Tax system reform is crucial for post Covid-19 recovery

By Andreas Charalambous

Based on current evidence, the next months are expected to be extremely challenging. The return to normality will still take some time and facing up to the adverse repercussions of the pandemic will continue to be the top priority over this period.

However, in parallel, we have to start preparing for the post Covid-19 era. In this context, reforming the tax system would be crucial, with a view to (i) safeguarding additional revenues thus avoiding a public debt crisis down the road, and (ii) paving the way towards a new development model.

Simplifying the tax system, in particular through a review of the entire spectrum of tax incentives and abolishment of those that are not in line with the current developmental and social objectives, should be at the heart of such a reform.

A second important element should be retaining low tax rates, a key element of the successful tax reform back in the early 2000, accompanied by a widening of the tax base. Tax incentives should be linked to entrepreneurial activities with real presence in Cyprus, focusing on the green economy and combating climate change, as well as fostering digital and technological adaptation.

Such a reform should be compliant with state aid rules, a very sensitive issue from the EU’s perspective. It is also important to take into account the basic principles of the EU as well as the Organisation for Economic Cooperation and Development framework on international cooperation. Cyprus should demonstrate that its tax system adheres to high standards in this respect, thus addressing negative perceptions abroad.

An additional element should be the orientation towards green taxation, by encouraging the use of renewable energy in electricity generation, heating and transportation, etc. and burdening through indirect taxation the consumption of environmentally damaging products such as plastics. In more general terms, the green economy should become the main developmental pillar of the post pandemic period.

Finally, a main feature of the tax reform should be the preservation of progressivity for very high-income earners. Such an approach could be accompanied by tax reliefs for middle- and low-income classes. Demonstrating fairness from a social perspective will be crucial also with a view to improving political acceptability.

In the context of such a policy approach, proposals that could be further explored include the widening of tax brackets for tax rates of 20-30 per cent with a parallel increase of the tax rate for high-income earners, the abolition of many of the tax incentives for corporates, the reduction of the tax rate for interest income, currently at 30 per cent which constitutes a disincentive for savings, etc.

Independent experts and organised groups should be assigned an important role in designing the tax reform.

Andreas Charalambous is an economist and former director of the finance ministry