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Tax reduction to follow recession

10/11/2015 12:13
A reduction of taxes paid by businesses and employees can contribute to increasing growth, following a period of recession, says the Ministry of Finance, in a note regarding the improvement of the fiscal framework.

For the economy to enter a sustainable path, tax adjustments are needed, as the note points out, to ensure efficiency and social cohesion on an individual and social level.

This can be achieved through optimal tax rates combining efficiency with social cohesion so as (dis)incentives on labour and capital remain consistent.

It is noted that all the above lead to the efficiency–equity trade off highly associated with the informal economy and the existence of tax evasion.

It is added that lower economic activity leads to reduction of tax revenues through reduced indirect and direct tax revenue collections.

For years prior to 2007, Cyprus has been enjoying high tax revenues associated with even higher growth rates due to some exogenous factors such as the tax reform of 2002/2003 and the tax amnesty law of 2007 that gave strong incentives to investors and depositors to repatriate their funds back to the economy.

Tax revenues were also affected by an overheating economy fuelled by a rapid credit expansion, lower interest rates and a resulting housing bubble.

It is noted that the correlation for Cyprus between GDP growth and tax revenue seems to be high enough explaining the closed correlation between GDP growth-tax revenue-fiscal deficit.

The report states that an important issue for effective tax collection is the issue of tax evasion, which is a drawback in Mediterranean eurozone economies.

The efficiency of the tax system could lead to more favorable effects on tax revenue, better public goods provision and ultimately, faster poverty reduction and embedded robust social cohesion.

Tax evasion distorts the tax collection system, increasing economic inefficiency, raising the fiscal deficit and lowering prospects of poverty reduction.

It is stressed that tax policy can reverse some of the negative economic impact following a significant economic downturn similar to the one that Cyprus experienced recently.

After Cyprus experienced a downswing in economic activity, tax containment on business activity and employment could enhance labour growth amid economic upturn and facilitate faster and robust recovery.

Policy measures to ease tax burden on labour could also mitigate overall taxation on employment and expand labour demand necessary for a sustainably sound growth.

Moreover, the expansion of the network of tax treaties for the avoidance of double taxation with countries that Cyprus maintains significant financial and trade relations also helps.

Policies to combat tax evasion could also reduce poverty once more public revenue could finance social protection expenditure to alleviate poverty.