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Cyprus should impose 'Labour Solidarity Tax' to counter deepening recession

03 April, 2013 | Posted By: Shavasb Bohdjalian

By Shavasb Bohdjalian
Certified Investment Advisor and CEO of Eurivex Ltd.

Following the Eurogroup agreement paving the way for the brutal and speedy restructuring of Cyprus banks and the economy in general, which in the process averted a catastrophic bankruptcy of the country, the government should immediately proceed to impose a “Labour Solidarity Tax” to counter the impact from the deepening recession.
It does not need a genius to realise that the impact from the 15-day bank closure, the freezing and deep haircut of deposits above EUR 100,000 at Bank of Cyprus and Cyprus Popular Bank will have a major negative impact on the economy and the government’s revenue targets will be missed badly.
Cyprus’ €17.5 bln economy was officially forecast to shrink 3.5% this year. Everybody will agree that the blow to our financial sector, which accounts for about half of economic activity, combined with an existing credit squeeze, which will have a massive impact on the rest of the economy, will probably force GDP to decline by double the forecast to 7% or even more.
We have seen how wrong the IMF has been in forecasting the negative impact on the Greek economy from the austerity packages, which led to more cuts until Greece finally managed to balance its books.
Cyprus has already wasted precious time under the previous administration and because of the stupidity of all our public and private sector organisations that, throughout the time when Troika representatives were meeting them to discuss the state of the economy and their particular sectors, all they were doing was drawing stupid “red lines” which crumbled and were erased in seconds.
The fallout from the crisis may lead to a decline in GDP of 10% this year and perhaps another 5%-7% in 2014, which when combined with the decline sustained during the past two years, could take the overall GDP contraction to above 20%.
"Weaker GDP performance implies a higher debt-to-GDP burden," noted ratings firm Standard & Poor's. Last week, the firm cut Cyprus's sovereign-debt rating a notch to triple-C from triple-C-plus, saying it sees the economy now shrinking 6%, heightening the risk that Cyprus may not be able to meet the terms set for the loan.
Similar to Greece, Cyprus is facing massive job losses, rising business bankruptcies and a decline in tax revenue as a result of the contraction. This means the forecasted revenue targets in the budget will be missed and if we don’t take action from now (reduce government expenses) then that would lead to even harsher measures and once again stoke fears about the island's long-term future inside the euro zone.
Let’s not beat around the bush and think that the crisis will somehow go away. The financial model and all our aspirations of becoming a financial centre have been damaged beyond repair and with the deteriorating economic climate, President Nicos Anastasiades needs to take action now.
The most sensible thing would be for Anastasiades to order a 10% additional cut in civil service and semi-government organisation salaries and a cap on pensions to make the extra savings.
The President may, however, be reluctant to impose greater pain on the population, which is why I propose calling this a “Labour Solidarity Tax” which could also include all those in the private sector earning more than EUR 2000 monthly.
The tax would remain in force for as long as it takes until the country starts growing again and tax revenues climb higher, allowing the government to eventually reduce or remove the tax. But if we don’t take action now, come September or December, the Troika will demand additional cuts, which will only extend the misery into 2014 and beyond.
President Anastasiades has shown courage and determination in taking painful measures to restore confidence in the economy and return this country to growth. He needs to take action on the fiscal imbalance now, rather than later.

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