French President Francois Hollande’s first annual budget raised taxes on the rich and big companies and included a minimum of spending cuts to reduce the deficit.

The 2013 blueprint relies on 20 billion euros ($26 billion) in tax increases, including a levy of 75 percent on incomes over 1 million euros, and eliminating limits on the wealth tax. Hollande aims to reduce spending by 10 billion euros, bringing the deficit to 3 percent of output from 4.5 percent in 2012. The budget predicts growth of 0.8 percent.

“It’s true we’re asking for an effort of the richest, the top 10 percent and the top 1 percent in particular,” Prime Minister Jean-Marc Ayrault said. “Big companies of the CAC 40 pay less than the small companies and sometimes don’t pay at all. So we’re asking them for an effort too.”

France has a financing requirement of 171.1 billion euros in 2013, down from 182.8 billion euros in 2012, Agence France Tresor said in a simultaneous release. The debt agency said bond issuance alone would total 170 billion euros next year, down from 178 billion euros this year.

The announcement triggered a gain in French 10-year bonds, with the yield falling three basis points to 2.18 percent. French borrowing costs have tumbled since Hollande took office in May. Still, with growth stalled and unemployment at a 13-year high, bond-market quiescence is partly hiding the scale of the challenge facing Europe’s second-largest economy, investors and economists say.

‘Big Test’

“This is the first big test of investor sentiment,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “For the past four months the bond markets have given the Socialist government a free pass.”

The yield on French 10-year debt dropped to a record-low of 2 percent on Aug. 3 and France also sold shorter-term notes at negative yields for the first time in July. Friday’s budget predicts an average 10-year yield of 2.9 percent next year.

The premium demanded by investors to hold French 10-year debt rather than German bunds has fallen to about 75 basis points from a euro-era high of more than 200 basis points on Nov. 17, when then-President Nicolas Sarkozy was fighting concern about the viability of French banks.

Much of the improvement has rested on Hollande’s commitment — repeated every week by himself or his ministers — to reduce the budget shortfall to 3 percent of gross domestic product next year.

Deficit Commitment

The figure, made sacrosanct by Europe’s growth and stability pact because it allows a growing economy to reduce its debt burden, puts France in the middle of its peer group. Germany expects its budget to be close to balance while Italy projects a shortfall of 1.8 percent next year.

Spain said Thursday it expects a 2013 shortfall of 4.5 percent. The United States and Britain will have deficits of 6.3 percent and 6.6 percent, according to the International Monetary Fund’s (IMF's) April forecasts.

Hollande has repeatedly said he wants to meet the target to keep borrowing costs low and maintain France’s independence at a time when the European Union and the IMF impose conditions on aid recipients such as Greece and Portugal.

“I don’t want France to be a prisoner of its debt,” Finance Minister Pierre Moscovici said Sept. 16. “It’s a question of France’s credibility. We’ll meet our commitments.”

Every 0.1 percentage point increase in French yields costs 200 million euros, he said.

German Counterweight

Hollande, whose has campaigned to shift Europe’s crisis-fighting focus to growth from austerity, wants to remain a credible counterweight to Germany, according to Socialist lawmaker Karine Berger.

Meeting the targets “is the only way to keep equality with Germany,” Berger said this week in an interview in Paris. “France’s weight at the table in Europe depends on Hollande making the growth case not for himself, but for others.”

The risk is that piling taxes onto an economy that has barely grown in five quarters will push the nation into a recession that erodes revenue collection.

France’s economy has failed to grow in four of the past five quarters. In the third quarter of last year, the only one to show an advance, the gain was 0.3 percent. Hollande’s government currently predicts growth of 0.8 percent next year.

Meanwhile, taxation has been rising. The increases announced Friday come after about 7 billion euros added in July and others implemented by Sarkozy’s government. Friday’s budget also includes a new tax rate of 45 percent on incomes above 150,000 euros.

Spending Cuts

The 10 billion euros in spending being eliminated include a reduction in operating costs by 2.8 billion euros and the slashing of 1.2 billion euros of investment.

Ludovic Subran, chief economist at credit insurer Euler Hermes, said the government would be bolder to allow a deficit of 3.7 percent to preserve growth while implementing labor-market reforms to boost competitiveness and investment.

“The 3 percent target is not possible, I don’t believe they’ll make it,” Subran told journalists Thursday in Paris. “France has a window of opportunity to act on competitiveness, but it’s short.”

Hollande has to juggle pressure from the bond market and Germany with the demands of his base. His approval rating has dropped 11 points in the past month to 43 percent, according to an Ifop poll released this week.

“The French government needs to walk a fine line between its fiscal constraints and the domestic and European political pressures it faces,” JPMorgan Chase Inc. economists Alex White and Raphael Brun-Aguerre said in a note to clients. “We see President Hollande’s political commitments to the Socialist Party base weighing on the likelihood of major structural reform and think there is a chance that the budget proposal will fail to deliver a credible path for fiscal consolidation.”