Cyprus Mail
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Cyprus: self-serving government budgets again

ΠτΔ – Τρισάγιο για θύματα αεροπορι

The proposed Government budgets for 2024 to 2026 presented to the House of Representatives in early October 2023 are once again self-serving in that the short-term financial and political interests of the decision-making elite are richly rewarded, while the long-term interests of society are largely neglected. The government’s over-riding fixation with achieving fiscal surpluses irrespective of costs and circumstances is aimed at impressing the EU and credit-rating agencies, but at the same time making room for comfortably compensating the expanding army of public sector employees, advisors and political collaborators by keeping development and social expenditures at very low levels.

Furthermore, Cyprus budgets are largely fantasy in that Ministry of Finance officials know that budgets will not be executed as planned and as usual do not appear to be taking any measures, such as performance-based budgeting to significantly improve their implementation.

 Tax Revenue

Although there are uncertainties on the growth and price prospects for Cyprus, especially relating to the impact of the Middle East conflicts on tourist inflows and energy prices, the official projected growth rate of nominal GDP of 5.3% in 2024 seems reasonable.  However, the projected increase in government revenues of 6.5% for 2024, while higher than that of nominal GDP, appears to be an underestimate as income taxes on employees and the self-employed are only forecast to rise by 2.2% after increasing by an estimated 10.4% for 2023. Surely, relatively large rises in incomes for public sector and bank employees along with the positive impact of rapid inflation on personal income tax collections together the large rise projected for VAT receipts of 9.3 % would boost the increase in government revenues in 2024 to well above 6.5%.

Also, there appears to be scope for collecting much greater amounts of income taxes from corporations given their massive increases in profits since 2020.  In addition, a serious effort by the government to tackle tax evasion by self-employed persons should raise personal income tax collections from these individuals as projected tax receipts from self-employed persons are projected incredibly to fall in 2024 to a meagre 62 million euro.

Spending Priorities

 With government revenue estimates being kept low, despite the prospect of inflation elevating substantially tax collections, the ability for the government to meet adequately most of its spending needs is limited. As usual a very large proportion of total budget expenditure amounting to 93.1% is allocated to outlays on current expenditure items. These are dominated by personnel expenditures, which are budgeted to rise by a whopping 14.3% in 2024 to 3.7 billion euro, with even much larger increases in salaries earmarked for President Christodoulides and his entourage of Ministers and deputy Ministers.

Social benefits that comprise the second largest category of current expenditures are budgeted to rise by 15% to 2.0 billion euro in 2024, with the healthcare benefits component, projected to rise by 22.4% to 819.4 million euro. However, despite these large increases the Cyprus government’s expenditure on social protection, which amounted to 12.5% of GDP in 2021, remains very low by European standards. Indeed, the euro area average for such expenditure was 21.1% of GDP in 2021.

Capital expenditure excluding purchases of land is budgeted to decline by 1.8% to merely 809 million euro in 2024 contrasting sharply with the large increase in projected government current expenditures of 6.5% to 11.6 billion euro. Surely, the design of the 2024 budget with its overwhelming emphasis on raising already very high public consumption expenditures as against implementing the low level of investment projects demonstrates the government’s appalling lack of interest in policies to support development. Furthermore, although the government budget designates large funding for the co-financing of investment projects with the EU, there does not seem to be sufficient items in the budget to indicate that serious efforts are being made to implement the large number of investment projects agreed with the European Commission under the Recovery and Resilience plan.

Budgetary Performance

Apart from the unsatisfactory design of budgets by Cyprus governments, their performances in effectively implementing budgets have been very disappointing. This has particularly been the case in controlling current expenditures for personnel and administration and most importantly in executing productive development expenditures as budgeted. In recent years the over-riding goal of the government in its fiscal policy has been to produce a primary budget surplus so as to pay down its public debt and impress the EU and credit-rating agencies. While targeted surpluses were more-than achieved it has been at the expense of severely cutting-back development expenditures to offset large over-runs in current expenditures.

In 2022, the targeted primary surplus of 0.7% of GDP was more than attained, even though actual current expenditures were over 800 million euro above the initial budget estimate. This surplus was achieved by reducing actual capital expenditures below initial budget estimates to a pitiful 2.6% of GDP, despite the sharp increase in construction costs. And the much higher-than-targeted fiscal surpluses recorded for 2022 were attributable more to the Ministry of Finance grossly underestimating the rate of inflation for last year and its very positive impact in boosting government revenues.

Proposals

In view of the above criticisms the government needs to fundamentally change its approach in preparing budgets.

Firstly, the budget should formulate a composition of expenditures that aims at meeting the development requirements of the economy and the social needs of its citizens as well in protecting the environment rather than being fixated with the over-riding goal of producing a fiscal surplus.

Secondly, the government should aim to generate sufficient revenue to adequately fund government expenditures without over-taxing low-and middle-income households and small businesses incurring higher costs and interest rates.  With the Cyprus economy facing uncertainties at present and many households experiencing cost of living problems it may not be appropriate to aim at raising enough tax revenue to generate the proposed sizable fiscal surplus say of 2.2% of GDP in 2024, and taking ample amounts of money out of the economy in the process. It is noted that Cyprus is the only euro area country apart from the exceptional case of Ireland that so far is proposing significant fiscal surpluses for 2024; in relation to GDP France proposes a 4.4% deficit, Germany a 2.0% deficit, Italy a 4.3% deficit, Spain a 3.0% deficit, while Greece and Portugal aim at recording surpluses of 0.1% and 0.2% of GDP, respectively.

Although tax rates on personal incomes and production should not be raised, the government can elevate its revenue estimates by realistically taking into account the very positive impact of persistent inflation in boosting tax receipts as has happened over the last two years. Furthermore, the government can substantially increase its revenue be making serious efforts to tackle prolific tax evasion and by being stricter in taxing the much higher profits of corporations.

While the large budgeted increases in certain key current expenditure components for 2024, such as outlays for government employees, advisors and top officials do not indicate a genuine commitment to the promised fiscal prudence, an equally important concern is that planned current expenditures targets will be exceeded as in previous years and result in development expenditures being considerably cut-back from an already planned low level in order to achieve  targeted fiscal surpluses This re-alignment of expenditures would be costly as implementation of many investment projects, such as the crucial upgrading of the electricity grid,  would continue to be delayed, with progress in executing the green transition under the Recovery and Resilience plan painfully slowed. Furthermore, losses would result by not being able to absorb large amounts of the EU co-financing funds designated for Cyprus.

Thus, it is paramount to put measures in place including performance-based budgeting to control current expenditures and ensure that capital expenditure can be implemented in accord with budget plans.  In particular, the government needs to raise its human resource capacity so that it can better prepare and effectively implement public investment projects and programs rather than just recruiting casual workers and advisors for political and public relations purposes.

 

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

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