France’s Wacky Definition of Competitiveness

Evidently, France has discovered the secret to enhancing economic competitiveness: really, really high taxes!

At least, that’s what new President François Hollande’s recent comments suggest. Defending his pledge to tax income above €1 million at 75%, he said: “This is not a punishment. It’s not to point at those who’ve succeeded by their talent and their work to accumulate wealth. But at the moment we’re seeking everyone’s help to cut the debt, deficit and improve our competitiveness.” Thus, parting with 75% of one’s supposedly excess income would be “a certain form of patriotism.”

Perhaps something was lost in translation?

Last I checked, onerous taxes generally hindered, rather than enhanced, competitiveness. In France’s case, the new income tax would effectively place a salary cap at €1 million — what’s the point of earning anything more if the government will just take three-fourths of it?

And if there’s no point in earning more, there’s no point in producing more. If I’m a French businessperson, assuming I stay in the country, I slack off a bit and settle for earning less — and the economy will have to survive sans the extra production or the goods and services I’d consume with the extra money I’d have earned.

And, well, it goes without saying the government wouldn’t get any extra revenue from me.

Or from the workers I wouldn’t hire because I’m producing less.

Or from the goods I didn’t purchase because I had less disposable income.

I’m guessing many of France’s high earners would adopt a similar mentality — perhaps not at first, but probably as time passes. Thus, over time, the nation’s productivity and output would likely dwindle. That’s true even if the tax only directly impacts the highest earners in France — if they’re producing less, they’re providing fewer opportunities for others, which likely diminishes output across society as a whole. This is the opposite of a competitive economy.

Tax reductions, however, can spur output and, in my opinion, would provide France a better way to improve competitiveness. Time and again we’ve seen tax-friendly states outgrow their peers. My boss, Ken Fisher, recently noted this trend in U.S. states over the past few decades, and it’s true globally.

When income taxes are lower, folks are incentivized to earn more — and to earn more, they’ll produce more. Maybe they’ll invest more in new equipment, software, facilities and product development. They’ll probably hire a few more workers to support their higher production. And with extra disposable income, they’ll spend more, spreading wealth throughout the broader economy. More opportunities for more people likely follow. As does a larger tax base, which typically brings higher tax revenue even though marginal rates are lower.

Further increasing the tax base — and output — are the additional workers low-income-tax areas attract. As Fisher also pointed out, tax-friendly states offer a better quality of life, which attracts refugees from high-tax states. It’s no coincidence the number of French people residing in Britain — which recently cut the top income tax rate — increases every year. And British Prime Minister David Cameron plans to, as he infamously put it, “roll out the red carpet” for anyone seeking to flee France’s proposed tax increase.

But if France were to reverse course and cut taxes, that migratory pattern might also reverse — and more people in other nations might find France an attractive place to live and work. Which brings more business and more capital to the Fifth Republic.

And that, mes amis, is how one fosters a competitive economy.

— Elisabeth Dellinger, Fisher Investments Editorial Staff

This article constitutes the views, opinions, analyses and commentary of the author as of July 2012 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

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