Short-term patchwork government measures to deal with cost-of-living crisis and persistent inequalities are not enough
By Les Manison
A report by the OECD on “taxing wages” reveals that the increase in nominal wages of workers in most of its 38 members in 2022 not only failed to keep pace with the rate of inflation, but pushed employees into higher tax brackets. With inflation climbing to its highest level in 30 years in 2022, the OECD report states that “effective tax rates rose in a majority of OECD countries across a range of incomes and household types, with a significant increase for families with children, particularly at lower income levels”.
The report focuses on estimates of the labour tax wedge – defined as total taxes including contributions on labour paid by both employees and employers, minus family benefits, as a percentage of labour costs – for OECD countries. For a single worker earning the average wage in 2022, the tax wedge ranged from 53 per cent in Belgium, 47 per cent in Germany, 38 per cent in Greece, 32 per cent in the United Kingdom, and to zero in Columbia, averaging 34.6 per cent across the OECD compared with 33.4 per cent in 2021.
Unfortunately, Cyprus is not a member of the OECD, an institution which produces rich data for economic analysis and decision-making. However, the recent publication of wage data for Cyprus by Cystat for 2022 provides strong evidence that despite rises in their nominal wages, the real incomes of most workers have fallen since 2019, with many of them driven into higher tax brackets and incurring an increased tax wedge.
Between the pre-Covid year of 2019 and 2022, when consumer prices in Cyprus increased by over 11.1 per cent, the median of gross monthly earnings of employees rose by 9.3 per cent, meaning that the real incomes of the majority of employees fell over this period. But changes in the average monthly earnings of total employees disguise the fact that many low and middle-income workers in the agriculture, manufacturing, retail trade, and food services and accommodation sectors experienced much greater declines in their real incomes. In truth, wide inequalities in income distribution are indicated by statistics showing that a great number of workers in these sectors earn incomes of less than €1,200 per month, which is around one-third of the average monthly income of public sector employees.
Furthermore, apart from having much less discretionary income, lowly-paid workers face higher inflation as they spend larger portions of their meagre incomes on food and energy products, the prices of which have risen more rapidly than average consumer prices.
Owing to the impact of inflation many workers have had in recent years their annual personal incomes increase to above the tax-free threshold of €19,500 and, accordingly, their income above this level would have been subject to a marginal tax rate of 20 per cent.
For example, a worker in construction earning the sector’s average monthly wage of €1,500 in 2019, but having it increased to €1,725 (annual income of €20,700) by 2022 would have to pay 20 per cent of his annual personal income above €19,500 in taxes, resulting in the worker’s disposable income being reduced by €240 for 2022. Similarly, middle-income earners including many government employees enter into higher tax rate categories ranging from 25 to 30 per cent as a result of inflation boosting their nominal wages and salaries.
However, the relatively low incomes of many persons in Cyprus including young adults needs to be related not only to consumer prices, but also to the cost of affordable and adequate housing accommodation. House prices and rents having risen steeply since 2020 with double digit increases in each of the last two years in prices for the buying and renting of houses and apartments.
With outside housing accommodation becoming increasingly unaffordable the proportion of persons from 22 to 29 years living with their parents in Cyprus has risen to elevated levels in recent years, being at approximately 44 per cent in 2022. And with many young couples unable to afford adequate housing and eke out a decent standard of living the birth rate in Cyprus is in marked decline.
What can be done?
Short-term patchwork measures to deal with the ongoing cost-of-living crisis and persistent inequalities, as seems to be the want of the current government, are not enough. Instead, there is a compelling need for policy measures and reforms that can have a sustained positive impact in narrowing inequalities and safeguarding the well-being of all citizens and also in protecting the natural environment.
Firstly, the government should take measures to raise the wages of lowly-paid workers in the private sector by increasing minimum wages to levels that enable a decent standard of living. Minimum wage regulations should be extended to all sectors of the Cyprus economy and all employees earning less than €1,200 per month should be eligible for full cost-of-living adjustments (CoLA). And the government should be diligent in monitoring and ensuring that employers implement such regulations.
Secondly, the above measures would raise the costs for employers substantially and would need to be phased in over a period, perhaps two years, that would allow employers to absorb a major part of the costs, while the government at the same time, would need to help more vulnerable employees with targeted assistance.
Thirdly, the government can assist the finances of a number of employers by directing and encouraging the shifting of the allocation of company resources to involvement in executing investment projects and programmes under the proposed revised Recovery and Resilience (R&R) plan.
Construction companies, for example, should be induced to redirect their activities to more lucrative and partly EU-financed investment projects such as in the renovation and erection of infrastructure associated with the upgrading of healthcare and education facilities and with the installation of energy efficiency improvements in buildings, as well as in the construction of social housing.
Fourthly, the main way to reduce inequalities in income and good employment opportunities is to create decent jobs, especially for the younger generation of highly educated and skilled persons. Here the implementation of the R&R plan should be directed toward using production techniques that employ skilled labour.
In addition, employment policies in the public sector should be fundamentally changed to recruit and promote qualified and competent persons rather than politically-connected persons and loyalists.
Furthermore, Cyprus needs to spend much more on research and development, currently at around 0.8 per cent of GDP, so as to among other things employ productively its large number of talented, yet underemployed, scientists.
Fifthly, the tax system and its administration need to be reformed in order to raise sufficient revenue to finance the multitude of investment projects and programmes to be implemented under the R&R plan as well as providing high-quality public services including in healthcare and education and in fulfilling targeted social needs.
More specifically, personal income tax rates including the tax-free threshold should be adjusted upwards progressively in line with inflation as has been the case in 17 OECD countries. And the tax base requires broadening through re-introducing a central government progressive tax on immovable property. Furthermore, an overhauling of the tax administration is urgently needed so as to effectively tackle widespread tax evasion and raise substantially tax revenue collections.
And, sixthly, to release resources to meet the government’s spending priorities mentioned above, current expenditures on its wage bill must be sustainably contained by eliminating CoLA for the more highly-paid employees and significantly cutting back on the employment of casual workers, advisors and consultants.
Leslie Manison is a former senior economist at the IMF and an ex-advisor in the Cyprus finance ministry and at the Central Bank of Cyprus