## cr17289

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### Overview and policy context
- Capital tax reform is central to the government’s agenda; planned measures include:
  - reduce the CIT rate (previously scheduled from 33.3 percent in 2017 to 28 percent by 2020; government announced a further reduction to 25 percent by 2022);
  - exclude financial investment from the wealth tax;
  - streamline the taxation of portfolio income (interest and dividends);
  - further reduce taxes on labor.
- The CIT regime is focal for efficiency and competitiveness; related capital taxes include real property, portfolio income, wealth, inheritances and gifts.
- Systemic distortions: high statutory CIT rate but low revenue productivity; bias toward debt financing; ineffective size-dependent regimes; inefficient tax incentives; comparatively high profit-insensitive taxes.

### Key features of capital taxation in France (aggregate indicators)
- Government spending: more than 56 percent of GDP.
- Revenue ratio: 53 percent of GDP.
- Taxes equivalent to 45½ percent of GDP.
- Level of capital taxes: about 10.8 percent of GDP.
- Share of capital taxes in total tax revenues: 23.5 percent.
- Tax on capital stock: 4.3 percent of GDP.
- Tax on capital income: 6.5 percent of GDP (2.8 percent from corporate income (CIT), 1.8 percent from household income, 1.9 percent from self-employed income).

### Major local business tax (CET) components
- Cotisation foncière des entreprises (CFE): tax on rental value of fixed assets (buildings and lands).
- Cotisation sur la valeur ajoutée des entreprises (CVAE): origin-based value-added tax paid by companies with annual turnover above 500,000 euro; CVAE rate ranges from 0.5 to 1.5 percent depending on turnover.

### Corporate Income Tax (CIT) regime: structure and base
- Statutory and size-dependent rates:
  - Headline statutory rate: 33.3 percent (in 2017); planned reductions to 28 percent by 2020 and to 25 percent by 2022.
  - Size-dependent: first 75,000 euro of profits of SMEs taxed at 28 percent; above that, 33.3 percent applies.
  - Enterprises with turnover below 7.63 million euro subject to reduced rate of 15 percent on profits up to 38,120 euro.
- Tax base and allowances:
  - Territorial system: foreign-source income generally not taxed; foreign-source losses cannot be deducted against income earned in France.
  - Depreciation: fixed assets depreciate over lifespan; company cars depreciable up to 18,000 euro; enhanced depreciation of 40 percent for certain equipment ordered before April 14, 2017.
  - Loss carryforward: indefinite carryforward allowed but limited to one million euro plus 50 percent of profits over one million euro; under conditions, losses up to one million euro can be carried backward for one year.
- Interest deductibility limits:
  - Multi-tier test including maximum related-party debt-equity ratio of 1.5 and ratio of net interest payment to EBITDA not exceeding 25 percent.
  - Ultimately deductible amount capped at 75 percent of net interest payments exceeding 3 million euro, after application of specific limits.
  - Disallowed interest deduction cannot be carried forward.
  - Cap applies to consolidated tax result in domestic groups.
  - Exclusion: banks are excluded from this disallowance rule.

### Tax expenditures under the CIT (largest items)
- Competitiveness and employment tax credit (CICE): 7 percent of the gross payroll, up to 2.5 times the national minimum wage in the preceding year; refundable.
- R&D tax credit (CIR): 30 percent of qualified R&D expenses up to 100 million euro, and 5 percent above this threshold; refundable.
  - Qualified expenses include wages of researchers (200 percent in the first two years of employment for those with a PhD degree), subcontracted and collaborative R&D expenses, R&D-related operating expenses including support staff, administrative expenses, and maintenance.
- Other expenditures:
  - Reduced CIT rate of 15 percent on income from qualified patents and know-how assets (“IP box”).
  - Young Innovative Enterprise (JEI) regime: CIT exemption first year of taxable profits, 50 percent exemption next year; JEI exemptions also apply to the CET and employers’ social security contributions.

### Anti-avoidance framework and international commitments
- France has rules on transfer pricing, controlled-foreign companies (CFC), and limitation to interest deductibility—largely in line with G20/OECD BEPS actions and the July-2016 EU Anti-Tax Avoidance Directive (ATAD).
- Commitments and features:
  - France committed to implementing the four Minimum Standards of G20/OECD BEPS actions and has largely implemented all 15 BEPS Actions (e.g., 2016 Finance Law implements country-by-country reporting).
  - ATAD-related measures in France (as described in source):
    - Interest limitation rule: multi-step test with related-party debt-equity ratio of 1.5; deductible amount capped at 75 percent of net interest payments exceeding 3 million euro; banks excluded. ATAD foresees an earning-stripping rule denying interest deduction where net interest payments to EBITDA exceed 30 percent; unused deduction can be carried forward. France will have until January 1, 2024 to conform to ATAD if its current system is equally effective.
    - CFC rule: applies where foreign effective tax rate is lower than 50 percent of France’s; if CFC in EU, may apply in case of an artificial scheme; capital income from a CFC in a “non-cooperative” country is subject to withholding tax at 75 percent.
    - Hybrid mismatches rule (ATAD II extension, March 2017).
    - General anti-avoidance rule (GAAR): French GAAR applies to arrangements that are “solely” tax driven; may need alignment with ATAD by December 31, 2018.
    - Exit taxation applied to prevent avoidance by moving tax residence or closing a permanent establishment.

### Revenue performance and identified weaknesses
- CIT revenue: around 2.1 percent of GDP versus EU average of 2.4 percent.
- CIT productivity (CIT revenue / gross operating surplus / top statutory CIT rate) consistently lower than comparators.
- In 2015, the top CIT rate noted as 38 percent (figure notes).
- Four primary explanatory factors for weak CIT revenue:
  1. Tax incentives (notably R&D incentives and size-dependent regimes, the CICE).
  2. Outbound profit shifting.
  3. Potentially lower genuine profitability due to high business costs.
  4. Deductibility of local taxes from the CIT base.
- Quantifiability: first and fourth factors relatively easy to quantify; revenue impacts of outbound profit shifting and lower genuine profitability are more uncertain.

### Policy implications and reform directions (high-level)
- Planned reforms (CIT rate reduction, labor tax wedge cuts, unification of capital income taxation, narrowing the wealth tax) create opportunity to improve efficiency and growth orientation.
- Staff analysis suggests complementing measures:
  - Remove inefficient tax incentives (reassess design and fiscal cost of CICE and CIR).
  - Further reduce the debt bias (strengthen limits on interest deductibility; address features favoring debt financing).
  - Address disincentives to company growth (limit loss offset features; reform size-dependent regimes).
  - Streamline taxation of long-term savings.
- Local capital tax reforms: consolidate local property taxes on companies into a single tax based on market values; reduce number of local earmarked taxes on production.
- Emphasis: improving productivity of capital taxation more important than only lowering average tax burdens.

### R&D incentives, IP box assessment, and efficiency evidence
- Rationale: government intervention justified where social benefits of R&D exceed private benefits.
- Empirical evidence:
  - One dollar spent by government on R&D tax incentives, on average, increases domestic private R&D by one dollar (IMF, 2016a; Dumont, 2015).
  - One dollar spent on IP income can, at best, increase R&D by less than one dollar (IMF, 2016a; Dumont, 2015).
  - Bloom et al. (2002): 10 percent reduction in the cost of R&D increases R&D by about 1 percent short-run and 10 percent long-run.
  - Griffith et al. (2014): IP regimes reduced revenues from IP in Benelux and the UK.
- French IP box:
  - Tax rate on qualified IP income: 15 percent.
  - Comparators: 2.5 percent in Cyprus, 5 percent in the Netherlands, 4.5 percent in Hungary.
  - Cost: about 300 million euro in 2016.
  - Synthetic control empirical result: French R&D spending does not differ significantly from synthetic control after 2000; IP Box not successful in stimulating domestic R&D.
- CIR and CII:
  - CIR beneficiaries in 2013: 15,245.
  - CIR cost: 5.6 billion euro (about 10 percent of total CIT revenue per Cour des Comptes, 2016).
  - SMEs innovation credit (CII): 20 percent of innovation expenses excluding R&D; CIR and CII are not additive.
- Policy implication: favor input-based R&D incentives over IP box regimes; consider CCCTB super deduction for R&D and phase out IP regimes if implemented.

