Consequences of the July 2012 repeal of income and payroll tax exemptions on overtime. Eric PICHET analysis.

Today, one year after the repeal of the income and payroll tax exemptions on overtime introduced in France’s 2007 TEPA law, the consequences have been positive for the budget but negative politically.

There is little doubt that the headline measure in France’s 21 August 2007 a TEPA loi en faveur du travail de l’emploi et du pouvoir d’achat (“law in favour of employment and purchasing power”) was to make all overtime exempt from payroll tax. This fulfilled an election promise made by the new president Sarkozy, expressing his political desire to upgrade work by encouraging overtime through wage increases for employees and lower overtime costs for employers.

Expert warnings in 2007.

At the same time, as far back as March 2007 France’s Conseil d'analyse économique was already warning the Fillon government that the measure would have negative side-effects . The fear was that de-taxing overtime would at best have an uncertain impact on employment while encouraging “opportunistic” (read: fraudulent) behaviour insofar as it would induce employees and employers to substitute overtime payments for normal wage increases, something benefiting existing workers to the detriment of jobseekers, and costing the public purse an exorbitant amount. These pessimistic predictions, accentuated by the polymorphic effects of the financial crisis, seemed to be widely verified.

A costly and unfair income and payroll tax loophole during a period of crisis

In its 2010 report , France’s Conseil des prélèvements obligatoires (“Tax Council”) recommended that these exemptions be purely and simply eliminated, the idea being that the measure cost more than the GDP increase it sparked (0.3% or around €5 billion a year) . The average number of overtime hours per employee (7 in 3Q 2007) peaked at 11.3 before falling to 9.7 in 1Q 2013. This resulted in 2012 in an extra cost to the public purse (French State and Social Security administration combined) on around €5 billion (€1.5 billion fall in income tax receipts, €1 billion fall in payroll tax receipts and €2.5 billion fall in employer Social Security contributions). The expected job creation never happened (largely due to the crisis), meaning that the measure became little more than a simple windfall for beneficiaries. The main winners were the employees involved (notably teachers who irrespective of anything else would receive significant overtime payments year in year out, with the measure ultimately exempting them systematically from having to do recurrent hours). Companies also benefited, however, with the measure subsidising their most profitable working hours. It was also anti-redistributive in nature, with the main beneficiaries being the country’s 10% best paid active workers, enjoying an average total exemption rate (savings on additional income and payroll tax for each extra €100 in income) of €60, versus €30 for the 10% lowest paid active workers.

Painful political consequences one year later

One year after the enactment of the 16 August 2012 law canceling the exemption of income tax on overtime (from 1 August 2012 onwards) and then the exemption of payroll tax (starting 1 September 2012), the budgetary impact has been clearly positive for the French State and its Social Security administration (around €5 billion over the whole of the year according to the government , but more likely around €4 billion). On the other hand, the political shockwave was poorly calculated by the Ayraut government and has been a clear factor in the executive’s loss of popularity since autumn 2012. This has occurred over three phases in a period running from September 2012 to September 2014. Employees receiving their paycheck in September 2012 noted a fall in net earnings caused by higher payroll taxes. The following September, they got their 2012 income tax forms in the mail, discovering the negative impact of any overtime they did over the final four months of 2012 being once again subject to tax. The last phase will be September 2014, when all overtime from 2013 will be taxed at whatever people’s marginal rate is. These last two phases clearly contradict President Hollande’s recent promise to “take a tax break” and nurture the feeling of being over-taxed that Economics Minister Moscovici recently diagnosed.

A signal that the level of compulsory taxation is too high

Although the political class in general has no serious intention of returning to an exemption that would be illusory given the poor state of public finances at present, voices are being heard – on the French right but also in the Socialist Party - criticising these negative side effects and suggesting changes. A Socialist parliamentarian from the Essonne district, Thierry Mandon, recently suggested for instance the creation of a €500 income and payroll tax exemption on overtime, something he believes would cost around €100 million. Whether or not the saga of France’s TEPA law is drawing to a close, it has been a signal that the country’s excessive level of taxation, specifically involving payroll taxes that penalise work, has become the leading factor in French companies’ loss of competitiveness since 1998. A perfect illustration of Hegel’s ruse of reason concept, this soap opera is bound to lead one day to a thorough reform of the way France taxes work.

1/ 21 August 2007 Law n°2007-1223 en faveur du travail de l’emploi et du pouvoir d’achat (“ Law in favour of employment and purchasing power”), Draft Bill, Rationale, page 3.
2/ P. Artus, P. Cahuc, A. Zylberger, “Réglementation du temps de travail, revenu et emploi” (“Working time, income and employment regulations”) in Conseil d’analyse économique “Temps de travail revenu et emploi”, report, Documentation Française, 2007.
3/ P. Artus, P. Cahuc, A. Zylberger, “Réglementation du temps de travail, revenu et emploi” (“Working time, income and employment regulations”) in Conseil d’analyse économique “Temps de travail revenu et emploi”, report, Documentation Française, 2007.page 11.
4/ Conseil des prélèvements obligatoires (“Tax Council”), Entreprises et niches fiscales et sociales, des dispositifs dérogatoires nombreux (“Companies’ income and payroll tax loopholes; a multitude of exceptions”), pages 227-230.
5/ Conseil des prélèvements obligatoires (“Tax Council”), Entreprises et niches fiscales et sociales, des dispositifs dérogatoires nombreux (“Companies’ income and payroll tax loopholes; a multitude of exceptions”), pages 229.
6/ 16 August 2012 Law n° 2012- 958, 2012 Budget Amendment, Draft Bill, Rationale, page 23.

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