There are many ways to measure a country’s economic health. One of these is the debt-to-GDP ratio. Simply put, this ratio compares a country’s public debt to its gross domestic product (GDP), or the total value of all the goods and services it produces. Think of it as a measure of how well a country is managing and paying back its debt. The higher the ratio, the harder it is for a country to manage its debt, as it indicates a higher risk of defaulting on its debt, which can lead to financial panic at home and abroad. This is exactly what’s happening in France.

France’s debt-to-GDP ratio recently skyrocketed to nearly 110%. This means the country owes banks and investors around €3.2 trillion (about $3.5 trillion). This is a big deal because, for a long time, a debt-to-GDP ratio above 77% is not good for economic growth. Every percentage point of debt above this level can hinder economic growth by about 1.7%.

Now, not all countries are in the same boat. Take Japan, for example. Its debt-to-GDP ratio is over 250%. But Japan’s default risk is low because it owes most of its debt to its own citizens.

France, however, is dealing with a different beast, with nearly half of its debt held by foreign investors. Given its slow economic growth, confidence in France’s ability to repay its debt is waning. This is a dangerous situation, and France clearly needs a plan.

But before we get into how France aims to solve its debt problem, let’s take a step back and see how it got here.

The story begins with the 2008 global financial crisis, which burst the much-hyped housing bubble. During the boom, everyone was building houses left and right, fueled by cheap debt (sound familiar?). People and construction companies borrowed money even when their credit history was shaky or they couldn’t really afford it. But when the bubble burst, property values ​​plummeted, and countries around the world, including France, felt the impact. As income from real estate dried up, the French government was forced to step in and inject funds into the struggling economy.

Fast forward a decade and the pandemic. Like many other countries, France pumped money into its economy for social protection. In 2022, the French government spent more than 58% of its GDP on bailouts, 9% more than the European Union (EU) average. This included cutting taxes. Naturally, revenues fell and debt soared.

Then came the Russia-Ukraine war, which sent energy prices through the roof, especially in Europe. Before the invasion, Russia was the world’s largest exporter of natural gas and its biggest customer was Europe. But when the EU imposed sanctions on Russia to deter war, countries scrambled to find alternatives. This left many countries, including France, scrambling to reduce their dependence on Russian oil and gas. Energy prices have skyrocketed, and household electricity costs have risen by at least 60% since 2021. To ease the burden on consumers, the French government has partially postponed price increases and reduced electricity taxes. Such subsidized electricity has left another gap in revenues.

Combine this with some of the tax cuts Emmanuel Macron’s government has implemented to win votes since he became president in 2017, and you have a perfect recipe for disaster, costing €15 billion in lost revenue. (All Politicians are like the same 😀 )

As a result, France’s budget deficit—the difference between what the government spends and what it earns—has ballooned to almost 6% of GDP, well above the EU’s 3% target. This was a red flag for investors, who were demanding higher premiums to lend to France because of the increased risk. All of this means higher interest costs for France, putting enormous pressure on the government to rebuild its finances and hit its 3% target by 2027.

This is a difficult situation, because it leaves France with only two difficult options.

The first would be to significantly reduce public spending by around €50 billion. But with major spending cuts looking almost impossible, the government’s focus has also shifted to raising taxes.

That’s what France’s new Prime Minister Michel Barnier is doing for now. He has a new budget plan to save €40 billion and potentially raise another €20 billion through new temporary taxes. These taxes would include taxing companies with excess profits over €1 billion in turnover and raising taxes on wealthy individuals. With this, he believes France could get back on track by 2029.

But there’s a problem with this solution. At 45%, France has one of the highest combined tax rates in the world, including income taxes and mandatory contributions to social security schemes. With the global average hovering around 40%, this means French citizens can’t afford to pay more tax.

If the government decides to shift more of this burden to wealthy individuals and high-net-worth companies, it could backfire. That’s because over the years, there has been a noticeable increase in the number of people looking to move to countries like Spain and Switzerland. If France raises taxes too much, we could see more people packing their bags for greener pastures.

But that’s not all. As part of its plan to tax the rich, France is considering raising taxes on air passengers. This could make travel to and within France more expensive, potentially weakening tourism. Furthermore, higher taxes on flights could hit the aviation sector, which is already working to switch from fossil fuels to sustainable aviation fuels, hard.

So while France is scrambling for solutions, the proposed fixes come with their own set of challenges.

Does this really leave France with no way to deal with this dilemma, you ask?

In fact, there could be a solution. Instead of raising taxes, France could expand its tax base by closing loopholes in its tax system. Take short-term rentals, for example. They currently benefit from a tax loophole that allows them to pay lower taxes, treating them like bed and breakfast services. This means they save almost 70% of the taxes they pay on their rental income; hotels cannot. It also contributes to a housing shortage that has drawn much criticism in France.

Reducing these tax savings from 70% to just 30% for short-term rentals, and addressing other similar tax loopholes, could create a fairer tax system and increase France’s revenue.

So yes, France is walking a tightrope. The country will have to wait until tomorrow for its final budget, scheduled for 2025, to see if it can really balance its shaky debt.

Until then, France seems to have a lot of work ahead of it.

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