Last Thursday, the French government transmitted to parliament the budget bill for 2025. There were no surprises relative to what had abundantly leaked in the press the previous week. This probably explains why the 10-year spread between OATs and Bunds did not react much on the release day. As of last Friday evening, it stood at 77 basis points (bps) – towards the upper end of the range observed since the dissolution of parliament in June, but still below a recent peak to 80 bps on 29 September – and still 3 bps above Spain (a more recent feature).

The government is communicating on an effort of EUR60bn, shared between tax hikes for one third and spending cuts for two thirds. This uses as a reference a “business as usual” scenario under which the deficit would have spontaneously increased from 6.1% of GDP in 2024 to 7.0% in 2025, 2 % of GDP higher than the government believes it can bring it thanks to the bill’s measures. As the High Council of Public Finance noted in its advice, this is however based on a very strong trend increase in public spending corrected for inflation, 2.8%, which would exceed by far trend GDP growth. This mechanically inflates the effort on the spending side. The council concluded that 70% of the adjustment came from higher tax, but also that the overall structural effort – i.e. the discretionary improvement in the deficit, net of any impact from the cycle – amounts to 1.2% of GDP for 2025, in line with the government’s claim, and 1.4% when taking on board the increase in interest payments of 0.2% of GDP. While the notion of primary structural adjustment is important from a macro point of view – this is equivalent to the “fiscal stance” and matters to gauge the impact on aggregate demand – it relies on estimates of potential growth and output gap which are always imprecise. When looking at ratios to actual, and not potential GDP, as we think many observers will, the story is simple: in 2025 tax in the government’s own forecast would reach 43.6% of GDP, up from 42.8% in 2024, while spending will only marginally fall from 56.8% of GDP to 56.5%.

Now, as we argued two weeks ago, these choices are understandable in the current configuration. Indeed, domestic demand has been weak so far in 2024 in France – consumer spending has been flat over the first half of the year and both corporate and household investment has been contracting – and drastic action on government spending could have precipitated the country into recession. The government chose to act on individuals at the upper end of the income distribution, whose propensity to consumer is lowest (EUR2bn from a “minimum tax” levied on those making more than 250K a year), and focused much of the effort on the corporate sector to the largest enterprises (EUR 8bn), with arguably the best capacity to “take this on the chin” without deeply revising their investment and hiring plans.

Still, even the smaller businesses will not completely escape the austerity drive, with potentially some adverse effect on employment. Since the mid-1990s, successive governments in France, across the political spectrum, reduced the social contribution rate on lower wages to boost employment. While this has probably contributed to the decline in unemployment in France on trend, these various measures entailed a sizeable cost to the government (c. EUR75bn per annum, i.e. 2.5% of GDP), while dis-incentivising business to promote workers: the upward slope of the social contribution rate means employers must consent to a disproportionate rise in their overall cost of labour when they want to raise their employees’ direct salary. That the system needs to be reformed makes little doubt, but the consensus view was that the overall financial envelope should be better distributed to avoid the worst threshold effects, not that it should necessarily cut, especially if this means raising labour costs close to the minimum wage, where the price elasticity of labour demand is the highest. This is however the choice made here, with a gross effect of EUR 5bn (4bn net when taking into account the mitigation from the corporate tax). In the same vein, social contributions are going to rise significantly for apprentices. The system had become very costly, and in some cases triggering windfall effects, but the emergence of apprenticeships has undoubtedly contributed significantly to the overall rise in employment in France these last few years (1/3 of the total job creation between 2019 and 2022).

Now, on top of trying to minimize the impact on demand, the government had little time to work on the budget and the recourse to “low hanging fruits” to send a signal was understandable. The thorniest issue in our view is not so much the much-discussed tax versus spending breakdown of the 2025 effort, but rather the possible trajectory beyond next year to ensure a proper stabilisation of French debt.

Looking beyond 2025

The government pledges to bring the deficit back to 3% of GDP in 2029 from 5.0% in 2025. In its own medium-term planning, this entails the continuation of a decent size structural adjustment (0.6% of GDP every year on average) after the steep effort of 2025 (1.4%). This “front loading” is commendable, and on the whole the trajectory looks do-able, as it would sit right in the middle of the two previous episodes of French fiscal consolidation, 1994-1999 and 2011-2015, as illustrated in Exhibit 1 (in the graph, “year zero” is the lowest point of the primary structural deficit before the improvement starts, and we stop the “consolidation phase” the last year the primary structural deficit improves). There is thus nothing unprecedented in what the government is proposing to do. Of course, the level of debt is much higher than at the beginning of these two consolidation phases (see Exhibit 2), and the government is not expecting to see the debt ratio fall before 2027.

A key problem – which has been mentioned by Fitch as one the factors motivating its decision to put the French rating on negative watch last Friday – is that it is very difficult to extrapolate from the measures announced in the budget bill for 2025 what could constitute the elements of a multi-year, maintained austerity drive. Indeed, most of the tax measures are designed to be temporary. In 2026 already the surcharge on corporate tax for the largest companies will fall, before – in principle – disappearing altogether in 2027. The same will apply on the income tax surcharge for the wealthiest individuals. The postponement of the inflation indexation of pension from January to July 2025 will have a permanent effect on the level of the pension payments in France (6 months of inflation will be lost “forever”) but in “delta” – i.e. triggering another braking effect on spending – it is a one-off. Beyond 2025, France will need to produce more systemic changes, and focus will need to be on spending. In 2025, some savings are expected by reducing the day-to-day spending of some ministerial departments (Defence, Grupa Azoty and Justice will be spared), while in Education the decline in the number of pupils – a consequence of population ageing – will allow some limited staff cuts. But if the modes of action, organisation and perimeters of public administration stay untouched, parametric approaches will quickly touch their limits.