By Stelios Orphanides
Cyprus is likely to face mounting pressure to increase its corporate tax rate soon and needs to diversify its economy with meaningful reforms as the victory of Emmanuel Macron in Frances’ presidential elections signals a new push for a fiscal union, a Cypriot academic said.
“Our economy needs to diversify risk,” said Marios Zachariadis, who teaches economics at the University of Cyprus. “We don’t want to see lawyers or accountants lose their business but by creating conditions through institutions and legislation that improve the business environment, we (can) establish the foundation for the economy’s risk diversification”.
Macron, 39, a former investment banker, elected on a pledge to reform and modernise the French economy, said a week ago after meeting German Chancellor Angela Merkel, that he would favour a change of the European treaty to establish a euro area finance ministry.
In the absence of a fiscal union allowing fiscal transfers from one euro area member to the other, “the monetary union will run into problems and may break down in the years or decades to come,” Zachariadis who was commenting in a telephone interview on Friday said. “Therefore, there will be a lot of pressure for fiscal transfers to happen but for this to be accepted, there has to be a fiscal harmonisation not only affecting spending but also taxation”.
The “best-case scenario” will involve a reduction of high (corporate) tax rates in various euro area countries, while a possible upwards harmonisation could affect Cyprus’s business services sector which profits from the 12.5 per cent corporate tax rate which attracts companies to Cyprus, he said.
The Cypriot economy, which expanded last year 2.8 per cent and, after it emerged from a prolonged recession, 1.7 per cent in 2015, is expected to grow 2.9 per cent this year. Last year, growth received a serious boost from tourism and construction, with the latter benefitting from incentives offered to foreign property buyers, including the Cypriot citizenship or residence permit.
This type of schemes, Zachariadis continued, may be necessary in the short term to kickstart the economy. “One can acknowledge that some of the measures taken by the Anastasiades government have resulted directly in growth but at the same time I would like to see investment in reforms which does not imply more spending,” the academic economist said.
On the other hand, these schemes are already causing side-effects, discouraging economic activity in other areas, causing a “bubble in a neighbourhood in Limassol with the construction of large buildings,” he said.
“Local bubbles impact negatively those who take business decisions,” by reducing the motivation of entrepreneurs to engage in more sustainable forms of economic activities, Zachariadis said.
In order to reduce the economy’s reliance on distorting activities such as the low corporate tax rate or the citizenship-by-investment schemes, the island will need to address areas such as education, where Cyprus spends more than the EU-average, transparency and judiciary, where it performs worse compared to other European Union countries, the economist added.
According to the 2015 results of the Programme of International Student Assessment (PISA) of the Organisation of Economic Cooperation and Development (OECD), Cypriot students were the worst performing in the EU, trailing Romania and just ahead of Moldova.
In the World Bank’s 2017 Doing Business Report which assessed he business environment in 190 countries, Cyprus which last year completed its reform programme agreed with international creditors in exchange for a bailout, ranked below Moldova and just ahead of Croatia. Cyprus was ranked 129th in enforcing contracts, a process that takes 1,100 days, 125th in dealing with construction permits which requires 507 days and 91st in registering property.
“Governments cannot change the structure of an economy in five or ten years but they can create the preconditions (for this to happen) in the future,” Zachariadis said and admitted that it also “takes guts to reform”.