Story highlights François Hollande's Socialist government announced a €20bn tax break for companies

Responding to months of pressure from business for urgent action to help compete

François Hollande's Socialist government finally responded on Tuesday to months of pressure from business for urgent action to address France's sliding industrial competitiveness by announcing a €20bn tax break for companies.

The measure fell short of the €30bn "competitiveness shock" recommended by Louis Gallois, former head of aerospace group EADS, in his government-commissioned report on the issue published on Monday.

But the scale of the tax credit -- the main feature among 35 measures set out by prime minister Jean-Marc Ayrault -- to a large extent belied speculation that the Gallois report would be "buried" by a government under pressure from the left not to give in to special pleading by the business community for a reduction in France's high labour costs.

The pressure of fast-rising unemployment, running at 10 per cent of the workforce, and the threat of recession next year appeared to overcome government reticence.

Pierre Moscovici, finance minister, said the measures would lead to the creation of 300,000 jobs over five years and would add half a percentage point to annual growth over the same period. "It is a moment of truth," he said. "It is a step no French government has taken before."

Laurence Parisot, the head of the Medef employers' federation which has led the campaign for a big cut in labour costs, said the proposals were "good and significant". She said Medef wanted the government to go further, with labour costs needing to fall by €70bn to match Germany. But she told the Financial Times: "For the first time the French government has admitted clearly and unambiguously that there is a problem of cost competitiveness. This is truly an important moment for our economy."

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However, the government avoided a direct reduction in the heavy social welfare charges levied on employers and employees that Mr Gallois said should be slashed. It postponed any reform of the financing of the convoluted welfare system until next year.

The measures "do not go to the heart of the problem, as they fail to tackle the high level of social security contributions that represent the bulk of the French tax wedge on labour," said Tullia Bucco, economist at Unicredit.

Instead, Mr Ayrault plumped for handing businesses a €10bn tax credit in 2013 with a further €5bn in each of the following two years, adding up to a permanent €20bn tax break -- the equivalent of 1 per cent of gross domestic product -- from then on.

The tax credit, set against employment and available to loss-making as well as profit-making companies, will apply to all businesses, not just to exporters. The benefits must be used to boost investment and employment, not to fund dividends or share buybacks.

Mr Ayrault said the tax credits amounted to a 6 per cent cut in labour costs, among the highest in Europe and blamed by employers for undermining their ability to compete internationally, especially with their German rivals.

They will be partly financed by €10bn in additional public spending cuts over 2014-2015, yet to be specified, on top of savings already planned from next year. The government has been under strong pressure, including by the International Monetary Fund this week, to make deeper cuts in public spending, which accounts for 56 per cent of GDP.

The remainder of the cost will be covered by an increase in value added tax and environmental taxes. The base rate of VAT will rise to 20 per cent from 19.6 per cent, with a further rise in a reduced rate, mainly for restaurants, to 10 per cent from 7 per cent at present. VAT on food and other essentials will be reduced to 5 per cent from 5.5 per cent.

This was something of an embarrassing reversal by President Hollande who had earlier ditched a plan bequeathed by his centre-right predecessor for an across-the-board increase in VAT of 1.6 percentage points in return for reductions in employer social charges.

But Mr Ayrault said the measures were a "major and decisive" step towards a "new French model" to make the economy "more competitive" and able to deliver "more solidarity". The strategy was to move French industry up the value chain to higher quality products, as Germany had achieved.

Mr Gallois said the proposals, which include many of his recommendations on boosting investment, innovation, skills and the strength of small and medium-sized businesses, showed that the government had "understood the measure of the problem".

It remained unclear, however, how far the government was prepared to go in pursuing deeper structural reforms in areas such as the rigid labour market, as demanded by business leaders and international institutions such as the IMF.

It warned on Monday that France risked further loss of its competitive edge if it did not keep pace with labour and service market reforms now under way in Italy and Spain.

Labour market reforms are subject to talks between employers and trade unions due to carry on until the year's end; the 35 government proposals included new pledges on cuts in public spending and reforms in areas such as transport, housing, the service sector and the public sector. But there was little detail.