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By DR. JIM LEONTIADES
CIIM, The Cyprus Business School
A government has three ways to reduce a deficit:
1. Reduce spending;
2. Increase revenue;
3. Some combination of the above.
The recent government package of 21 proposals to reduce the Cyprus deficit appears to go for number 3, a combination of both spending cuts and revenue raising. In fact, the government has opted heavily for number 2, an increase in revenue.
The proposals to reduce spending which are included in the government’s package of 21 measures are miniscule, an exercise in cosmetics. Can anyone take seriously the plan to reduce civil service employees by 1000 over three years? This amounts to considerably less than 1% annually of the total civil service workforce. Even this tiny amount cannot be taken for granted, given the government’s past record of freezing civil service employment and then promptly adding new personnel to the public sector payroll.
NEW TAXES
The new revenue proposed by the government is to come from increases in VAT, taxes on cigarettes, petrol, liquor and new water rates. Add in the recent increase in electricity prices and this means only one thing, a regressive set of measures which will hit particularly hard at the lower income strata of Cypriot society. Those who need to consume the highest proportion of their income.
Given the country’s current economic condition the last thing needed are measures which will curtail domestic demand – which is precisely what the proposed tax measures will do. In its efforts to do something about the deficit the government risks turning what has so far been a rather mild recession into a depression.
A drop in consumer spending is at the heart of any economic recession. The UK, USA, France, Germany and most members of the European Union have incurred major increases in their deficits at this time primarily due to their efforts to support consumption. The main economic strategy of all these powers during the downturn has been to boost the ability of consumers and businesses to continue spending. The recent Cypriot package of proposals will move the economy in the opposite direction.
It will also adversely impact our main industry, tourism. Talk to any foreign visitor and they will soon get around to telling you how expensive they find everything in Cyprus. It is clear that there has been a flow of tourists away from high cost Cyprus toward Egypt, Turkey and other lower priced destinations. The proposed consumption taxes will only make Cyprus less competitive. Tourists will have to pay more for everything outside their hotels. The hotels themselves would experience price pressures from the inflationary effect of increased VAT and other taxes on their suppliers and employees.
Although the economic measures in the government’s package echo the recent Greek economic proposals, the two situations are not the same. The Greek national debt is roughly double the 60% permitted by the EU. Cypriot debt is only 7 percentage points above that level. While Greece has to reduce its national debt from 112% to 60%. The Cypriot task is to reduce it from 67% to 60%. Different situations call for different measures.
The Cyprus deficit should eventually be curbed but taxes falling on consumers and businesses in the midst of a recession are not an appropriate remedy. The current deficit can also be viewed as an opportunity. An opportunity for making structural corrections which, though necessary, are in normal times politically unpopular. The Greek measures to restrain the public sector are an example which should be followed more vigorously.
TIMING
Timing is everything. The government has to think of ways to reduce the public deficit but taxes on consumption and spending are not the right prescription at this time. There are alternative measures to raise revenue which have a less adverse impact on the consumer. Literally billions of Euros are spent by Cypriots on different forms of gambling. A tax on the many gambling institutions proliferating on the island is a promising possibility. So are taxes on undeveloped properties which contribute nothing to national development. The government’s many subsidies to quasi-government institutions are an area of potentially significant savings. In the final analysis, Cyprus may have to accept a budget deficit of roughly the current order for a year or two until the economic situation becomes more favourable.
The recent tax proposals of the government are not well thought out. They simply reflect the fact that consumers are the least politically powerful pressure group on the island. However, a steep downturn in economic activity also has political implications. Unemployment and decreases in the standard of living can also influence votes, a point which has hopefully not escaped our perceptive parliamentarians.