### Size-dependent regimes, JEI, and small-business trap
- SME-targeted incentives include CIR, CII, reduced CIT rate or CIT exemption, ISF-PME investor relief.
- Cumulative incentives can include interest deduction + CIR + CII + CICE + reduced CIT rate + IP box + investor tax breaks.
- Reduced CIT rate (15 percent) scope and cost:
  - About one-third of companies subjected to CIT have benefited from the 15 percent rate in recent years.
  - Number of companies benefiting from 15% reduced rate (millions): 2013 = 0.64; 2014 = 0.67; 2015 = 0.67.
  - Number of companies subjected to the IS (millions): 2013 = 1.9; 2014 = 1.9; 2015 = 2.0.
  - Budgetary cost of the reduced rate (millions of euro): 2013 = 2,550; 2014 = 2,550; 2015 = 2,560.
- JEI regime:
  - Beneficiaries in 2015: about 3,500 enterprises.
  - About 80 percent of beneficiaries have less than 10 employees.
  - Cost in 2015: 170 million euros in social security contribution exemptions and 10 million euros in tax cuts.
  - Outcomes: firms in JEI had 8 percent higher employment growth, higher survival rates, and generally paid higher wages (Hallépée and Garcia 2012).
- Recommendation: target young rather than small businesses; review size-dependent regimes (CII) and periodically assess JEI cost-effectiveness.

### Outbound profit shifting, FDI patterns, and empirical estimates
- Reducing the CIT rate lowers incentives for outbound profit shifting.
  - Empirical semi-elasticity: 0.8; i.e., a 10 percentage-point higher tax rate in an affiliate leads to a decline of its pre-tax profits by 8 percent (Heckemeyer and Overesch, forthcoming).
  - Dharmapala (2014) suggests smaller elasticities.
- FDI patterns (2015, IMF CDIS):
  - Inward FDI (% of total inward FDI): Luxembourg 20; Netherlands 12; Switzerland 12; United Kingdom 11; United States 11.
  - Outward FDI (% of total outward FDI): United States 18; Belgium 13; United Kingdom 11; Netherlands 10; Germany 5.
- Transfer mispricing and profit shifting estimates:
  - Transfer mispricing estimated to reduce French corporate tax revenue by 1 percent (Davis et al., 2016).
  - Vicard (2015) estimates transfer pricing abuse cost in 2008 in France at about 8 billion US dollars.
- Recent tightening (including country-by-country reporting) makes abuse more difficult.

### Debt bias, interest deductibility, and allowance for corporate equity (ACE)
- Non-financial corporate debt: almost 130 percent of GDP in 2015 (comparators: Germany 53 percent; UK 67 percent; G20 91 percent).
- Debt bias consequences: encourages borrowing, increases corporate leverage and instability risk.
- Policy options:
  - Further increase interest disallowance (was raised from 15 percent to 25 percent starting in 2014) to reduce debt bias and combat earnings stripping.
  - Introduce an ACE to mitigate increases in the cost of capital; incremental ACE (only new equity) is much less costly and avoids windfalls for existing equity.
  - ACE rate should approximate risk-free rate proxied by government bond rates, with a minimum ACE rate of 2 percent.
  - Cap equity allowance to match allowed interest deduction to reduce fiscal cost.
- Trade-offs: tighter disallowance can raise cost of capital, risk double taxation internationally, and create transition issues for pre-existing debt.

### ACE and the banking sector; coordination considerations
- ACE applicable to banking without major implementation problems.
- Financial corporation debt-to-equity ratio in France: "4.5" (slightly above OECD average).
- Belgian experience: ACE associated with a decrease in leverage in the banking sector by "13 percent" (Schepens, 2016); associated with increased lending to firms (Celerier et al., 2017).
- France imposes a bank levy of "0.222 on minimum equity".
- Bank levy may affect portfolio choices and increase holdings of riskier assets (Devereux et al., 2015).
- Recommendation: coordinate debt-bias reforms at EU level to limit spillovers and combine interest limitation with ACE.

### The CICE, labor tax wedge, and transition
- Tax wedge for a single person earning average income: "48 percent" (OECD average "41.5 percent").
- Employers’ social security contributions (SSC) in France average "36.5 percent" (OECD average "23 percent").
- CICE offset: CICE expected cost "15,770 million euro in 2017" (Cour des Comptes, 2016).
- CICE Monitoring Committee: CICE had no impact on investment, R&D, exports or wages, but appears to have created or saved between "50,000 and 100,000 jobs" in 2013–2014.
- Policy implication: replace CICE with direct SSC cuts (government plan) to better target employment; first-year transition cost from prior-year claims could be phased over two years.

### Linkages between CIT and broader tax system (legal form neutrality and capital income)
- Planned CIT cut to "25 percent" may increase incentives to incorporate, risking erosion of PIT (IR).
- PIT marginal tax rate ranges from "14 to 45 percent" under current progressive schedules.
- CSG is a schedular single-rate tax around "8 percent".
- Distortions across instruments and layers of taxes on flows and stocks raise pre-tax required return on savings.
- Reforms recommended:
  - Move toward single-rate tax on capital income (interest, dividends, capital gains) consistent with government plans.
  - Transform instrument-based tax breaks into comprehensive tax-deferred long-term savings vehicles.
  - Review coexistence of wealth and inheritance taxes; example estimate: Didier and Ouvrard (2016) estimate a rate of "30 percent" as a replacement for all taxes on capital held by individuals.

### Tax uncertainty and tax policy process
- France has highest number of yearly corporate tax law changes among selected EU countries; earlier studies indicate close to "20 percent" of provisions in the tax code are subject to change each year.
- Measures to improve stability and predictability:
  - Advance tax rulings (“rescrit fiscal”) should be swift and published (redacted).
  - Maintain government control over tax policymaking under the ministry of finance and parliamentary finance committee.
  - Limit major tax changes to annual finance laws.
  - Avoid retroactive tax legislation ("petite rétroactivité"); use transitional, grandfathering and sunset provisions.
  - Systematically engage in ex-ante stakeholder consultations.

### Competitiveness, exports, and value-added findings
- Gross and value-added export analyses show France lost external competitiveness since the 1990s in price and non-price dimensions.
- Tradable sectors:
  - Since 2000, tradable sectors contributed ¾ percentage points to France’s gross value added growth.
  - Manufacturing contributed very little to tradable GVA growth; tradable services main contributor to employment growth; employment falling in manufacturing.
  - Share of non-tradable sectors in GDP: about 46 percent of GDP in 2016.
- Profit margins and profitability:
  - Profit margins in tradable sectors declined since early 2000s but rebounded moderately recently.
  - Gross operating surplus to GVA declined, especially in manufacturing, with recent rebound.
- Aggregate external position:
  - Current account deficit around 1 percent of GDP in 2016, or 1¾ percent of GDP cyclically adjusted.
  - IMF External Sector Assessment judges this to be 2¾ percent of GDP lower than level consistent with fundamentals and desirable policy settings.

### Econometric findings on exports (panel of 6 exporting countries)
- Both foreign demand and price competitiveness significantly affect value-added exports; most explanatory coefficients significant at 1 percent.
- Elasticities and key coefficients:
  - One percent increase in real domestic demand in a destination country => 1.6 percent increase in value of exports of a particular sector.
  - One percent depreciation in nominal bilateral exchange rate or one percent increase in ratio of destination to exporter GDP deflator => 0.4 increase in value of exports on average.
  - 1 percent increase in ratio of average GDP deflators of all exporters to the exporting country => 0.2–0.25 increase in value of exports.
- Regression summary (selected):
  - Log(aggregate demand): 1.590***, 1.575***, 1.695***
  - log(bilateral NER): 0.393***, 0.374***
  - Log(relative bilateral VA deflators): 0.406***, 0.381***
  - Log(VA deflator rel. to all exporters): 0.205***, 0.260***
  - Observations: 137,811; R-squared: 0.938; Fixed effects: Source*Destination*Sector included.
- Predicted contributions to export performance (2001–2011, log changes):
  - France: Demand 34%, NER -5%, Relative output price 5%, Total predicted 34%, Unexplained 28%, Actual log change 63%.
  - Germany: Demand 40%, NER -5%, Relative output price 9%, Total predicted 45%, Unexplained 41%, Actual log change 85%.
  - Interpretation: prices and foreign demand each explain about one quarter (10 percentage points) of France-Germany export performance difference; 12 percentage points remain unexplained attributed to non-price competitiveness.

