Government policies in allocating resources implicitly promote consumerism, mass tourism and property development as the key drivers of economic growth

President Nikos Christodoulides and the Finance Minister Makis Keravnos claim that the Cyprus economy is performing well and cite as evidence rapid real GDP growth, relatively low unemployment, and the favourable reports of the IMF and credit rating agencies on the management of the economy and government finances.

But, are the bulk of citizens benefitting from sizable increases in the GDP pie and low levels of unemployment? What do recent data on the distribution of GDP in terms of income and on the well-being of households show?

National accounts statistics on the distribution of income reveal the share of GDP going to profits has increased markedly, while that received by employees has fallen. In fact, net operating surplus, essentially the profits of corporations, as a proportion of GDP rose from 20.5 per cent in 2015 to 28.2 per cent in 2024. In contrast, the compensation of employees fell from 44.1 per cent of GDP in 2015 to 41.0 per cent in 2024.

Despite the profits of banks, energy companies, hoteliers and supermarkets probably reaching record high levels in 2024, and the share of GDP going to employees declining, the average real disposable incomes of households, which depend importantly on the compensation of employees, increased over recent years. In fact, Cystat estimates show that between 2015 to 2023 the mean equivalised disposable income of households rose by 43.1 per cent, which though much less than the increase in nominal GDP of 74.5 per cent, was higher than the rise in the Consumer Price Index of 15.1 per cent.

However, averages at the macro level hide the low incomes of a great number of private sector employees and conceal the income inequalities taking place within the household sector. Indeed, recent Cystat data indicate income inequality among households increasing with the Gini coefficient rising to 30.1 and the number of persons at risk of poverty rising to around 164,000 or 17.1 per cent of the population in 2023.

What factors are causing the widening economic inequalities and the risk of poverty for Cyprus households? The answer is basically because employees, particularly those in the private sector, and many recipients of social benefits increasingly do not receive sufficient income to cope with rising cost-of-living expenses, including housing costs. Indeed, Cystat data reveal that in 2023 Cyprus households with the lowest 50 per cent of incomes spent on average over 106 per cent of their incomes on consumption. Thus, many households were forced into incurring more debt. 

Personal estimates largely based on Cystat statistics indicate that in the years from 2015 to 2022 average annual compensation of employees in both the government and private sectors rose at similar rates of around 25 per cent and by over 12 per cent in real terms. However, in the two years since 2022, the average compensation of government employees has surged upwards by an estimated 15 per cent, while the corresponding compensation of private sector employees, excluding those in the finance and insurance sector, fell by 1.0 per cent, and by nearly 6 per cent in real terms.

Thus, the huge gap between the incomes of government and private sector employees must have widened considerably from 2022 to 2024. In fact, it is estimated that average monthly compensation of government employees reached around €4,600 in 2024, which was at least 2.5 times that of average monthly compensation of private sector employees, excluding those in finance and insurance.

Although social benefits, including old age pensions, have been raised in recent years, their relatively low-level means that many persons are vulnerable to poverty risk. Whereas, one in six pensioners are at risk of poverty in the EU, retired persons in Cyprus have a risk of poverty of one in three with this risk having increased markedly from one in five in 2021. In this connection the ratio of pension income to late-career earnings, the so-called replacement rate, was 42 per cent in 2023 compared with an average of 58 per cent for EU members. In addition, social benefits for vulnerable persons such as the unemployed and single parents are inadequate, with the former having a 33 per cent risk of poverty according to Cystat and the latter a 20 per cent risk.

Government policies

There are many ways in which government policies in Cyprus are contributing to the widening of economic inequalities and increasing the risk of more households descending into poverty.

Although the government does not have an explicit growth model its policies in allocating resources implicitly promote consumerism, mass tourism and property development as the key drivers of economic growth. And these main growth propellants are associated with the labour-intensive and low-productivity retail and hospitality sectors of the economy that pay low or “below-living” wages.

