Tax reductions only way forward for Cyprus

The philosophy and policies of draconian austerity are being challenged in the EU and beyond at a time when the Cyprus Ministry of Finance has submitted its 2015 Budget to the House of Representatives for debate. This necessitates an assessment of the broader economic environment as well as the pursued economic policy by the government.
The European Statistical Service recently changed the way the GDP is calculated so that this figure would appear higher. With this methodology, some indicators such as the budget deficit and the public debt would appear better (i.e. lower). This move is indicative of the pressures that exist. But besides the effort exerted to create a better picture it is important to focus on the substance and the harsh realities.
There is a serious unemployment problem while non-performing loans (NPLs) approach 50%; in March 2013 they were only 25%. At the same time, economic activity is still declining. There is also a severe decline in construction and the related sectors, a serious liquidity problem and difficulty in sustaining many small and medium enterprises (SMEs). It is important to understand the reasons for these problems: over and above the poor economic situation, the increased taxation and particularly the property taxes introduced are not helping the situation. On the contrary, they are deepening the crisis.
It is important to understand that the private and public debt cannot be repaid while the recession persists. One should also understand that the problem of the NPLs cannot be addressed only by foreclosures. An entirely new approach is required focusing on growth.
For this to happen, reduction of taxation is essential. In this regard, despite the increases in taxation, the state’s revenues appear lower. This article highlights the importance of just two of the proposals that the Center for European and International Affairs, University of Nicosia has submitted in the past few months.
1. Loan practices: After March 2013, strict restrictions and thorough checks are being imposed by the banks to grant loans which has a negative impact on economic activity as we have passed from a state of great imprudence to suffocation. This should be reversed.
2. Comprehensive fiscal, developmental and social policy planning. In this context the following suggestions are made:
i. A new tax reform which will take into account the social dimension as well as a set of incentives for investment, savings and encouragement of specific activities. The philosophy of the entire tax system will incorporate the principle “low tax rates and high penalties for non-compliance”;
ii. Reduction of the maximum rate of the Income Tax from 35% to 30% and similar arrangements thereafter;
iii. Reduction of the VAT from 19% to 15% and reduced-VAT from 9% to 7%;
iv. Reduction of the Corporate Tax from 12.5% to 10%;
v. Reduction of the contribution to the Social Insurance Fund from 7.8% to the previous level (6.8%);
vi. Reduction of the tax rate on income from deposits from 30% to 9.5%. The objective is that the specific tax can return to previous levels so as not to deter depositors and foreign investors;
vii. For economic stability, balanced budgets should be sought within a framework involving a longer period of time;
viii. Reduction and rationalisation of the property tax. As it stands the government's proposal for property tax (in 2013 prices) is not satisfactory. This issue is important and the proposal should be addressed separately:
EUR 0-149,999: exemption
EUR 150,000-199,999: 50 euros (flat rate)
EUR 200,000-999,999: 0.0005% (half of one thousandth)
EUR 1 mln-4,999,999: 0.00075% (three quarters of a thousandth)
EUR 5 mln-9,999,999: 0.001% (one thousandth)
EUR 10 mln and over: 0.00125% (one and one quarter of a thousandth)
ix. No additional salary cuts should take place as this would deepen the crisis;
x. Reduction of public spending as a share of GDP to below 40% in the long term.
The implementation of these two policy measures will lead to a quick and substantial stimulation of economic activity with very positive implications.
It is widely noted that lower tax rates do not necessarily lead to a reduction of revenues; on the contrary, they will encourage enhanced investment and consumption as well as lead to the creation of new jobs. By the same token, the increased liquidity will boost the economy.
These developments will also contribute to addressing the problem of NPLs. Above all, the core message will be that the state has again taken hold of the situation in its own hands. This would come at a time of increasing uncertainty in the broader European environment and with a growing tide calling for the rethinking of the Eurozone’s recipes.