### Policy-relevant conclusions on competitiveness
- France’s loss of external competitiveness reflects both price and non-price factors:
  - REER overvaluation estimated between 8 and 14 percent (2016 IMF ESA).
  - Relative declines in cost competitiveness before the global financial crisis; since crisis, indicators improved due to wage moderation and measures lowering labor tax wedge.
  - Comparative advantage shifted toward Low and medium-low technology sectors since mid-1990s.
  - France-specific effects (policies, institutions, high and variable tax burden, labor/product market rigidities) contributed materially to export underperformance.
- Policy priorities:
  - Address labor and product market rigidities, high tax burden on capital and labor, and reform capital taxation to improve allocation, investment, and competitiveness.
  - Recognize that CIT rate cuts alone are insufficient; reform base, remove inefficient incentives, reduce debt bias, and improve tax stability to support competitiveness and productivity.

*Source: INTERNATIONAL MONETARY FUND — Excerpts from IMF staff report (cr17289).*

### 1. France's International Obligations and Commitments Regarding the CIT ______________ 7

### 1. France's International Obligations and Commitments Regarding the CIT

### Overview and policy context
- Capital tax reform is a central element of the government’s agenda; planned measures include:
  - reduce the CIT rate (previously scheduled from 33.3 percent in 2017 to 28 percent by 2020; government announced a further reduction to 25 percent by 2022);
  - exclude financial investment from the wealth tax;
  - streamline the taxation of portfolio income (interest and dividends);
  - further reduce taxes on labor.
- The corporate income tax (CIT) regime is a focal point because of its importance for efficiency and competitiveness; other capital taxes (real property, portfolio income, wealth, inheritances and gifts) are linked in the analysis.
- The current system is characterized by distortions and inefficiencies: high statutory CIT rate but low revenue productivity, bias toward debt financing, ineffective size-dependent regimes, inefficient tax incentives, and comparatively high profit-insensitive taxes.

### Key features of capital taxation in France
- Aggregate and composition indicators:
  - Government spending: more than 56 percent of GDP.
  - Revenue ratio: 53 percent of GDP.
  - Taxes equivalent to 45½ percent of GDP.
  - Level of capital taxes: about 10.8 percent of GDP.
  - Share of capital taxes in total tax revenues: 23.5 percent.
- Capital taxation split:
  - Tax on capital stock: 4.3 percent of GDP.
  - Tax on capital income: 6.5 percent of GDP (decomposed as: 2.8 percent from corporate income (CIT), 1.8 percent from household income, and 1.9 percent from self-employed income).
- Major local business tax:
  - Territorial local contribution (CET) with two components:
    - Cotisation foncière des entreprises (CFE): tax on rental value of fixed assets (buildings and lands).
    - Cotisation sur la valeur ajoutée des entreprises (CVAE): origin-based value-added tax paid by companies with annual turnover above 500,000 euro; CVAE rate ranges from 0.5 to 1.5 percent depending on turnover.
- Profit-insensitive taxes are significant, including taxes on personal wealth, real estate, and local business taxation.

### The Corporate Income Tax regime: structure and provisions
- Statutory and size-dependent rates:
  - Headline statutory rate: 33.3 percent (in 2017), with planned reductions to 28 percent by 2020 and to 25 percent by 2022.
  - Size-dependent rates: first 75,000 euro of profits of SMEs taxed at 28 percent; above that, 33.3 percent applies; enterprises with turnover below 7.63 million euro subject to reduced rate of 15 percent on profits up to 38,120 euro.
- Tax base and allowances:
  - Territorial tax system: foreign-source income generally not taxed; foreign-source losses cannot be deducted against income earned in France.
  - Depreciation: fixed assets depreciate over lifespan with exceptions (e.g., company cars depreciable up to 18,000 euro); enhanced depreciation of 40 percent for certain equipment ordered before April 14, 2017.
  - Loss carryforward: indefinite carryforward allowed but limited to one million euro plus 50 percent of profits over one million euro; under conditions, losses up to one million euro can be carried backward for one year.
- Interest deductibility limits:
  - Multi-tier test including a maximum related-party debt-equity ratio of 1.5 and ratio of net interest payment to EBITDA not exceeding 25 percent.
  - Ultimately deductible amount capped at 75 percent of net interest payments exceeding 3 million euro, after application of specific limits.
  - Disallowed interest deduction cannot be carried forward.
  - Cap applies to consolidated tax result in domestic groups.
  - Exclusion: banks are excluded from this disallowance rule.

### Tax expenditures under the CIT
- Largest tax expenditures:
  - Competitiveness and employment tax credit (CICE): amounts to 7 percent of the gross payroll, up to 2.5 times the national minimum wage in the preceding year; refundable.
  - R&D tax credit (CIR): amounts to 30 percent of qualified R&D expenses up to 100 million euro, and 5 percent above this threshold; refundable.
    - Qualified expenses include wages of researchers (200 percent in the first two years of employment for those with a PhD degree), subcontracted and collaborative R&D expenses, R&D-related operating expenses including support staff, administrative expenses, and maintenance.
- Other tax expenditures:
  - Reduced CIT rate of 15 percent on income from qualified patents and know-how assets (“IP box” regime).
  - Young Innovative Enterprise (JEI) regime: exempts startups (businesses less than eight years old) from the CIT in the first year of making taxable profits, followed by an exemption of 50 percent for the next year; startups under JEI are also exempted from the CET and from employers’ social security contributions.

### Anti-avoidance framework and international commitments
- France has anti-tax avoidance rules covering transfer pricing, controlled-foreign companies (CFC), and limitation to interest deductibility—largely in line with G20/OECD BEPS actions and the July-2016 EU Anti-Tax Avoidance Directive (ATAD).
- Box: France’s International Obligations and Commitments Regarding the CIT
  - France is committed to implementing the four Minimum Standards of G20/OECD BEPS actions: countering harmful tax practices, preventing tax treaty abuse, transfer pricing documentation, and improving tax treaty dispute resolutions.
  - France has largely implemented all 15 BEPS Actions; e.g., the 2016 Finance Law implements country-by-country reporting in line with transfer pricing documentation requirements.
  - EU obligations: implementation of ATAD (adopted July 12, 2016) requiring Member States to implement five anti-tax abuse measures; ATAD goes further than BEPS four minimum standards.
  - Summary of key ATAD-related measures in France (as described in source):
    - Interest limitation rule: France has a multi-step test including a maximum related-party debt-equity ratio of 1.5; ultimately deductible amount capped at 75 percent of net interest payments exceeding 3 million euro, after specific limits; banks excluded. ATAD foresees an earning-stripping rule denying interest deduction where net interest payments to EBITDA exceed 30 percent; unused deduction can be carried forward. France will have until January 1, 2024 to conform to the ATAD if its current system is equally effective.
    - Controlled foreign company (CFC) rule: applies where foreign effective tax rate is lower than 50 percent of France’s; if CFC in EU, may apply in case of an artificial scheme; capital income from a CFC in a “non-cooperative” country is subject to withholding tax at 75 percent.
    - Hybrid mismatches rule: counters arrangements exploiting differences in legal characterization leading to double deductions; ATAD originally for EU arrangements extended in March 2017 to cover EU–non-member state arrangements (ATAD II).
    - General anti-avoidance rule (GAAR): French GAAR applies to arrangements that are “solely” tax driven as opposed to “principally” in the case of ATAD; might need alignment with ATAD by December 31, 2018.
    - Exit taxation: France applies an exit tax as EU Member States shall apply an exit tax to prevent avoidance by moving tax residence or closing a permanent establishment.

### Revenue performance and identified weaknesses
- CIT revenue in France:
  - CIT revenue around 2.1 percent of GDP versus EU average of 2.4 percent (Figure 2).
  - CIT productivity (CIT revenue / gross operating surplus / top statutory CIT rate) has been consistently lower than comparators.
  - In 2015, the top CIT rate in France was 38 percent (figure notes).
- Four primary factors explaining relatively weak CIT revenue performance:
  1. Tax incentives (notably R&D incentives and size-dependent regimes, the CICE).
  2. Outbound profit shifting.
  3. Potentially lower genuine profitability due to high business costs.
  4. Deductibility of local taxes from the CIT base.
- Quantifiability: the first and fourth factors are relatively easy to quantify; the revenue impacts of the others (outbound profit shifting and lower genuine profitability) are more uncertain.

