Missed opportunities on budgets and tax reform

In recent days the government of President Nikos Christodoulides and MPs approved the government budgets and a tax reform. In doing so they have missed real opportunities to support policies which could generate the balanced and equitable growth of the Cyprus economy.

Christodoulides stated that the changes effected in the tax reform make for a “fairer, more modern, and more competitive tax system”. However, this is far from the truth as these changes hardly represent a reform and are merely measures aimed at benefitting middle-income households in the short-term and boosting the profitability of larger companies.

Both the government budgets for 2026 to 2028 and the tax reform are geared to largely maintaining the status quo in perpetuating mounting inequalities in the distribution of incomes and wealth and the allocation of real and financial resources, with no consideration given to addressing longer-term challenges shaped by cumulative inflation and demographic changes.

More specifically, with its large surpluses and deposits at banks totalling €5.8 billion at end-November 2025 the government had the resources to finance substantial reductions in taxes on lower and middle-income persons and in the VAT on basic products and services in the tax reform so as to make the tax system less regressive and in turn contribute to narrowing income inequalities. And to ensure that real disposable incomes of households were not steadily eaten up by inflation and having personal incomes dragged into higher tax brackets over the medium to longer-term, there was a compelling need in the tax reform to include a commitment to index or adjust periodically the tax-free threshold and higher tax rates as well as tax deductions to inflation.

Furthermore, to contribute toward the broadening of tax base and to mitigate the ongoing surge in wealth inequality, whereby the top 10 per cent of income earners now own over 66 per cent of the net wealth of Cyprus, the significant and progressive taxation of property wealth, should have been incorporated as a key element in the tax reform.

But unfortunately, the tax reform and the government budgets continue to be directed at supporting the existing allocation of resources that prioritise investments in the property development/construction, retail trade, and hospitality, including tourist accommodation, sectors. Indeed, the tax reform by aiming to benefit big public companies with large reductions in tax rates on dividend payments and by providing and extending very generous tax incentives tends to militate against the phasing out of inefficient firms and the creation of new economic activities driven by technical innovations and entrepreneurship.  

Notably, the tax reform appears to be geared to bolstering the profitability of existing public-listed companies. More specifically, even though the corporate tax rate has been raised from 12.5 to 15 per cent for companies with annual revenues of €750 million or more, the tax reform favours big enterprises. The much-maligned deemed dividend distribution system has been abolished and the tax on actual dividend payments is reduced from 17 to 5 per cent. And companies also can take advantage of the Notional Interest Deduction (NID) scheme, that allows a deduction of up to 80 per cent on taxable profits from new equity financing, which in turn enables the effective corporate tax rate to be reduced to as low as 2.5 per cent.

Admittedly, the tax reform does include new and extended tax incentives aimed at raising productivity and competitiveness. Generous tax breaks for promoting innovative technologies and entrepreneurship for green and digital transition activities are part of the tax reform and are earmarked for funding in the government budgets. In addition, the 120 per cent super tax deduction for R&D expenditure related to intangible assets (patents, copyrights, brand names etc.), that is intended to reinforce Cyprus innovation and align with the Intellectual Property (IP) Box incentives, has been extended until 2030.

However, there should be concern that with the under-taxation of the property sector, suppression of private sector wages, and use and abuse of tax incentives by businesses to prop up their finances rather than in raising their productivity and competitiveness, a significant reallocation the economy’s resources toward efficient firms employing advanced technologies and creating decent jobs, would be unlikely to materialise.

Notably, all three of the aforementioned leading sectors of Cyprus are heavily dependent on lowly-skilled labour yielding low productivity. Accordingly, as in hotels and retail shops, for instant, low wages are paid making such jobs unattractive to many Cypriots, that in turn leads to the employment of a great number of foreign workers in these more labor-intensive sectors.

Government leaders should realise that with their policies continuing to support many existing companies profiting from suppressing wages, rather than raising their productivity and competitiveness with the employment of skilled personal, Cyprus increasingly is becoming a low-income economy.

Indeed, Eurostat figures reveal that labour costs in Cyprus are relatively low being €21 per hour in 2024 compared with the EU average of €33.5 per hour. And strikingly among EU countries, Cyprus in 2024 had the third highest ratio of low wage earners to total employees at nearly 40 per cent in 2024, whereas the average ratio for EU members was 26 per cent.

Pointedly, indicating the suppression of wages and the increasing distribution of income going to profits, national accounts figures reveal that the share of the compensation of employees in GDP fell from 45.2 per cent in 2014 to 44.2 per cent in 2024, while the share flowing to “net operating surpluses”, essentially the profits of public-listed companies, rose spectacularly from 18.5 per cent of GDP in 2014 to 26.1 per cent in 2024. And with richer persons being the main recipients of mounting profits it is no wonder that inequality in wealth distribution has skyrocketed in recent years.

Furthermore, given that compensation from employment is the main source of incomes of the majority of households, Eurostat estimates show that the gross disposable income of households in PPS in Cyprus for 2024 averaged €26,693, which was well below the Euro area average of €31,139. In addition, it was estimated that one in seven households in Cyprus ran the risk of being impoverished.

Policy recommendations

It can be concluded that by approving a deficient and unfair tax reform that fails in addressing the medium and longer-term issues of the distribution of incomes and wealth and the allocation of resources necessary for determining the balanced and equitable growth of the economy and the sustained improvement in the well-being of households, the Cyprus authorities missed a great opportunity to engineer a decent and productive tax reform.

Cyprus leaders should realise the important shortcomings of the tax reform and at least amend the reform in two important ways.

Firstly, there should be a commitment by the government to index or adjust periodically (say every two years as in Germany) the tax-free threshold and higher tax rates to inflation so as to help ensure that real disposable incomes of persons are not cumulatively eroded by inflation and taxes over the medium to longer-term.

Secondly, to contribute to mitigating rising inequalities in wealth distribution and to broaden the tax base the Cyprus authorities should reintroduce an annual central government progressive tax on the up-dated market value of immovable properties.

However, for a decent tax reform to be effective in achieving the specific goals of sustainably making income distribution fairer and producing a modern, more competitive economy, the reform needs to be complemented by the sound implementation of supporting fiscal policies.

In this connection, it is disappointing that the government, despite its current abundant financial resources, has persisted in targeting large surpluses in its latest budgets by, among other things, allocating inadequate amounts for social protection in providing income support for vulnerable persons and spending too little on worthwhile hard and soft infrastructure, including on developing its own institutional competence to contribute more efficiently in allocating the economy’s resources.

Moreover, minimum wages, tax-free thresholds, and social benefits can be increased and indexed to inflation over the longer-term, but sustained improvements in the economic well-being of households will require government policies that promote a well-functioning modern economy experiencing sustainable productivity growth and the creation of decent well-paying jobs.