs, mostly young. And then the creation of a Facebook fan page with tens of thousands of followers. A page that's just been shut down.

In the "against" reactions, we got everything, from blankets... of Liberation defeating government backsliding with poorly researched and editorial bad faith by Audrey Pulvar quickly karcherized, until the very thorough analysis of Rodrigo Sepulveda published in the blogs of Les Echos. It's hard to fight ideology!

It is to be regretted in passing that the figures given by the pros and cons are not very precise, except in the case of Rodrigo Sepulveda. Thus, the 65% of taxation was the worst case and was only a marginal rate whose application depends on his total income and family quotient. And nice "exits" in France with significant gains are very rare. They only concern a few dozen people at most each year.

But seemingly detailed elements of PLF2013 were in dire need of correction, and fortunately the government backed down. In particular, the time dimension had to be taken into account in the value creation of a company. This is spread out over time, but manifests itself in the form of capital gains, which are heavily taxed due to a progressive scale. This simple reasoning should make it necessary to return to a fixed scale in a number of cases, particularly for entrepreneurs who pay themselves very badly at the start of their business to offset their remuneration on the capital gain in the event of a successful exit. In the same way, entrepreneurs who manage to create value quickly, in just a few years, should not be penalized in the other direction.

The FDP 2013 also reveals another symptom that penalizes the country: complexity! Taxation is one of the most complex in the world. The State uses it to micro-manage the economy with an unparalleled level of detail. And complexity is increasing rather than decreasing, despite all the good intentions. Like a badly crafted piece of software, we have a completely buggy spaghetti dish, with no software architect designing it and with tinkering everywhere written in different languages and technologies that are incompatible with each other. The tax niches are nothing more than band-aids on a tax system that is basically badly structured.

Is the cost of labour too high? It is artificially lowered on both low wages, catering and researchers (CIR). And the burden is placed on other employees. Does the change to 35-hour working hours increase the cost of labour? Social charges are lowered accordingly and this costs about €20 billion (billions) per year in tax expenditure, the famous "niches". And each profession has to do its own thing to demand the same thing. We are now talking about salaries between one and three SMIC, where a greater part of competitiveness lies, whereas salaries at the SMIC level are more often linked to less relocatable service jobs. Those who call for a reduction in the cost of labour do not, however, call for a reduction in the benefits that go with this cost (health, unemployment, old age)!

On the PLF 2013, you have a nice demonstration of the French complexity with this comparison compa between the FDP 2013 and capital gains taxation in a whole bunch of western countries. It's edifying! We are a long way from the fiscal convergence with Germany that Nicolas Sarkozy wanted to bring about. Buried by alternation!

With the government's backsliding on FDP 2013, we have come to our senses as the says Jean-David Chamboredonbut unfortunately not for business angels. As our elected representatives understand nothing about the complicated cycle of innovation, they have skipped over the financing of startups! And this is nothing new.

In the end, we spend all our time worrying about the inept decisions of our governments and reassuring ourselves that we are getting back to normal. The problem is that taxation is the tree that hides the forest, because even without it, it is already very difficult to do business in France, which is dragging along a number of bottlenecks: in regulations, in labour law, in the behaviour of major customers, in payment deadlines, in the very culture of innovation, and finally, in the structure and behaviour of its governing elites.

The creeping nationalization of innovation financing

In the taxation of innovation, three notions can be distinguished:

- Entry taxation that reduces taxes (IR or ISF) when investing in innovative SMEs. The TEPA law had made it possible to almost double the number of business angels in France from 2008. However, the downward trend in IR and ISF deduction rates and their increasingly low ceilings have led to a decrease in the number of business angels.

- Taxation of the company that affects its operating account. This is where the JEI status and the CIR status come in, which reduce it and thus lighten the company's expenses: by lowering corporate tax and social charges for the former and by reducing the cost of R&D for the latter.

- Exit taxation, which concerns the capital gains generated. The higher it is, the less the entrepreneur and the investor are able to reinvest themselves in the ecosystem. As Marc Simoncini points out, at a certain stage, it makes you want to be a business angel in another country!

Then there are the direct instruments of the State: loans, repayable advances, grants and other equity contributions, most of which are managed by Oséo and Caisse des Dépôts.

Taxation at entry had been seriously favoured with the TEPA-ISF law and was then gradually trimmed as part of the search for tax expenditure savings to reduce debt. The FDP 2013 did not significantly change entry and corporate taxation, but did deal a blow to exit taxation. Not a very clever way to encourage investment!

The PLF 2013 is in fact part of a creeping evolution that does not say its name: nationalization if not the progressive nationalization of innovation financing. Under the cover of the financial crisis, the State is getting its hands on an increasingly important number of levers of this financing. This nationalisation of innovation financing was already well advanced with previous governments and the various tax reforms and initiatives such as the "large loan" initiative. Increasing taxation or reducing tax expenditure in all or part of the three categories mentioned above is accompanied by an increase in redistribution. This began with the fashion for collaborative R&D projects, which were heavily financed within the framework of the competitiveness clusters and the investment plan for the future.

We are now preparing a major "Public Investment Bank" that will consolidate the activities of Oséo, Caisse des Dépôts and its branches such as the Strategic Investment Fund and the operation of the Future Investment Plan. Above all, the government wants to regionalize the operation of the BPI and create one-stop-shops for entrepreneurs. This probably starts from a good intention, but as with the IIP, the devil will be in the execution and it easily goes out of the box! The regionalization of decisions is traditionally a source of mismanagement and clientelism. We're not going to create world leaders with that!

The virtuous circles of innovation, particularly in Silicon Valley or Israel, are special in that they allow intelligent recycling of the money earned by entrepreneurs, without necessarily going through the "taxes and state" box. I had documented this well after a trip to Silicon Valley in 2007 and the overall picture remains valid, in terms of the contrast between Silicon Valley and France.

On the contrary, the French tax system is designed to ensure that flows are channelled through the State, which plays an enormous redistributive role. While this role is reasonable when it comes to managing the mutualisation of regalian functions and social protection, redistribution to companies seems to be under-productive. Promoting private recycling of money in innovation should be a priority, but without the State micro-managing this. It cannot do this properly as long as its agents do not have a sufficiently good knowledge of business life.

The state would do better to be a good customer than to struggle to be a redistributor. Everyone would benefit: citizens would benefit from better infrastructures, the SMEs helped would work on real needs rather than on R&D projects without a market and they would have more real customers helping them to find others and then export.

We have another area where the State could give more freedom of initiative: inheritance. In the USA, large inheritances are tax-exempt for donations to foundations. This is one of the reasons why many billionaires like Bill Gates set up foundations. But they can do it because we let them! In France, up to 75% of an estate (after his death as well as during his lifetime) is reserved for his descendants. This is called the available share and it depends on the number of children. If this makes sense for everyone, it is absurd for very large fortunes. This is what Xavier Niel rightly denounces. If one has a patrimony of 4 billion Euros, one's children do not need 1 billion each! After that, be surprised at the low number of foundations in France!

My story isn't over. We will see in the second part of this article that economic misunderstandings go far beyond the startups in this country. And the left wing of the government unfortunately has little to envy the right in this respect.

To go further

Read Elie Cohen's interview "Elie Cohen's assessment of French industry".

{Jacuzzi on}

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