### Policy implications and reform directions (high-level)
- The government’s planned reforms (CIT rate reduction, labor tax wedge cuts, unification of capital income taxation, narrowing the wealth tax) offer an opportunity to improve efficiency and growth orientation.
- Staff analysis suggests these reforms could be complemented by:
  - Removing inefficient tax incentives (e.g., reassessing the design and fiscal cost of CICE and CIR).
  - Further reducing the debt bias (strengthening limits on interest deductibility and addressing features that favor debt financing).
  - Addressing disincentives to company growth (limitations on loss offset, size-dependent regimes).
  - Streamlining the taxation of long-term savings.
- Improving the productivity of capital taxation is emphasized as more important than only lowering average tax burdens; potential reforms to local capital taxes include consolidating local property taxes on companies into a single tax based on market values and reducing the number of local earmarked taxes on production.

*Source: IMF staff (excerpts from IMF report).*

### 15.      Well-designed and implemented R&D tax incentives can have a sizable impact on

### 15.      Well-designed and implemented R&D tax incentives can have a sizable impact on productivity

### Rationale for government intervention
- Where the social benefits from R&D investments exceed the private benefits from R&D, government intervention to correct for this positive externality is justified.
- Taxation can incentivize private R&D activities through:
  - the input side (in the form of an R&D tax credit or deduction), or
  - the output side (in the form of a reduced tax rate on IP income).

### Efficiency: R&D tax credits/deductions versus IP box regimes
- Empirical evidence and estimates:
  - One dollar spent by the government on R&D tax incentives, on average, increases domestic private R&D by one dollar (IMF, 2016a; Dumont, 2015).
  - One dollar spent on IP income can, at best, increase R&D by less than one dollar (IMF, 2016a; Dumont, 2015).
  - Bloom et al. (2002): a 10 percent reduction in the cost of R&D increases the level of R&D by about 1 percent in the short-run and 10 percent in the long-run.
  - Griffith et al. (2014): IP regimes have resulted in lower revenues from IP in the Benelux countries and the UK.
- Conceptual concerns with IP box regimes:
  - Reward only success; successful R&D outputs depend on many non-R&D inputs (including management) not characterized by market failure.
  - Disconnected from the level of R&D expenditures: tax benefit proportional to qualifying IP income, not R&D input.
  - Cannot perfectly target the location of R&D: may influence legal ownership of know-how assets without affecting domestic R&D investments; large enterprises, particularly in manufacturing, benefit most.

### Assessment of the French IP box regime
- French IP box specifics and comparative rates:
  - French tax rate on qualified IP income: 15 percent.
  - Comparators: 2.5 percent in Cyprus, 5 percent in the Netherlands, 4.5 percent in Hungary.
  - Cost of the French IP box regime: about 300 million euro in 2016.
- Empirical assessment (Box 2 — synthetic control method):
  - Using Eurostat R&D data and a synthetic control of 12 non-IP Box countries, the actual French R&D spending does not differ significantly from the synthetic R&D spending after 2000.
  - Result: the IP Box regime was not successful in stimulating domestic R&D activities.
- Policy implications:
  - A potential reform could follow the European 2016 proposal to introduce a Common Consolidated Corporate Tax Base (CCCTB), which envisages a super deduction for R&D expenditures; if implemented, the CCCTB would phase out IP regimes (Annex II).

### R&D tax incentives in France: CIR and CII
- CIR (Crédit d’Impôt Recherche) details:
  - Beneficiary companies in 2013: 15,245.
  - Cost: 5.6 billion euro.
  - This cost is about 10 percent of total CIT revenue (Cour des Comptes, 2016).
- CII (innovation tax credit) and size-dependent features:
  - SMEs can benefit from a tax credit of 20 percent of innovation expenses excluding R&D expenses.
  - CIR and CII are not additive; they cannot be claimed in relation to the same R&D expenses.
- Efficiency concerns:
  - Size-dependent R&D credits and size-dependent regimes in general tend to be inefficient.

### Size-dependent CIT regimes and the “small-business trap”
- Extent of SME-targeted tax incentives: CIR, CII, reduced CIT rate or CIT exemption, ISF-PME reduced wealth tax for individual investors.
- Example of cumulative benefits for a medium-scale business: interest deduction + CIR (including skilled-labor employment costs) + CII + CICE + reduced CIT rate + IP box reduced rate + investor tax breaks (ISF-PME or other share saving plans).
- Cost and distortions of reduced CIT rate:
  - About one-third of companies subjected to the CIT in France have benefited in recent years from the reduced rate of 15 percent.
  - Table 1: Number of companies benefiting from the reduced rate of 15% (millions): 2013 = 0.64; 2014 = 0.67; 2015 = 0.67.
  - Number of companies subjected to the IS (millions): 2013 = 1.9; 2014 = 1.9; 2015 = 2.0.
  - Budgetary cost of the reduced rate (millions of euro): 2013 = 2,550; 2014 = 2,550; 2015 = 2,560.
  - These regimes generate disincentives to firm growth and open loopholes for tax planning (e.g., splitting legal structures to remain below thresholds).

### Young Innovative Enterprise (JEI) regime
- Coverage and cost:
  - Beneficiaries in 2015: about 3,500 enterprises.
  - About 80 percent of beneficiaries have less than 10 employees.
  - Cost in 2015: 170 million euros in social security contribution exemptions and 10 million euros in tax cuts.
- Economic outcomes:
  - Firms in the JEI regime had an 8 percent higher employment growth rate, higher survival rates, and generally paid higher wages than nonparticipants (Hallépée and Garcia 2012).
- Conclusion: targeting young rather than small business is more effective in promoting innovative entrepreneurship (IMF, 2016a).

### Options for reforming special tax regimes (policy recommendations)
- Adopting a single CIT rate to eliminate distortions from multiple rates; current plan to reduce the statutory rate further to 25 percent offers an opportunity to reconsider multiple rates.
- Reviewing other size-dependent regimes including the SMEs’ innovation tax credit (CII).
- Periodically assessing the cost-effectiveness of the JEI regime.

### Outbound profit shifting and FDI patterns
- Reducing the CIT rate lowers incentives for outbound profit shifting.
  - Empirical semi-elasticity: 0.8; i.e., a 10 percentage-point higher tax rate in an affiliate leads to a decline of its pre-tax profits by 8 percent (Heckemeyer and Overesch, forthcoming).
  - Dharmapala (2014) suggests somewhat smaller elasticities.
- France’s EU commitments:
  - EU Code of Conduct for Business Taxation and EU state aid rules constrain harmful tax competition and state aid through tax systems.
  - Proposed CCCTB would be expected to eliminate profit shifting within the EU but could intensify CIT rate competition and shift incentives to move profits outside the EU.
- Observed FDI patterns (2015, IMF CDIS):
  - Inward FDI (% of total inward FDI): Luxembourg 20; Netherlands 12; Switzerland 12; United Kingdom 11; United States 11.
  - Outward FDI (% of total outward FDI): United States 18; Belgium 13; United Kingdom 11; Netherlands 10; Germany 5.
- Profit shifting mechanisms and evidence:
  - Advanced rulings and treaty shopping can affect bilateral FDI; European Commission investigations have examined tax ruling practices in member states.
  - Transfer mispricing estimated to reduce French corporate tax revenue by 1 percent (Davis et al., 2016).
  - Vicard (2015) estimates the cost of transfer pricing abuse in 2008 in France at about 8 billion US dollars.
  - Recent tightening of French transfer pricing rules, including country-by-country reporting, makes abuse more difficult.

### Debt bias, interest deductibility, and allowance for corporate equity (ACE)
- Debt levels and context:
  - Debt of non-financial corporations in France: almost 130 percent of GDP in 2015.
  - Comparators: Germany 53 percent; UK 67 percent; G20 91 percent.
- Problems from tax bias favoring debt:
  - Encourages borrowing to benefit from interest deductions, increasing corporate leverage and risks of instability.
- French policy actions:
  - Interest disallowance raised from 15 percent to 25 percent starting in 2014.
- Further options and trade-offs:
  - Further increasing interest deduction disallowance could reduce debt bias and combat earnings stripping, and help offset revenue loss from CIT rate cuts.
  - Challenges of relying solely on tighter interest disallowance:
    - Can raise the cost of capital and dampen investment.
    - Unilateral tight disallowance increases risk of double taxation internationally.
    - Transition issues with pre-existing debt.
- ACE as a complementary reform:
  - An allowance for corporate equity (ACE), combined with a tighter interest limitation, would mitigate increases in the cost of capital by allowing a deduction for the normal return on equity.
  - An incremental ACE (deduction only for new equity compared to a reference period) is considerably less costly than an ACE based on total book value of equity and avoids windfalls for existing equity.
  - Strengthening the interest limitation rule would allow capping the equity allowance to match allowed interest deduction, reducing fiscal cost.
  - The ACE rate should approximate the “risk-free” rate, proxied by government bond interest rates, but with a minimum ACE rate of 2 percent.

