The tax reform approved by Parliament was presented as an intervention that would leave households with more disposable income by reducing the tax burden and supporting economic activity. A new academic study, authored by three economists from the Central Bank of Cyprus, attempts for the first time to assess who the real beneficiaries of the changes are.

Its main conclusion is that the higher the income, the greater the tax reduction resulting from the reform. Consequently, the largest benefits are concentrated among the highest-income groups, while the gains for lower-income households are extremely limited.

The figures presented by the Central Bank economists clearly illustrate the disparity. According to their calculations, a household in the lowest income group will receive an average annual benefit of just €5 from the changes to income taxation.

At the other end of the scale, households with the highest incomes will receive an average annual benefit of €1,057, while those in the income group immediately below them will benefit by an average of €949 per year.

The findings leave little room for doubt regarding the distribution of the tax reductions, as most of the benefits are directed towards those who already pay the highest amounts of tax.

The explanation provided by the authors is directly linked to the structure of the tax system. Even before the reform was implemented, approximately 43% of taxpayers had taxable incomes below the previous tax-free threshold of €19,500.

This means that almost four in ten taxpayers were already not paying income tax. As a result, increasing the tax-free threshold could not provide them with any meaningful relief.

By contrast, those with higher incomes and larger tax liabilities benefit more from the changes to tax rates and income brackets, explaining the significant gap in the final benefits.

The study notes that the tax reform achieves its primary objective of reducing the tax burden and increasing households’ disposable income.

At the same time, however, it finds that the redistributive function of the tax system is marginally weakened, as the largest tax reductions are directed towards higher-income households.

In other words, the reform maintains the progressive nature of the tax system but slightly reduces its ability to limit income inequality through taxation.

The economists estimate that the annual fiscal cost of the changes will amount to approximately €240 million.

This estimate includes the increase in the tax-free threshold, changes to the income tax brackets, new tax deductions for dependent children and students, and tax relief related to mortgage interest and rent for a primary residence.

The authors clarify that the figure does not include incentives for green investments, as insufficient data was available to produce a reliable estimate of their effect on public finances.

One of the most notable aspects of the study is that it does not limit itself to assessing the reform but also examines alternative policy options.

Under one of the scenarios considered by the researchers, limiting the tax reductions available to higher-income groups would allow the state to save approximately €37 million annually, without materially affecting low-income and most middle-income households.

In this scenario, the average annual benefit for the highest-income households would fall from €1,057 to approximately €450.

According to the study, this would create additional fiscal space for other policies without significantly changing the outcome for the vast majority of households.

The increase in the tax-free threshold will also significantly reduce the number of people required to pay income tax.

The study estimates that approximately 55,000 taxpayers will no longer have an income tax liability, reducing the tax base by around 22%.

The authors also examine the reform’s wider economic impact, noting that the tax relief will not be converted entirely into additional consumption. Higher-income households tend to save a larger proportion of their additional disposable income, while a significant share of consumption is directed towards imported goods.

Under certain assumptions, the reform’s overall effect on nominal GDP is estimated at approximately 0.4%.

The study does not dispute that the tax reform will reduce taxes and increase disposable income.

What it highlights is that the benefits are not distributed evenly. The largest amounts are directed towards higher-income households, while the changes have limited practical significance for a substantial proportion of citizens who were already below the tax-free threshold.

The authors conclude that a different design for the tax reductions could lower the reform’s fiscal cost while leaving the benefits for low-income and most middle-income households almost unchanged.

Note: The analysis was published as a Working Paper by the Central Bank of Cyprus. As stated in the publication, its conclusions represent the academic views of the three authors and do not necessarily reflect the official position of the Central Bank of Cyprus or the Eurosystem.

Source: Ink.com