Is the economic growth of Germany, the largest economy in the Eurozone, bleak, and is the second-largest economy, France, also struggling to sustain itself?

Recently, the restructured French government unveiled a budget draft for 2025, referred to as "belt-tightening," planning significant tax increases and spending cuts, totaling approximately €60.6 billion, in hopes of reducing the fiscal deficit to 5% to address the country's substantial deficit issue.

French Prime Minister Barnier described the significant gap in public finance as the "sword of Damocles," which could push France, the Eurozone's second-largest economy, "to the edge of a cliff."

The draft has caused a stir since its introduction, and it is expected that the French Parliament will engage in intense debate over it in the coming weeks. Why has France experienced such a massive deficit? Who will be affected by such significant spending cuts? Can it be successful?

Zhao Yongsheng, a researcher at the National Institute of International Trade and Economics at the University of International Business and Economics and a doctoral supervisor at the Sorbonne University in Paris, is currently conducting research in France. He stated that France's public spending levels are high, primarily driven by generous social welfare programs, healthcare, and education, while the heavy tax burden is insufficient to cover these expenses. Furthermore, the economic slowdown caused by the pandemic has led to a significant increase in French debt.

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He told reporters that, looking at the current thinking of the new French government, there is a lack of involvement in how to integrate into the global green and artificial intelligence technological revolution. The current budget plan is on one hand "belt-tightening" and on the other hand, taxation, but neither of these are ways to make the cake bigger. Instead, they are still addressing how to distribute the same piece of cake. "What should be considered more is how to stimulate the French economy and face the technological competition and challenges from around the world."

Why has France experienced such a massive deficit?

For over twenty years, France has been striving to keep its deficit under the EU-mandated target of 3% of Gross Domestic Product (GDP).

However, according to estimates, it is expected that France's deficit in 2024 will reach at least 5.6% of its GDP, higher than the original target of 5.1%, and slightly higher than last year's 5.5%. Last year, France's fiscal deficit amounted to €154 billion.

At the same time, if no measures are taken to control the public sector's budget, France's public deficit in 2025 will reach 6.2% of France's GDP, which will far exceed the EU's requirement that member states' deficit ceiling be 3%.The European Union has placed France under the so-called "Excessive Deficit Procedure" and has demanded that France provide a plan to reduce its deficit in the coming years.

The reason for the aforementioned issue in France lies in the fact that, on the basis of a high level of public expenditure, the French government continued to overspend in the budget to stabilize the economy during the pandemic, while tax revenues fell short of expectations: in 2023, France encountered an unforeseen tax shortfall of 21 billion euros.

Data released by the French National Institute of Statistics and Economic Studies shows that the main reason for the deficit exceeding expectations is a significant decrease in the growth of national income in 2023: it increased by 7.4% in 2022 and only by 2% in 2023. The reasons are, first, the slowdown of the French economy; and second, the implementation of new tax measures that have delayed the collection of taxes by the state, that is, after the implementation of new tax measures, the increase in French taxes in 2023 was only 0.3%, while in 2022 it was 7.9%.

Previously, the international credit rating agency Standard & Poor's (hereinafter referred to as "S&P") downgraded France's sovereign credit rating from "AA" to "AA-", but this level did not have a significant impact on France's borrowing costs, and French bonds have long been considered a substitute for German government bonds (the safest assets in the region).

This situation has recently changed, as unresolved political turmoil in the French Parliament and a sharp deterioration in the budget deficit have occurred simultaneously, undermining investor confidence. France finds itself becoming a typical representative of fiscal imbalance, with its debt yield now on par with Spain and increasingly approaching Italy.

At present, the sharp decline in French bonds has increased the premium of the country's 10-year debt compared to Germany from below 50 basis points before the early vote in the French Parliament to nearly 80 basis points.

In short, the current situation has affected France's credibility in the financial market, causing its borrowing costs to soar. In order to continue to develop, France also has to make budget cuts.

The Governor of the Bank of France, Villeroy, stated that France is in a situation where income does not cover expenses, "Therefore, France must reduce expenditure and increase a little income. First, we need to control our expenditure, because when you compare France with our European neighbors, we have the same social model, the same public service model, but we spend much more. We need everyone's efforts."

How about Barnier's prescription?

In response to France's current high debt situation, Barnier's "prescription" is: by 2025, the French government will cut fiscal expenditure by about 40 billion euros, mainly including reducing the expenditure of various government departments and the social security system. At the same time, the government will increase fiscal revenue by nearly 20 billion euros by increasing taxes on large enterprises and the wealthy, and raising green taxes. It is reported that the budget is based on the forecast of France's GDP growth of 1.1% next year.For example, in terms of the fiscal expenditure reduction plan, which accounts for nearly two-thirds, the French government department is expected to cut nearly 20 billion euros in spending, mainly achieved by reducing the staffing of the public sector.

At the same time, the expenditure plan for the social security system will also be cut by 15 billion euros. For instance, the adjustment of pensions linked to inflation will be postponed by six months, and support for apprentices and subsidized contracts will be reduced, among other things.

In terms of tax increases, the draft shows that more than 400 large enterprises with an annual turnover of more than 1 billion euros will be subject to a 20% corporate tax, which is expected to bring in 8 billion euros in revenue by 2025.

Regarding the highly controversial "wealth tax," the draft is expected to impose a temporary surcharge on 65,000 "wealthy families" (0.3% of the total) with an annual income of more than 250,000 euros, which is expected to bring in 2 billion euros in tax revenue over the next three years.

Zhao Yongsheng said that this is to tax the richest people, but he doubts whether it can be implemented, "If these people are forced to leave France, it will lead to capital outflow, and such a policy is self-contradictory."

At the same time, France will also increase taxes on sectors involving high-pollution transportation, such as the maritime sector, and also tax airlines. However, the French defense budget is expected to be retained.

As mentioned earlier, due to the wide impact of fiscal cuts and tax increases, this has also triggered dissatisfaction from both the left and the right.

Left-wing opposition MPs and trade unions criticized the "austerity budget" as unfair, saying it could severely affect millions of low-income families, apprentices, retirees, and small businesses. Even the more moderate left-wing trade union - the French Democratic Confederation of Labor (CFDT) also criticized Barnier's plan and warned that "public services such as education will deteriorate severely, and our healthcare system will be further weakened."

Employer unions also warned about the potential impact of tax increases on businesses, including potential unemployment. The Confederation of Small and Medium-sized Enterprises (CPME) said that the government's plan "will lead to a sharp increase in business costs." The centrists in President Macron's alliance are also very dissatisfied, believing that tax cuts are a key requirement to maintain France's competitiveness in the world.

At present, this budget bill needs to be approved before the end of the year. Considering that Macron's ruling alliance has already lost its majority in the French parliament, the turmoil caused by this draft has just begun. The Macron government can also use the special powers granted by the constitution to pass the budget bill without a vote, but this may also trigger a vote of no confidence in the parliament, and the outcome is unpredictable. Fitch downgraded France's rating outlook from "stable" to "negative" on the 11th.At the same time, France will also soon face the "verdict" from other credit rating agencies. Moody's will release a report on October 25th, and Standard & Poor's will release a report a month later.

Zhao Yongsheng stated that Barnier's challenge is not about obtaining full support, but rather finding a balance point that can be accepted by the far-right, thus avoiding an alliance with the left to overthrow the government.