*International Monetary Fund — France chapter (excerpts provided in the source content).*

### 34.      The ACE can be applied to the

### 34.      The ACE can be applied to the

### ACE and the banking sector
- The ACE can be applied to the banking sector without major implementation problems.
- Addressing the debt bias in the financial sector is important given potential instability risks and externalities.
- Financial corporation debt-to-equity ratio in France:
  - "4.5" (slightly above the OECD average).
- Belgian experience:
  - Offering an ACE is associated with a decrease in leverage in the banking sector by "13 percent" (Schepens, 2016).
  - Associated with increased lending to firms (Celerier et al., 2017).
- France imposes a bank levy of "0.222 on minimum equity".
- Empirical evidence suggests a bank levy can affect banks’ portfolio choices and increase holdings of riskier assets, partly undoing the effect of lower debt on overall bank riskiness (Devereux et al., 2015).

### Dealing with the corporate debt bias and coordination
- Dealing with the corporate debt bias calls for a carefully calibrated reform, ideally coordinated at the EU level.
- An EU-wide perspective can limit potential spillovers from a tighter interest limitation rule and explore ways to combine an interest limitation rule with an ACE.
- Incremental ACE potential budgetary impacts (described in text):
  - Higher equity finance (hence, lower interest deduction).
  - Less need for accelerated depreciation (since faster depreciation in one period leads to a lower equity in the next period, and thus a lower ACE base).

### The CICE and the labor tax wedge
- Tax wedge context:
  - Average tax wedge for a single person earning an average income in France is "48 percent", compared with an OECD average of "41.5 percent".
  - Employers’ social security contributions (SSC) in France average "36.5 percent", compared with an OECD average of "23 percent".
  - These figures do not account for the employment tax credit (CICE), which offsets labor costs, up to a threshold, against the CIT (loss-making firms get a refund).
- Evidence on CICE:
  - The CICE Monitoring Committee concluded CICE has not had an impact on investment, R&D, exports or wages, but appears to have had a positive impact on employment, by creating or saving between "50,000 and 100,000 jobs" in 2013–2014.
- Policy implications:
  - Little economic rationale for using the CIT to reduce labor costs instead of directly lowering employers’ SSC.
  - Government plan to replace the CICE with an outright SSC cut should be an improvement by more directly targeting employment creation via lower non-wage cost per employee.
  - If the minimum wage is above the market clearing level, targeted SSC cuts around the minimum wage can help boost lower-wage earners’ employment; however, the employment impact depends on subsequent wage bargaining outcomes and firms’ incentives for hiring in jobs that do not benefit from the targeted SSC cut.
- Cost and transition:
  - Converting the CICE into a lower SSC: CICE expected to cost "15,770 million euro in 2017" (Cour des Comptes, 2016).
  - First-year transition cost associated with claims in relation to the previous year could be spread by phasing in the SSC cut over two years.

### Linkages between the CIT and the broader tax system
- Tax neutrality vis-à-vis legal business forms:
  - Planned CIT rate cut to "25 percent" may increase incentive for individuals to incorporate, risking erosion of the personal income tax (PIT, “impôt sur le revenu”; IR).
  - Tax treatment of business income depends on business form (corporate vs non-corporate); alignment is important to avoid distortions in choice of legal form.
  - Empirical evidence for Europe points to significant shifts in choice of legal form due to tax differences between corporate and non-corporate businesses (De Mooij and Nicodème, 2008).
  - Under current PIT and CIT arrangements:
    - A single-earner household has a strong incentive to incorporate at relatively low tax rates, but not dual-earner households due to the “quotient familial”.
    - Under a CIT at "25 percent", incentive to incorporate is increased significantly for dual earners, while unchanged for single-earner households.
  - CIT rate cannot be seen in isolation from PIT rates to lower arbitrage opportunities via organizational form.
  - PIT marginal tax rate ranges from "14 to 45 percent" (noting complexity associated with progressive wage tax schedules vs single CIT rate).
- Capital income taxes at the individual level:
  - The system combines multiple taxes on returns and stocks of capital: PIT progressive rate structure, the “contribution sociale généralisée” (CSG), and other earmarked taxes.
  - CSG is a schedular single-rate tax; rates vary little across types of income and are low relative to PIT marginal rates (about "8 percent").
  - Taxes on stock of capital include recurrent taxes, transaction taxes on real property, a wealth tax, and inheritance and gift taxes.
  - Numerous tax-deferred schemes reduce many of these taxes, directing savings to specific areas or retirement.
- Distortions and proposals:
  - Distortions identified:
    - Distortions across types of instruments, use of savings in the productive sector, and inter-temporal decisions.
    - Multiple layers of taxes on flows and stocks increase pre-tax required return on savings, raising the cost of domestic capital.
    - Certain schemes may encourage individuals to take more risks with savings, undermining retirement savings incentives.
  - Scope to simplify and improve neutrality:
    - Move toward a single-rate tax on capital income (interest, dividends, capital gains), giving the income tax system a “dual” form (as planned by the new government).
    - Transform instrument-based tax breaks into comprehensive tax-deferred long-term savings vehicles.
    - Review coexistence of wealth and inheritance taxes; inheritance taxes can theoretically be more effective in raising revenue from high income persons and tend to be less distortionary than wealth taxes.
  - Revenue implications:
    - With proper design, overall revenue and equity implications of reforming capital taxes on individuals can be manageable.
    - The planned unified tax rate on capital income, possibly combined with a broader inheritance tax base, can be designed to yield the same amount of revenue from capital income as currently collected.
    - Example estimate: Didier and Ouvrard (2016) estimate a rate of "30 percent" as a replacement for all taxes on capital held by individuals—flows and stocks, and central and local.

### Tax uncertainty
- Tax uncertainty is a concern among the business community, including regarding the corporate income tax.
- Stable and predictable tax system is important for businesses and governments; empirical studies suggest tax uncertainty can adversely impact investment and trade.
- Complexity and frequency of tax law changes are commonly cited sources of tax uncertainty.
- France has by far the highest number of yearly corporate tax law changes among selected EU countries (Figure 8); earlier studies indicate close to "20 percent" of provisions in the tax code are subject to change each year.
- Measures to improve stability and predictability:
  - Advance tax rulings (“rescrit fiscal”) enable prior assurance from tax administration; should be swift and published (redacted) to maximize transparency and beneficial impact.
  - Streamline tax policy design and implementation:
    - Maintain government control over tax policy making—under the direct supervision of the ministry of finance and control of the parliamentary finance committee.
    - Limit major tax law changes to annual finance laws.
    - Avoid retroactive tax legislation (“petite rétroactivité”), and use transitional, grandfathering and sunset provisions to manage impact.
    - Systematically engage in ex-ante stakeholder consultations (release policy papers and draft legislation for comments prior to parliamentary debate).

### Conclusions
- Opportunities exist for efficiency- and growth-enhancing reforms of France’s capital tax system.
- Central issue: many distortions and inefficiencies lead to misallocation of resources and a low revenue productivity of certain taxes, especially the CIT.
- Relying solely on reducing the CIT rate would not address the full range of issues that may hamper France’s international competitiveness and productivity at the corporate level.

*Source: INTERNATIONAL MONETARY FUND.*

### 54.      The high statuary CIT rate in France has contributed to the creation and use of

### cr17289 - 54.      The high statuary CIT rate in France has contributed to the creation and use of 

### Corporate income tax (CIT) incentives, distortions, and reform options
- High statutory CIT has contributed to the creation and use of “niches” many of which are beyond the proper focus of the CIT (examples cited: using a CIT credit to lower labor costs; size-dependent regimes that provide disincentives to company growth).
- Reform objectives identified: improve competitiveness and reduce inefficiencies by adopting a broader perspective on capital tax and pursuing a CIT base reform.
- Reforms in combination with planned measures:
  - Planned cut in the French CIT rate and conversion of the CICE into an outright reduction in employer SSC (envisaged for 2019).
  - Reform options include:
    - Removal of inefficient CIT incentives, such as the IP box.
    - Elimination of size-dependent regimes, such as reduced CIT rates.
    - Streamlining of local production taxes.