Furthermore, with many Cypriots unwilling to take up such lowly paid jobs and preferring to remain unemployed or underemployed, they like the foreigners that engage in such employment become vulnerable to the greater risk of falling into poverty. In this connection it is noted that both unemployed persons and non-EU27 foreigners had a risk of at least 32 per cent of experiencing poverty in 2023.

In addition, even in certain areas where labour productivity is increasing, employers, such as hoteliers, use their market power to exploit workers and suppress labour income to pitifully low levels in order to boost substantially their profits. 

And in the ongoing inflationary environment, taxation policies are increasingly unfairly burdening lower and lower-middle income households with greater reliance on regressive taxes such as the VAT and excise duties as well dragging persons into higher tax brackets.

In contrast, the wealthy and high-income earners benefit from a tax system and its administration that lacks progressivity (top personal income tax rate of just 35 per cent), entails minimum taxation of immovable property, and provides much scope for tax evasion and avoidance. In truth, it is the rich and politically connected persons in Cyprus that can most easily bypass laws and regulations so as to reap large financial gains that exacerbate income and wealth inequalities.

To help achieve the government’s overwhelming priority of generating sizeable surpluses, expenditures on social benefits have been held at inadequately low levels resulting in many vulnerable persons descending into poverty. Notably, Cyprus government spending on social protection amounted to just 15.1 per cent of GDP in 2023, well below the EU average of 19.2 per cent.

And the government’s failure to effectively implement key infrastructure projects owing importantly to incompetence and irregular practices is squandering taxpayer’s money and diminishing the quality of public services, including producing festering problems in the provision of reliable supplies of electricity and water to a rising number of households and businesses.

There is little doubt that government policies are making many more persons worse-off through contributing importantly to profound economic inequalities and increasing risks of poverty for households in Cyprus. In broad terms the main solution to these socio/economic problems is to raise substantially and sustainably income from employment and government social benefits.

To create good jobs enabling employees to earn decent incomes, resources need to be allocated to activities where workers can utilise their skills to raise productivity to higher levels. In this respect, the government should increase substantially its funding of R&D so as, among other things, provide jobs for highly skilled persons in both the public and private sectors. And the government needs to step up its investments in the green and digital transitions employing skilled personnel utilising advanced technologies.

In addition, the government should enhance its active labour market policies involving training, job search assistance and wage subsidies, in partnership with companies so as to improve worker skills and their employability.

Furthermore, the interaction of market forces and automation in Cyprus is leaving many lesser-skilled individuals with a wage too low to eke out a decent standard of living. The Cyprus government must promote social justice and ensure that everyone has a livable income with lower-skilled employees in all sectors being paid at least the minimum wage and having their annual incomes adjusted automatically for cost-of-living changes.

In addition, the government needs to raise social benefits to adequate levels and better target such support to deserving individuals and households. At present the government with its ample fiscal space and very large amounts of bank deposits has the ability to increase substantially social protection spending. However, with the population ageing there is the high probability that over the longer-term contribution rates to the national health and social security schemes will have to be raised.

The forthcoming tax reform offers the opportunity for the government to institute a progressive, fair and efficient tax system that can contribute to a dynamic economy and a just society.

Given that the scope for reducing indirect tax rates such as for the VAT is limited by EU rules, the focus of tax reform should, firstly, be on increasing in the progressiveness of the personal income tax system through, among other things, raising the tax-free threshold for annual incomes to at least €22,500 and by elevating the top marginal income tax rate to 40 per cent or more, and, secondly, by reintroducing a central government progressive recurrent tax on immovable property.

However, a tax reform will be only successful in Cyprus if it is accompanied by serious measures that effectively stamp out prolific tax evasion and avoidance. Otherwise, the government will not only be cheated out of sufficient revenue to finance essential expenditures, but competition between enterprises will continue to be grossly distorted and the reputation of Cyprus as a destination for quality investments will remain tarnished.