France's New Budget Plan: A Model for the United States?

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First, debt fears spread across Europe like a flu. Now EU countries are catching the austerity bug.

France and Spain have announced plans to raise taxes and cut benefits in the next few years to protect their debt rating and allow them to affordably borrow money. France will raise income taxes and increase the retirement age and the work years required to receive full pension benefits. Spain wants to make it easier for employers to fire workers, even with unemployment at 20% -- the second highest in the EU after Latvia.*

France's austerity strategy is relatively straightforward from an accounting standpoint -- raise taxes on income over $100,000 and control social security benefits by raising the retirement age from 60 to 62. Indeed, this is similar to what the United States should, and almost certainly will, do in the medium term: let the Bush tax cuts expire on high earners and make incremental adjustments to Social Security. Our long-term deficit crisis essentially boils down to low tax revenue and high entitlement spending.

However, raising taxes on the upper middle class in the middle of a recession is playing a dangerous game with your recovery. Like the rest of Europe, France is trying to walk a tightrope. On the one hand, they want to cut costs to demonstrate to investors that they can make their promised payments in the midst of countries tip-toeing around default. On the other hand, they're in the midst of recession/recovery that could easily turn back into a recession if higher taxes and lower spending (from higher saving associated with the delayed retirement age) chokes of the upturn. That would make interest rise even higher. This might be the right plan at the wrong time.

*A quick rundown of their financial health: Spain's deficit is the third highest in the EU, after Greece and Ireland. But its public debt -- the sum of its deficits and a better measurement of its financial state -- is only 53% of GDP, similar the United States and less than half Greece's crushing burden. France is a different animal. Its 10% unemployment is half as bad as Spain, and its deficit is 8% of GDP is lighter. But its public debt ratio is over 80%, well past the 60% that is generally considered healthy and sustainable.