### Anti-avoidance, profit shifting, and corporate leverage
- France employs extensive anti-avoidance rules to combat outbound profit shifting, but profit shifting remains a concern and corporate leverage in France is relatively high.
- Policy option proposed to address debt bias and interest expense stripping:
  - Increase the 25 percent interest disallowance while introducing an ACE to limit the impact on the cost of capital.
- Franco-German CIT harmonization initiative (recently announced) could provide an opportunity to advance measures coherent with EU CIT coordination (little is known so far about the initiative).

### Individual-level capital taxation
- Capital taxes can be made more neutral across savings and investment instruments.
- Promising policy option: a unified rate on capital income (interest, dividends, and capital gains), as envisaged by the new government; characterized as having little impact on revenue and equity but possibly significant simplification and efficiency gains.
- Complementary measure: transform instrument-based tax breaks into a generalized tax-deferred long-term savings vehicle.

### Tax policy process and legal stability
- Frequent changes to tax laws (addition/removal of specific provisions and entire new taxes) create undesirable uncertainty; in France this appears a greater concern than administrative uncertainty.
- Suggested improvements:
  - Instill more discipline in the tax policy process.
  - Limit tax changes to annual budget laws.
  - Improve consultations with the private sector to minimize unintended effects.

### Annex I — Restrictions on tax deduction for interest expense in France (rules and thresholds)
- Interest deduction limited to the higher of:
  - the average annual interest rate charged by lending institutions to companies for medium-term (e.g., the rate was fixed at 2.15 percent in 2015)
  - the interest that the indebted company could have obtained from independent banks under similar circumstances
- Thin capitalization rules: interest paid to related parties (deductible under the above test) is limited to the highest of:
  - The intragroup loan exceeds 1.5 times the net equity,
  - the interest exceeds 25 percent of the EBIDA, and
  - the intragroup interest exceeds intragroup interest received.
- Carry forward provisions: rules apply to each enterprise member of the group on a standalone basis with the possibility of carrying forward interest expenses that are not immediately deductible without a time limit (but the carry forward amount is reduced by 5% each year).
- Exceptions (rules do not apply):
  - to interest payable by banks and lending institutions;
  - if the interest paid does not exceed 3 million euro; or,
  - if the French indebted company demonstrates that the debt-to-equity ratio of the worldwide group to which it belongs exceeds its own debt-to-equity ratio.
- Additional cap: the deducted amount is capped at 75 percent of net interest payments. This cap does not apply if net interest payments do not exceed 3 million euro.

### Annex II — CCCTB proposal (European Commission, October 26, 2016)
- Two-step approach proposed:
  - First step: Common Corporate Tax Base (CCTB)
    - Mandatory for large multinational groups with global sales of at least EUR 750 million; other companies can opt in.
    - Broad tax base; allows deducting financial costs up to the extent of financial revenues, with the excess restricted to the higher of EUR 3 million or 30 percent of EBITDA.
    - Measures to enhance growth:
      - Allowance for growth and investment (AGI) — notional return on equity deduction.
      - Super-deduction for R&D expenditure between 125 percent and 200 percent of actual costs.
    - Includes anti-avoidance measures including those from the ATAD and a “switch-over clause” for dividends and capital gains from zero or low-taxed companies.
  - Second step: Complete CCCTB — EU-wide consolidation and formulary apportionment
    - The group's common consolidated corporate tax base shared between Member States using an apportionment formula comprising three equally weighted factors:
      1. labor (based in equal measure on the number of employees and payroll costs),
      2. assets (tangible fixed assets, whether owned, rented or leased),
      3. sales (other than intragroup sales) of goods and services net after discounts, returns, VAT and other taxes and duties; sales factor calculated based on destination.
    - Member States would apply their own CIT rate to the apportioned share of profits (no harmonization of tax rates).
- Timeline in proposal:
  - Proposal date: October 26, 2016.
  - CCTB Directive compliance by December 31, 2018, for application as from January 1, 2019.
  - CCCTB Directive legislation by December 31, 2020, with application from January 1, 2021.
- Adoption requires unanimous approval by Member States.

### Competitiveness: stylized facts (contextual findings)
- France has lost external competitiveness over the past two decades in both price and non-price dimensions; this contributed to weak export performance and deterioration of the external position.
- Despite solid productivity growth, cost competitiveness weakened before the global financial crisis; since the crisis, cost competitiveness indicators have improved somewhat reflecting wage moderation and steps to lower the labor tax wedge.
- France’s loss in global market shares since the 1990s is steeper than in many peer countries though not unique among advanced economies; market shares have broadly stabilized since 2012.

*International Monetary Fund — Excerpt from chapter on France (cr17289).*

### 6.      The same trend broadly applies to the value added of exports. With the rapid

### 6.      The same trend broadly applies to the value added of exports. With the rapid

### Value-added of exports and market shares
- Gross exports have become less appropriate measures of trade performance because they may embody a large share of imported intermediate products and do not measure the value-added that is produced on the domestic market.
- Using a new OECD database with bilateral trade flows broken down by domestic or foreign value-added content shows the main stylized facts of France’s declining market shares continue to hold.
- If the domestic value-added of exports is considered:
  - The decline differential with Germany is similar by the end of the period relative to the mid-1990s.
  - The decline differential with Germany is smaller if the starting point is the early 2000s, perhaps because of France’s relatively lower integration in global value chains.
- The market share decline in value-added terms was more pronounced vis-à-vis countries outside the OECD than in the OECD, and occurred both for goods and services.

### Tradable sectors: gross value-added (GVA) and employment
- Since 2000, tradable sectors contributed ¾ percentage points in France’s gross value added growth.
- France’s tradable-sector GVA contribution is:
  - Somewhat below the growth contributions of tradable sectors in Germany, the UK, and Spain.
  - Well above Italy.
- Manufacturing contributed very little to tradable GVA growth, as in most other countries (Germany being a notable exception).
- Tradable GVA plunged less than in other countries at the height of the Global Financial Crisis, but its recovery has been lackluster, especially compared to Germany.
- Employment patterns since 2000:
  - Tradable services have been the main contributor to employment growth, as in other countries.
  - Employment has been falling in manufacturing.
- Possible explanations for employment composition:
  - Relative success and delocalization in emerging markets.
  - Outsourcing trends and reclassification of activities from manufacturing to services (Bernard, Smeets, and Warzynski, 2017).
- The secular decline in France’s manufacturing industry and related competitiveness problems have been documented by Cohen and Buiges (2014), and Fontagné, Mohnen and Wolff (2014).
- The share of non-tradable sectors in GDP reached about 46 percent of GDP in 2016.
  - Non-tradable sectors include the public sector, health, education, social work, entertainment and recreation, and real estate and construction.

### Profit margins and profitability in tradable sectors
- Profit margins of France’s tradable sectors declined since the early 2000s, but have rebounded moderately in recent years.
- In French and Italian industry (excluding construction):
  - The margin between output price and unit labor costs declined moderately between the peak of early 2001 and the onset of the global financial crisis, suggesting exporters were compressing profit margins to protect market shares.
  - This trend continued during the crisis years, but price margins have started to trend upward.
- These patterns contrasted with Germany and Spain, where price margins were widening before and after the crisis years.
- In tradable services, price margins have generally been on a declining trend, accelerating since the Global Financial Crisis.
- Gross operating surplus to GVA was on a declining trend, especially in manufacturing sectors in France, although it rebounded in recent years.
- Notes:
  - The evolution of margins at the industry level could also reflect compositional factors (reallocation from high margin firms to low margin firms).
  - The CICE is accounted as a tax credit instead of a reduction in social contributions and is not reflected as a reduction in ULC in some measures.
  - Methodologies to estimate gross operating surplus differ across euro area countries; differences may be partly attributed to firm size distribution and sampling techniques.

