French Fries Redux

There are two countries about to enact new laws.

There are two countries about to enact new laws. One is about to levy a new tax on private equity firms, and the other is set to broadly cut taxes throughout its economy. One of these countries is France and the other is the United States. Can you guess which is which?

Astoundingly (and embarrassingly), the tax-cutting nation is France. With the ascension of Nicholas Sarkozy and his right-leaning UMP party to power, it might just be time to change those Freedom Fries back to French Fries.

We held our breath, but Sarkozy's UMP and its allies won the final leg of the legislative elections with a majority 346 seats in the 577 seat National Assembly. This left the Socialists with a mere 231 seats. Last month, the MarketMinder editorial staff informed you about the potential reforms, and possible pitfalls, of the new French pro-capitalist leadership. (See our past commentary, "Morning in France?") Today, we can say with more certainty that reforms are likely on the way.

Sarkozy has unveiled details of his $15B+ master plan to "shock" the French economy back to life, primarily via supply side economics:
• Exempt overtime work from income taxation and social security taxation, effectively ending the 35-hour work week
• Make mortgage interest payments tax deductible
• Lower the inheritance tax
• Put a 50% cap on overall individual taxation (i.e. no person can have more than 50% of his total income taxed, currently the max is 60%)
• Cutting wealth taxes (France actually charges a tax on net worth)

In particular, we like the overtime tax reform. Incentive to work more and earn more is a highly stimulative move, potentially a much more valuable boost to the economy than the few billion it will "cost" the government. But, as always, economists have grave doubts about tax cuts:

Sarkozy Tax Cuts May Widen Deficit, Economists Say
By Sandrine Rastello, Bloomberg

MarketMinder readers know trade deficits don't matter—to an economy or its stock market. What's more, we can't help but be astounded by the lack of belief in tax cuts. Over and again, history's shown tax cutting actually increases tax revenues. The Laffer curve lives on, though few in the socialist European camp will acknowledge it.

But the UMP victory isn't all champagne and strawberries. Sarkozy represents an interesting paradox we can't seem to reconcile: on the one hand, he's a staunch capitalist with great faith in capital markets, and on the other, he denounces globalization. Mr. Sarkozy wants his capitalism to remain, for lack of a better term, cozy within France, discouraging foreign investment. That's a problem. Closed borders and protectionism are anathema to capitalism. Environmentalism is also high on the UMP agenda—meaning restrictive "eco-friendly" regulations are probably also on the way.

Usually, we prefer a gutless government unable to achieve much. (See our past commentary, "A Political Punch.") Impotent legislations are good for stocks. But we'd also hesitate to call all legislation bad. In this case, reforms toward a freer market economy are a good thing. But if Sarkozy proves effective at getting his way, that could also mean all sorts of new legislation in addition to the tax cuts—and there's no telling what damage those could do.

So far, markets don't seem skittish. The CAC is up over 13% year-to-date. For now, we remain cautiously optimistic about the new pro-market regime in France. Maybe Congress could benefit from a group trip to Paris to see what pro-market reforms look like. Lacking that, we invite them to the local McDonald's—the French Fries are on us.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.