Every day that goes by without the Cypriot government taking action to constructively remedy the economy is disastrous, tarnishing the reputation the island enjoyed for more than two decades (and worked so hard for) as a reputable business hub and financial centre. It is clear the recent downgrades by both S&P and Moody’s are not taken seriously by those in power, as their only consideration for action is related to the outcome of the coming elections.
Shame on both the government but also on all political parties and trade unions whose public declarations are unworthy of whatever they claim to be. These are times when every cent counts, that is, every cent that one spends, saves or invests.
In times like these, the advantages offered by Cyprus – a strong legal and regulatory system, the lowest corporate tax within the EU and double-tax-treaty agreements with about 50 countries – should have drawn even the most hesitant investor to the island.
Instead, lack of vision and sciolism, populism and demagogy, not to mention apathy towards the appraisal of influential nations and professional bodies, weaken the very foundations of the island as a business hub and a financial centre.
Cyprus, like every other nation, has to realise she exists within a globalised environment influenced by unforeseen risks and increased volatility. She has to be ready at all times for the worst without solely seeking ways just to get by.
How will the recent socioeconomic problems of the neighbouring MENA countries affect the island? What if Saudi Arabia, the largest oil producer in the world, is next? What if Greece cannot pay off its debts? What if other European partner nations follow Greece’s path? What if the US suffers another recession? What if the EU forces Cyprus to raise its corporation tax?
If Cyprus is to prosper it has to strive for excellence, become competitive and accumulate capital – first and foremost by cutting unnecessary and primitive ‘non-logical axioms’ such as the Cost of Living Allowance (COLA). COLA only creates large increases in real wages and deterioration in competitiveness of domestic companies, undermining flexibility and competitiveness as it impedes relative wage adjustments across companies and sectors in line with productivity differentials. It imparts inertia to the public sector wage bill, making it more difficult to reverse the excessive growth of public sector wages and salaries. Added to a policy where people get jobs for life despite their performance, and pampered trade unions influence management decisions the result is a formula for self-destruction.
Additionally, the social security system has to be restructured. Surplus is currently about four per cent of GDP as contributions by employers, workers and the government exceed outlays. Over the next three to four decades pension outlays are projected to rise by some 10 percentage points as the system matures and demographic changes play out. Unless other areas of government spending are curtailed, this would raise total state spending to more than 50 per cent of GDP – a very high level sustainable only via a heavy increase of taxes.
A solution: incorporate COLA into the basic salary and thereafter base salary increases on merit and performance. Regarding the social security system, bring outlays more in line with contributions through lower replacement rates and higher retirement age. Freeze salary increments for 2011 and 2012 and increase government-employee pension-fund contributions to four per cent in 2011 and five per cent in 2012.
Corporate and personal income taxes have to remain intact. Income tax evasion should be handled without complex legislation and inspection – if procedures do not remain simple they will scare off investment and eliminate the entrepreneurial spirit that resurrected this country after 1974. Recent studies indicate the size of the black economy in Cyprus cannot be more than 8.5 per cent, one of the lowest in the EU. Given the high tax-free income here (and the skewed income distribution) the majority of workers are below the income-tax threshold.
A solution: a high tax-free income can not only help to reduce tax evasion directly but also to limit evasion amongst higher earners. Adoption of such a policy will even make tax-compliance measures less costly to implement.
Additional issues to address: the banking, tourism and real estate industries have to be reinforced. Incentives for borh foreign investors and private local ones have to multiply. Prudential controls towards cooperative credit societies should become stricter. Governmental procedures at every level have to be streamlined and become more responsive. Double tax treaties with more countries are a priority and should be treated as such. Trade unions should adopt an open-minded policy. More decisive steps are needed to eliminate delays related to title deeds issuance. Building coefficients in selected areas have to increase. Hospitality and tourism have to be upgraded and better promoted. International hotel chains should be targetted and ‘invited’. Architectural uniformity in all areas has to become a way of life. Tradition and heritage have to be protected and better projected. The government should refrain from being involved in business, which should be undertaken only by the private sector – the recent under study project with Qatari Diar for instance should have been considered only on a BOT basis.
Moreover, rumours and proposals for a temporary or permanent hike in the corporate income tax rate are disastrous, as is talk of higher property taxes. Rumours and proposals for burdening the banking sector with any form of taxation are disastrous. The current high interest rate regime is disastrous. Rumours and proposals for lifting bank confidentiality to spot tax evaders are disastrous. The temporary reduction in tourism sector VAT rates if not extended is disastrous.
The Cyprus government and every Cypriot must realise time is running out and that a spirit of collectivity, pride and transparency must complement every effort undertaken. Otherwise the next global financial tremour may make suffering a Cypriot way of life. It’s not too late.
n Harris A Samaras is Chairman and CEO of Pytheas Ltd, which publishes Pytheas Market Focus. The full version of this article can be found at: http://www.pytheas.net/docs/20110228-Cyprus-must-change-or-suffer.pdf