### Aggregate external position
- France’s current account deficit was around 1 percent of GDP in 2016, or 1¾ percent of GDP on a cyclically adjusted basis.
- According to the IMF’s External Sector Assessment methodology, this was judged to be 2¾ percent of GDP lower than the level consistent with medium-term fundamentals and desirable policy settings.

### Factors affecting competitiveness (categorization)
- Potential causes for the apparent loss of external competitiveness since the 1990s are grouped into four interrelated categories:
  - (i) price and cost competitiveness;
  - (ii) non-price competitiveness (productivity and technology, product quality, integration in global supply chains);
  - (iii) policies;
  - (iv) “bad luck” in terms of export specialization and trading partners.

### Prices and cost competitiveness
- Real effective exchange rate (REER) and cost indicators:
  - REER has mildly appreciated since the early 2000s by many measures; despite some depreciation in recent years, the exchange rate is considered to be overvalued by between 8 and 14 percent based on 2016 data according to the IMF’s External Sector Assessment methodology.
- Relative domestic prices:
  - The cost of intermediate inputs to tradable production has strongly risen, particularly in manufacturing.
  - The price of non-tradable sectors inflated by some 40 percent between the mid-1990s and the onset of the Global Financial Crisis, and remain about 45 percent above their 1995 level.
  - The price of tradable services relative to industrial goods increased significantly—by some 25 percent—between 2000 and 2010, and subsequently experienced a moderate decline of about 5 percent.
  - France has a large share of service inputs in the value chain of manufacturing goods relative to other large countries, and this share has increased over time (Cezar et al., 2017).
- Labor costs and unit labor costs (ULCs):
  - Labor costs have risen since the early 2000s.
  - ULC dynamics were not out of line with other euro area countries, thanks to relatively robust labor productivity growth.
  - Compared with Germany, the pre-crisis period opened a bilateral competitiveness gap in unit labor costs, largely reflecting wage growth differentials, especially in service sectors.
  - Since the crisis, the gap with Germany has somewhat closed, thanks to more rapid wage growth in Germany.
  - The evolution of the ULC after 2013 does not reflect the additional impact of the CICE which is accounted as a tax credit, instead of a reduction in social charges on wages.

### Non-price competitiveness (productivity, quality, technology, global supply chains)
- Productivity:
  - TFP growth has declined as in many other advanced countries, with the slowdown more substantial in services than manufacturing.
  - Labor productivity and TFP kept pace with Germany (in part due to lower employment of unskilled workers and higher increase in real capital stock).
- Product quality:
  - France remains relatively well placed in terms of non-price competitiveness and product quality in the OECD.
  - Bas et al. (2014) find four of France’s top ten manufacturing sectors are ranked in the top three leading sectors for non-price competitiveness among OECD countries.
  - The top three manufacturing sectors where France is most competitive in non-price/quality—aeronautics, leather goods, and wine—accounted for only 7 percent of exports in 2013.
  - Cheptea et al. (2014) show that French and German goods in the top quality range had better market share performance between 1995 and 2010 than other goods, after filtering out geographical and sectoral factors.
- Technology and specialization:
  - Since the mid-1990s, France’s comparative advantage has evolved toward “low and medium-low technology” sectors, with a gradual loss of comparative advantage in higher tech and more knowledge-intensive sectors.
  - The loss of comparative advantage in higher tech goods can generate challenges to differentiate products and respond to foreign competition.
- Global supply chains:
  - France’s importance in the European value-chain and as a supplier of intermediate products has declined.
  - Germany has emerged as a key European hub.
  - Despite a growing share of re-exports associated with deeper integration in supply chains, Germany’s export value-added contribution to GDP increased while it declined in France (IMF, 2014).

*Source: cr17289 - IMF staff report.*

### 14.      Policies. A high and rising tax burden on

### 14.      Policies. A high and rising tax burden on 

### Policies, labor markets, and competitiveness
- A high and rising tax burden on businesses (with frequently changing rules), high labor tax wedges, and long-standing rigidities in product and labor markets constrain productivity of both tradable and nontradable sectors by:
  - Distorting the allocation of resources.
  - Preventing alignment of wages with productivity (see Bas et al., 2014; Rapport Economique, Social et Financier, 2012 and 2016).
- Policies may have impacted:
  - Cost competitiveness (for example, through wages and taxes).
  - Non-price competitiveness (for example, through labor and product market rigidities that could impede resource allocation), which may have affected innovation, technological progress and product quality.
- Labor market institutions may have contributed to wage developments not always well aligned with productivity growth, as also observed in several other European countries.
- Reforms in recent years helped reverse the trend and contributed to improving competitiveness, including:
  - Various labor and product market reforms (for example, the Macron and El Khomri law).
  - The CICE.
  - The Pacte de Responsabilité et Solidarité, which helped contain unit labor cost growth.

### Export specialization and trading partners — key findings
- France’s comparative advantage is concentrated in medium to low tech sectors (see Box 1), implying greater exposure of exports to price competition from fast growing emerging economies.
- Geographical effects, and to a lesser extent sectoral specialization, can explain some loss in France’s export market share, but France-specific factors are important drivers, especially for high-tech sectors (Section D).
- Relative price developments played a significant role in France’s competitiveness loss, including their effect on high-tech exports (Section E).

### Box 1 — Evolution of France’s Comparative Advantages Since the Mid-1990s
- Since the mid-1990s, France’s comparative advantage has been in sectors with lower technological content or that are less knowledge intensive, and France has lost competitiveness in High-tech sectors.
- The analysis uses a standard Balassa Revealed Comparative Advantage (RCA) index constructed from sectoral trade in value-added exports from the OECD TiVA database.
- Key observations:
  - France’s comparative advantage has evolved toward Low Tech sectors.
  - Relative to peers, France is the only country that experienced a decline of its comparative advantages in High Tech and knowledge intensive sectors since the mid-1990s; by 2009–2011, France had the largest comparative disadvantage in these sectors on average among large European countries.
  - Exceptions:
    - “Other transport equipment” (about 6 percent of value-added exports in 2011) increased comparative advantage and was already an advantage in 1995.
    - In knowledge intensive services, France gained comparative advantage in “Post and Telecommunications” (0.8 percent of total value-added exports in 2011).
    - France increased comparative advantage in “Chemicals and Chemical Products” (RCA of about 1.55), which account for about 10 percent of exports.
- Classification notes:
  - “High Tech” sectors denote high technology, medium-high technology, or knowledge intensive sectors; all others are “Low Tech”.
  - RCAs are aggregated by sectoral groups using value-added weights from the EU-KLEMS database; conclusions are robust to alternative aggregation.

### D. Is “Bad Luck” to Blame? Shift-Share Analysis of Market Shares — methodology
- Aim: disentangle impact of sector specialization and trading partner demand from factors specific to France using shift-share analysis.
- Decomposition of export market share evolution into:
  - Global geographical effects.
  - Global sectoral effects.
  - Exporter-specific effects (exporter fixed effect captures shocks to export supply and potentially differential demand effects).
- Sample and data:
  - Period: 1995–2011 (analysis stops in 2011 due to data limitations).
  - 21 advanced economies, 63 export destination countries and 22 manufacturing and service sectors.
  - Market shares constructed from domestic value added content of exports (OECD TiVA), which nets out foreign value added embodied in domestic exports.
- Caveat: decomposition does not identify underlying drivers of each effect (for example, what specifically causes exporter-specific shocks).

### D. Shift-Share Analysis — main results and statistics
- France-specific factors played a significant role in explaining loss in export market shares; demand from trading partners also mattered.
- Findings for 1995–2011 (aggregated impacts from fixed effects by sector and destination):
  - The explained evolution of market shares appears to be related to “France-specific effects”, which had the largest contribution to France’s overall market share performance over 1995–2011.
  - Geographical shocks (common to sectors of all countries) negatively impacted France’s export market share, especially before the global financial crisis—suggesting comparatively lower growth in France’s trading partners for goods important to France.
  - Sectoral shocks (common to all countries) had little impact over the full period.
  - In the sample of 21 advanced economies, France has the fourth largest negative own exporter performance effect: -20 percent (after Japan, the US, and Switzerland).
  - For High Tech sectors only, the France-specific effect is more negative: -40 percent, while common geographical shocks play a smaller role.
  - Year-by-year decomposition for France:
    - Positive performance effect until 1998.
    - Negative marginal year-by-year effects from 1999 until 2008.
    - Some moderate recovery afterwards.
  - Sectoral pattern:
    - Service sectors were drivers of market shares globally.
    - Manufacturing sectors’ market shares contracted.
  - Destination pattern:
    - China and India generated strong demand for exports.
    - Large European countries, the US and Japan relatively slowed down export demand.

