Cyprus recently became the fifth country asking for an EU bailout. With a rescue of about 15.8 billion Euros to save Cypriot banks from collapsing, one of the conditions to be met was the introduction of a tax on all deposits. An account up to 100.000€ would pay a one-time tax of 6.5%, while sums above would be taxed by 9.9%. The panic was immediate as people run to withdraw their money fearing to lose a big part of a lifetime savings. ATMs withdraws were limited to a certain amount and a bank holiday was declared, as national and supranational entities are accused of robbery.
But is this alarmism and insurgence justified? Are people overreacting? Well, one could risk saying that people’s reaction was not totally unpredictable. If we take a look over the tax system in Cyprus we easily become aware that it remained unchanged since 2004 (the entrance of Cyprus in the EU), so people became used to its stability. Moreover, it encompasses a highly attractive system: the corporate tax rate is the lowest in the EU (10%), there is no withholding of dividends or interest paid to non-residents, plus a whole set of exemptions, and the progressive taxation on income varies from 20% to 35% according to the table below.
For these reasons, Cypriot banks became the destination not only of Cypriots’ funds but also those of other European citizens (not to mention the Russian oligarchs) looking for a stable environment to deposit their money, particularly the Britons. These have around £1.7 billion deposited in Cypriot accounts and risk losing £170 million with the bailout agreement.
Indeed, the rescue took many by surprise and came to alter significantly the perception people have on the country’s tax system and its financial and economic stability. Furthermore, under the Troika’s tight rules, austerity measures are likely to follow and what the world is waiting to see is how a country with an average annual growth of GDP per capita of about 1.31% and where gross savings represent 18.76% of the gross national income, will respond to the slump.
OECD evidence suggests that economic growth is a function of a country’s tax policy and one of the most harmful taxes is the personal income tax. Therefore, some things can be anticipated for the Cyprus case: increasing personal income taxes will likely reduce the incentives to work, and if capital controls are relaxed the money will flow out of the country. In accordance, Paul Krugman wrote he “wouldn’t be surprised to see a 20 percent fall in real GDP”.