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The Deeper Lesson of the French Downgrade

France is discovering that taxation doesn't solve a spending problem...

'AAH THE FRENCH', as Orson Welles once declared in an infamous champagne commercial. The Hollywood legend made the point that French champagne has always been celebrated for its excellence. Today, the French are being punished for their excess. At least, that's how we see it, writes Dan Denning in the Daily Reckoning Australia.

Moody's Investor Service downgraded France's sovereign credit rating one notch yesterday. The ratings agency says France has some structural problems, including 'the gradual and sustained loss of competitiveness and the longstanding rigidities of its labour, goods and services markets.' It also said that, 'France's fiscal outlook is uncertain because of its deteriorating economic prospect.'

But we reckon the French economy has the same problem as most of the countries in the industrialized Western World: unrealistic expectations and a perverted understanding of wealth. On the one hand you have citizens who want more from their government without paying for it. On the other hand you have governments grasping at revenues and higher taxes to remain popular and stay in power.

Squeezed like a grape between both hands is the productive middle class. 

Francois Hollande, the well-groomed and charming socialist bureaucrat, strolled into office with soaring popularity and the promise that he'd raise income taxes on the rich to 75%. By 'rich' he meant anyone earning an income over $1.27 million.

Now, Hollande finds his popularity plummeting. The 'temporary' hike in the highest marginal tax rate hasn't plugged France's big budget holes. The people are realizing that you can't tax your way out of a spending problem. Wealth isn't automatically created so that the government may legally steal it.

This is the whole flaw with the idea of progressive taxation. Nothing about it is progressive. It is not forward-thinking, enlightened, or modern to increase the government's role in economic life. It only transfers power from the people to the elites, and money from your pocket to the public purse, where it is wasted or otherwise lines the pockets of the connected and the lazy.

Mind you, things could always be worse. In the past they HAVE been worse. The King or the Church could take what's yours and leave you with a patch of dirt, if you were lucky. The improvement in the modern feudal system largely comes down to cable TV and Wi Fi internet on a handheld mobile device. Bad food is also much cheaper. Calories have become just as debased as money.

Nobel Prize-winning economist Paul Krugman knows how to make things better. Pining for the 'economic justice' of the 1950s, Krugman reckons we should go back to a 91% marginal income tax rate. The more you make, the more the government takes. That is the surest way to make sure no one is more equal than anyone else.

But America in 1951 was a much different place, in economic terms. Unemployment was low. American manufacturing powered the world, partly thanks to the destruction of the rest of the world's industrial base in World War II. Employers were willing to invest with such a huge competitive advantage in place, and they had to pay competitive wages. The world's manufacturing workforce hadn't been globalized.

America was a lot more productive a place back then, too. Krugman wants to tax his way back to prosperity by way of what he calls a more equal, more progressive distribution of the country's wealth. But in the current context, he's really just talking about how to divide up the remaining Twinkies in the national cupboard. Meanwhile, no one's making any more Twinkies.

Time to Buy Gold?...

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

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