### E. How price competitiveness and foreign demand impacted value-added export performance — approach
- Focus: measure the role of price competitiveness by sector between the exporting country, the destination country, and other exporters to that destination, controlling for foreign demand in the destination country.
- Data and scope:
  - Analysis based on OECD TiVA domestic value-added exports; stops in 2011.
  - Panel regression with annual data for six large economies: France, Germany, Italy, Spain, the United Kingdom and the United States.
  - Sample: 63 destination countries and 22 sectors.
  - Aggregate demand in each destination measured by the (real) domestic demand indicator from the World Economic Outlook (WEO).
- Price variables included:
  - Two indicators of bilateral price competitiveness between exporter and destination:
    - Nominal bilateral exchange rate between the exporting country and the destination country.
    - Relative GDP deflator of the exporting country and of the destination country.
  - Two indicators of price competitiveness of an exporting country relative to all other countries exporting to the same destination:
    - Nominal effective exchange rate between the exporting country and all other countries exporting to the same destination.
    - GDP deflator of the exporting country relative to all other countries exporting to the same destination.
- Implementation notes:
  - The two relative-to-others variables are constructed on a sample of 21 exporting advanced economies to capture competitiveness in third markets relative to other advanced economies.
  - Specification includes full set of home country/destination country/sector fixed effects to control for time-invariant unobserved factors that could jointly affect exports and explanatory variables.
  - Potential endogeneity of exchange rates is mitigated by sector-destination level regressions and fixed effects, though some endogeneity concerns may remain.

*Italic: Source — IMF staff analysis in "France" country report section 14–E based on OECD TiVA and IMF staff calculations.*

### 23.      The econometric findings for the panel of 6 exporting countries reported in Table 1

### 23. The econometric findings for the panel of 6 exporting countries reported in Table 1

### Econometric summary: determinants of exports
- Both foreign demand and price competitiveness significantly affect the value of exports; the estimated coefficients on all but one explanatory variable are statistically significant at the 1 percent level.
- A one percent increase in real domestic demand in a destination country on average results in a 1.6 percent increase in the value of exports of a particular sector.
- A one percent depreciation in the nominal bilateral exchange rate, or a one percent increase in the ratio of GDP deflator of the destination country to the GDP deflator of the exporting country, results in a 0.4 increase in the value of exports on average.
- A 1 percent increase in the ratio of the average GDP deflators of all exporters to the GDP deflator of the exporting country considered is associated with a 0.2–0.25 increase in the value of exports from the exporting country.

### Regression results (Table 1) — coefficients and fit
- Dependent variable: Log (Export) (ijst)
- Coefficient estimates (standard significance markers preserved):
  - Log (aggregate demand) (jt): 1.590***, 1.575***, 1.695***
  - log (bilateral NER) (ijt): 0.393***, 0.374***
  - Log (relative bilateral VA deflators) (ijt): 0.406***, 0.381***
  - Log (VA deflator rel. to all exporters) (ijst): 0.205***, 0.260***
  - Log (NER rel. to all exporters) (ijst): 0.00194, 0.0118
  - Constant: -7.264***, -7.166***, -8.778***
- Fixed effects: Source*Destination*Sector Fixed Effects = YES (included in all specifications)
- Observations: 137,811
- R-squared: 0.938
- Notes: Sources: OECD TiVA database and the IMF World Economic Outlook. Robust standard errors in parentheses; *** p<0.01, ** p<0.05, * p<0.1. Observations clustered by Exporter*Destination*Sectors.

### Predicted contributions to aggregate export performance (Table 2)
- Foreign demand and price competitiveness explain a large share of the relative evolution of aggregate exports for France and Germany over 2001–2011.
- Predicted effects (Log changes over 2001-11):
  - France: Demand 34%, NER -5%, Relative output price 5%, Total predicted 34%, Unexplained 28%, Actual log change in total exports 63%
  - Germany: Demand 40%, NER -5%, Relative output price 9%, Total predicted 45%, Unexplained 41%, Actual log change in total exports 85%
  - Difference (France minus Germany): Demand 6%, NER 0%, Relative output price 4%, Total predicted 10%, Unexplained 12%, Actual difference 23%
- Key interpretations:
  - Overall, prices and foreign demand each respectively explain about one quarter (10 percentage points) of the difference in the performance of France’s exports relative to Germany’s exports over a 10-year period.
  - The nominal exchange rate effect was moderately negative and of the same order of magnitude both for France and Germany.
  - Relative output prices contributed some 4 percentage points less to the export performance of France relative to Germany.
  - Demand addressed to France exports was significantly below that of Germany: estimated to have reduced France’s export growth by 6 percentage points over a 10-year period relative to Germany.
  - The remaining half of the difference (12 percentage points) is unexplained and is attributed to unobserved factors, encompassing changes in non-price competitiveness.

### Sectoral impacts (Table 3 and sectoral decomposition)
- Foreign demand and price competitiveness differentials relative to Germany mainly impacted France through High Tech sectors.
- Sectoral predicted contributions to overall predicted log change in exports (Period 2001-2011):
  - France LT industries: Demand 15.9%, NER -2.1%, Relative output price 3.1%, Total predicted 16.8%
  - France HT industries: Demand 17.7%, NER -2.6%, Relative output price 2.4%, Total predicted 17.5%
  - France Total all sectors: Demand 33.6%, NER -4.8%, Relative output price 5.5%, Total predicted 34.4%
  - Germany LT industries: Demand 14.6%, NER -1.5%, Relative output price 3.8%, Total predicted 17.0%
  - Germany HT industries: Demand 25.6%, NER -3.3%, Relative output price 5.9%, Total predicted 28.2%
  - Germany Total all sectors: Demand 40.3%, NER -4.8%, Relative output price 9.8%, Total predicted 45.3%
- Interpretation:
  - The negative foreign demand differential addressed to France’s exports was entirely explained by High Tech sectors.
  - Foreign demand addressed to France’s Low Tech exports was moderately higher than the foreign demand addressed to Germany’s Low Tech sectors.

### Conclusions and policy-relevant findings
- Evidence indicates France has lost external competitiveness over the past two decades, reflecting both price and non-price factors.
- Declines observed:
  - Global market shares of exports declined more than in many peer countries, in both gross and value added terms.
  - Decline notable for goods and services, and for destinations within and outside the OECD.
  - Apparent decline in France’s comparative advantage in High Tech sectors, with few notable exceptions.
- Consequences:
  - France’s overall external position has weakened.
  - Contribution of tradable sectors to France’s growth in real value added and employment has been constrained.
- Reviewed possible explanations for France’s loss of competitiveness:
  - Some degree of REER overvaluation, as measured against France’s medium-term fundamentals according to the IMF’s External Sector Assessment.
  - A relative decline in cost competitiveness before the global financial crisis:
    - Despite solid productivity growth and ULC dynamics broadly in line with other euro area countries (with the exception of Germany), wage growth in the services sectors were not fully aligned with productivity growth.
    - Growing costs of services inputs, in particular from non-tradable sectors, which may reflect a lack of competition and labor cost pressures.
  - Comparative advantages evolving into sectors and products with medium or lower technological content, exposing French exports to price competition from fast-growing emerging markets.
  - Effects from partner country growth and relative price developments, mainly affecting France’s High Tech sectors.
  - France-specific effects not studied in detail here include policies and institutions—such as labor and product market rigidities, and a high and variable tax burden—which can affect productivity and competitiveness through their impact on investment, innovation, allocation of labor, as well as wages and other input costs.
- Since the crisis:
  - Cost competitiveness indicators have improved somewhat, reflecting wage moderation and policies to lower the labor tax wedge.
  - Given data limitations, it is not clear to what extent non-price factors have evolved in recent years.
  - Successive governments have advanced structural reforms aimed at addressing labor and product market rigidities and high tax burden on capital and labor.
  - Given the still limited contribution of net exports to GDP growth and the weak external position as assessed by the IMF’s External Sector Assessment, external competitiveness will remain an important and policy-relevant topic in France for the coming years.

*Source: cr17289 - 23. The econometric findings for the panel of 6 exporting countries reported in Table 1*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17289.pdf_