Laugh at France’s economy all you like. The bill is coming here too

It’s a question that will likely precipitate a once-in-a-generation decline in European living standards. But, as Australians, we cannot feel superior. We are further down the same road than we like to admit.

France’s deficit now runs at 5.1 per cent of gross domestic product (GDP), or €152.5 billion, nearly three times its defence budget. Its annual interest bill is alone €64.7 billion, larger than the entire economy of Latvia, Estonia, Cyprus, or Malta.

So what options does France have? And how can Australia avoid the same fate?

The lesson of the 75% tax

France has tried to tax its way out before. However, the European Union makes it very easy for high-income earners to domicile elsewhere. Quelle horreur!

In 2013, the Socialist president François Hollande introduced a 75 per cent tax on earnings above €1 million. In what may be the great irony of the European project, nearly 1,500 wealthy taxpayers left France. The tax raised an estimated €420 million. Over the period from 2007 to 2016, the country lost €23.8 billion in taxable net assets. The policy was abandoned in January 2015.

The point is not to laugh at a policy failure that undoubtedly left France poorer. It is that we live in a globalised world, and capital leaves. Punishing asset holders and workers with tax does not make a nation richer. Only productivity does that.

Note: I am deliberately not invoking the Laffer curve, and this is not an endorsement of Reaganomics. It is a plainer observation: other nations have tried taxing their way out of debt and deficit, and they got poorer.

Australia now sits in a very precarious position. The average worker in Australia faces higher income, capital gains and business taxes. We have a larger public service per capita, and now we are staring down the barrel of substantially reduced tax receipts.

The budget’s changes to stamp duty alone could remove up to $8 billion a year. The changes to the capital gains tax discount mean little when there are no capital gains to tax, and the data suggests the average post-COVID-19 gain in Sydney and Melbourne has been wiped out since the budget: five years of gains lost in a matter of months. Smaller capitals are seeing price falls that extend as far as 18 months, which would mean the Tax Office collects nothing at all. Unemployment, meanwhile, has risen by 55,200 over 12 months, an increase of 8.2 per cent.

The consequence is simple. Forward tax revenues are heading down by tens of billions of dollars a year, while transfer payments for a growing number of unemployed and retired Australians are heading up. I expect Australia’s budget to look uncomfortably French by next year’s federal budget.

The data is clear. We’re not so different after all

Australia likes to see itself as the lightly taxed, well-run alternative to Europe. Well, do I have some news for you.

Our public sector tells a similar story.

The bond market is not waiting

French bond yields are moving north. So are ours.

The arithmetic is unforgiving. France’s debt is €3.46 trillion, and it spends around €64.7 billion a year servicing it. If €300 billion of that were refinanced at a rate one percentage point higher, the extra cost would be €3 billion a year. At two points, it would be €6 billion. If €1 trillion were to be eventually refinanced at rates two points higher, annual interest spending would rise by an additional €20 billion.

These are costs in addition to France’s ballooning interest repayments. Simply: a risk-adjusted requirement for the market to continue lending to France.

Higher borrowing costs force choices. Governments raise taxes, freeze hiring, reform pensions or cut spending, and each of those weakens household consumption and growth. A sustained sell-off in government bonds also hurts banks, whose holdings lose market value, and tightens lending conditions at the worst possible moment. It means businesses can’t borrow and expand.

At this point, the medicine becomes a poison.

What Keynes would have said

After my last op-ed, I was lambasted for being too critical of what can only be described as a criminally negligent federal government. So I’m going to keep it simple: my economic theory is as simple as the legendary economist’s own line: “The boom, not the slump, is the right time for austerity at the Treasury.”

That matters because of what happens when governments are forced to tighten in a slump. In 2013, the International Monetary Fund admitted that spending cuts and tax increases during the European debt crisis had done far more damage than it had expected. Its models had assumed a fiscal multiplier of around 0.5, which implied that every €1 billion of tightening would cost about €500 million in output. Later research put the multiplier between 0.9 and 1.7. The same €1 billion adjustment could cost between €900 million and €1.7 billion.

Greece shows what that means in practice. After its debt crisis in 2009-10, it raised VAT from 19 to 23 per cent, added income and property taxes, and cut public sector wages and pensions by more than 25 per cent on average. Those measures, alongside a bailout and a banking crisis, contributed to a collapse in domestic demand. Greece’s economy shrank by more than a quarter between 2008 and 2016. Unemployment rose from 8 per cent to 27.5 per cent by 2013, and youth unemployment reached 58.3 per cent. Public debt, meanwhile, climbed from about 100 per cent of GDP to almost 180 per cent, because the collapse in output undermined the fiscal position the austerity was meant to repair.

France is not facing a Greek-style financing crisis, at least not yet. But sustained higher borrowing costs would force politically painful choices, and those choices could weaken growth and make stabilising the debt harder.

There is no longer anything to laugh at

The lesson for Australia is not that France is doomed, or that taxes should never rise. It is that a country cannot tax mobile capital and mobile people indefinitely, that a shrinking revenue base is a poor foundation for a growing state, and that bond markets are less patient than voters.

For years, Australians have watched Europe’s fiscal troubles with a certain smugness. That is no longer justified. The warning in the French bond market is addressed to us as well, and the time to heed it is while there is still a boom to be austere in.

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