Taxing problem of increasing VAT in France

Value added tax has been called the Mata Hari of taxation. Every government has succumbed to its charms and found it irresistible. So much so that VAT has spread around the world more quickly than any other new tax.

The French claim to have invented this basic tax on consumption. They were certainly the first Europeans to adopt it in 1954. So perhaps it is no surprise that the new French government is again turning to VAT to get it out of its fiscal fix.

Fresh from its electoral landslide, the government has sparked a furious debate this week by proposing to increase sharply the country’s 19.6 per cent VAT rate.

After all, the Germans have just done this and it does not seem to have had dramatic repercussions on domestic demand.

The French government also argues that labour costs need to come down to revive the domestic economy and prevent widespread offshoring by manufacturing companies.

The idea is to transfer some of these social costs from companies to consumers. In addition, this would have the added advantage of imposing a tax on imports, given that French exporters will benefit from the lower charges and will not be affected by the increased VAT rate.

The Socialist opposition has wasted little time attacking the new government for favouring the rich at the expense of the poor. The attack has some justification, as VAT is widely considered a regressive tax, with the poor paying more in comparison to the rich.

But François Fillon, the prime minister, insists consumer prices will not rise, despite a proposed 5 percentage point increase in the VAT rate, pushing it close to exorbitant Scandinavian levels of 25 per cent. Just how the prime minister of a free market economy intends to ensure prices will not rise defies imagination, unless the idea is to impose price controls – hardly an advertisement for a liberal government.

It is also highly arguable that this “social VAT” as it is being described will help preserve jobs and prevent offshoring. If companies are going to be forced to hold prices and absorb the VAT increase, surely they will face more pressure on costs. That can only mean job cuts.

To be fair, the government claims it is still studying the measure and will not implement any increase until 2009. And one can expect a number of diplomatic exceptions to the VAT increase in certain sensitive sectors.

One would hope, however, that this government will be a bit more discerning in its exceptions than Britain was in the 1970s. Remember the great Jaffa Cake debate, when the country’s brightest economists devoted hours to defining the difference between a highly taxed chocolate-covered biscuit and a tax-exempt cake? One hopes the same fate will not befall the chocolate éclair.

Rags or riches?

The huge mess surrounding the possible flotation of RAG is a perfect symbol for this messiest of companies. The future of this unwieldy German conglomerate is fast turning into an industrial and political test case.

RAG grew out of the coal activities of many of the heavyweight companies of the Rhine-Ruhr region – the likes of Eon, RWE and ThyssenKrupp as well as ArcelorMittal. But an extraordinary array of assets from property to speciality chemicals and energy was bunched together with the old coal business.

Sorting out this industrial hodgepodge was always going to be difficult but the solution is particularly complicated, even by German standards. The coal activities are to be hived off into a foundation, which will take over all the sector’s liabilities as it is run into the ground over the next decade. Funding for the foundation will come from floating the rest of RAG.

Despite the lack of direct government involvement, the future of the coal industry has turned RAG into the hottest of political controversies.

The unseemly squabbling continued this week with a new dispute over who should head the foundation. Jochen Melchior, the former chief of RAG’s energy business, is a leading candidate.

The foundation will be a giant in the Rhine-Ruhr industrial area, in charge of billions of euros in assets and liabilities. It was therefore quite fanciful for Werner Müller, RAG’s chief executive and a former SPD economics minister, to think he could lead the foundation – essentially setting up an SPD stronghold in the middle of the country’s largest region.

But vacuity and vanity have marked the entire project – and risk that has cost the taxpayer dear. There are still no answers to some basic questions – why does putting together three sub-scale businesses in vastly different sectors make a coherent company? Why does Germany need a new conglomerate? And why not simply break up RAG?

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