2 weeks Ago
In presenting his ‘State of the Republic’ address on Cyprus on January 29, President Nikos Christodoulides stressed that the goal of the policy actions to be taken in 2025 would be “to improve citizens’ daily lives and create the conditions for more progress”. Christodoulides stated that policy actions taken by the government over the last year had improved the welfare of citizens, citing the prudent management of government finances as leading to upgrades from credit rating agencies and related progress of the economy. And on economic policies for 2025, the president announced that “through tax reform we are strengthening the available income of households and supporting the growth of Cyprus businesses”.
He added that labour market conditions would be improved through “modernising the cost-of-living allowance, readjusting the minimum wage, and addressing undeclared work”. On social policies, the president announced intentions to “reform the pension scheme to secure decent pensions”, to “modernise the social insurance fund investment policy”, to “enhance the vocational pension plan” and “upgrade the social insurance system”. On the health system he said that “the health services would be upgraded” and “control and supervision of the National Health Scheme (NHS) strengthened”.
Policy intentions lacking substance Many of the reforms and measures announced by Christodoulides lacked detailed content and are mostly preceded by buzzwords such as “modernise”, “upgrade”, and “strengthen”. The address of the president was populist in tone and orientation, with little reference to ongoing, deep-seated problems such as corruption, prolific tax evasion and avoidance, and the heavy indebtedness of households and companies, indeed, problems that if not dealt with would inhibit the balanced and equitable growth of the economy. Probably, the most populist and questionable statements of the president relate to the proposed tax reform in which he said that “for households there will be tax exemptions for the middle class” and “for businesses” there will be benefits arising from “the reduction of taxation, the increase in the competitiveness of exports, and the strengthening of the country as a destination for quality investments”.
And by announcing the proposed reduction in the tax burdens on households and businesses the president seemed to be seeking popularity at the likely cost of damaging government finances and economic stability over the long-term. Endangering government finances By just focusing on the more populist components of the promised tax reform, namely reducing taxes on the middle class and businesses, the president did not give attention to the longer-term and over-arching issue of the need to substantially raise government revenues in order to finance sustainably enhanced national health and social security systems in the face of an aging population. While government officials continually advertise that the public finances are in good shape it has been stated repeatedly by this author that the recent recording of considerable surpluses by the government has been attributable mainly to keeping social expenditures very low relative to their European counterparts and by the continued failure to implement many important development projects.
At the same time ministers and politicians have expressed the view that the government can’t afford to outlay more money on boosting social expenditures and note that Gesy is becoming an increasing drain on the government finances. An examination of the general government accounts reveals that the operation of Gesy, is suffering from mounting financial strains, with the deficit between contributions to and payments of this service, excluding salaries of health administrators, increasing from €277,2 million in the first 11 months of 2023 to €330,3 million in the same period of 2024. In marked contrast, over recent years the Social Security Fund (SSF) component of the general government has recorded considerable surpluses with that in 2024 expected to be over €1.
2 billion. Moreover, it is the surpluses of the SSF that have contributed importantly to the government registering overall surpluses in recent years. Notably, in Cyprus, with the ‘pay-as-you-go’ national social security and health schemes, contributions to these systems are paid into a general fund of the central government component from which payments for social security and health services are made.
With the SSF generating surpluses and other components of the general government such as the NHS producing deficits and syphoning off funds from the SSF, the government has engaged in internal borrowing. In fact, the debt of the central government to the SSF amounted to €11.6 billion at end-November 2024.
Prospects and need for reforms Given an aging population and demands for the improved quality and coverage of social benefits, financial pressures on the government’s finances in Cyprus can be expected to mount over the longer-term. Indeed, it will be a shrinking working age population that will have to provide the bulk of tax revenues including contributions to national health and social security schemes, while the rising elderly population by living longer become an increasing drain on government resources with the higher payment of pensions and health benefits. Gesy is increasingly placing strains on government finances because of the abuse of the scheme by many doctors, patients and health administrators mainly for financial purposes.
The NHS needs to be reformed so that it provides incentives for providers and users to be more efficient in using the system. Furthermore, in view of the aforementioned longer-term issues, continued relatively large surpluses of the SSF can’t be guaranteed and the need for this fund to be used for purely social purposes, such as for social housing as suggested recently by Averof Neophytou and/or for it to be backed by adequate reserves warrant careful consideration. Important social expenditures such as old-age pensions and social housing could be raised by confining resources of the SSF to be spent only on outlays for social purposes as well as supporting the fund with the transfer of part of the ample reserves of over €6 billion of the government to the SSF.
However, from a broader perspective these initiatives are most likely to be far from sufficient for financing total government expenditures. Decent tax reform and administration needed In truth, the bottom line is that if the quality of and better targeting of the government health and social protection services are to be substantially improved and, in addition, if large outlays on infrastructure for effectively implementing the green and digital transitions are to be made without the general government experiencing heavy pressures on its finances, its overall revenue would have to be increased substantially. Most notably, the president in his address did not state the need to beef-up government revenues through tax reform measures including raising the progressivity of the tax system and broadening the tax base.
While consideration might be given to raising contribution rates to the SSF and Gesy, even by some three percentage points, such increases would be not near enough for raising government revenue to required levels, and, moreover, would be most inequitable for lower- and middle-income earners. Indeed, it would be preferable to enact reforms that would require citizens to pay taxes more according to their means, through raising of the progressivity of the personal income tax rates and re-introducing a central government progressive tax on immovable property so that individuals with high incomes and considerable wealth contribute importantly and disproportionately to sustainably raising tax revenues. A glaring omission in the address of the president was the failure to refer to the compelling need to tackle the festering problems of prolific corruption and tax evasion and avoidance prevailing in Cyprus.
The government should realise that for a planned tax reform to work in generating the required increase in revenue, there is a compelling need for the Cyprus authorities to take strong measures and make sterling efforts to combat prolific tax evasion and avoidance. In this respect, for corporations this means that large multinational enterprises should comply with the new 15 per cent tax rate and that the authorities should close loopholes, which encourage tax avoidance and money laundering. Undeniably, failure to significantly stamp out tax evasion and avoidance could seriously undermine the productive impact of decent tax reform and further tarnish the reputation of Cyprus as a destination for quality investments.
In conclusion, while Cyprus might experience relatively rapid economic growth over the short-term accompanied, unfortunately, by cost-of-living pressures for many citizens, the address of President Christodoulides with its lack of detailed content on many of the announced economic and social policies and the failure to cite and deal with real problems such as corruption and the heavy indebtedness of households and businesses, did not inspire confidence that the conditions for improving the well-being of Cyprus citizens in their daily lives would be created. Les Manison is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus.
