Cyprus tax reform favours higher earners

The latest tax reform is expected to deliver the biggest gains to wealthier householdsThe Central Bank of Cyprus (CBC) has found that Cyprus’s 2026 personal income tax reform will deliver its largest financial gains to upper-middle-income and high-income households, according to a recently published working paper. The paper, titled Assessing the Distributional and Fiscal Impacts of Cyprus’s Personal Income Tax Reform, was prepared by Aris Avgousti, Charalambos Michael and Georgiana Photiadou and examined how changes to personal income taxation could affect households, public finances and broader economic dynamics. The study found that while the reform will increase average disposable incomes and reduce personal income tax liabilities, the benefits will be unevenly distributed across income groups. The analysis estimated that the reform measures examined would carry an annual fiscal cost of around €240 million, broadly in line with official projections. The working paper said major tax reforms can redistribute disposable income among households with different consumption patterns, saving behaviour and financial positions, making their effects relevant from a central bank perspective. Although tax policy falls outside the CBC’s responsibilities, the paper said understanding how income is redistributed can help assess possible effects on monetary policy transmission and financial stability. The researchers said tax changes can influence how households respond to economic conditions through different channels, including cash flow effects, asset prices and borrowing pressures. The study used EUROMOD tax-benefit microsimulations combined with confidential household microdata from the EU Statistics on Income and Living Conditions survey and the Household Budget Survey. The analysis focused on three main elements of the reform, namely changes to income tax brackets, a new income-dependent tax allowance for dependent children and university students, and an income-dependent allowance for mortgage interest or rental expenses linked to primary residences. The paper excluded the tax incentive for green capital expenditure because of data limitations. The findings showed that a significant proportion of taxpayers would receive little or no direct benefit from the reform because their taxable income was already below the previous tax-free threshold. In 2022, 43 per cent of taxpayers reported taxable income below the pre-reform threshold of €19,500, meaning many lower-income households were unlikely to gain substantially from changes to tax brackets. The simulations showed that gains among the lowest income groups were minimal, with the bottom decile receiving average estimated gains of just €5 per year. By comparison, households in the top income decile were estimated to gain an average of €1,057 annually. The largest benefits were concentrated among upper-middle-income and high-income households, while lower-middle-income and mid-middle-income groups, broadly covering households between the third and seventh deciles of equivalised disposable income, received more modest gains. The researchers found that gains as a share of disposable income increased across most of the income distribution, reaching a peak among households in the ninth decile at 2.9 per cent. The top income decile recorded a slightly lower proportional gain of 2 per cent. The reform is also expected to reduce the number of taxpayers with positive personal income tax liabilities by around 22 per cent, narrowing the direct tax base. Overall, the paper concluded that the reform would slightly weaken redistribution, although social welfare indicators would improve because average disposable incomes would rise. From a public finance perspective, the CBC paper said the €240 million annual cost of the measures appeared manageable given Cyprus’s current fiscal position. However, it warned that the chosen structure of the reform involved an opportunity cost, as alternative approaches could have directed more resources towards other policy priorities. The study examined hypothetical scenarios involving a narrower expansion of the upper tax brackets, finding that such alternatives could have reduced gains among higher earners and lowered the overall fiscal cost. The paper said this could have preserved additional fiscal space for areas such as social cohesion measures and productivity-enhancing public investment. The researchers said the reform could support private consumption and generate modest increases in consumption tax revenues, resulting in a positive but limited effect on gross domestic product. However, they added that the impact would likely remain limited because Cyprus has a high import content in private consumption. The paper also placed the tax reform within the wider debate over how Cyprus should use its fiscal resources during a period of sustained budget surpluses. It said additional fiscal capacity could be directed towards investment that improves productivity and strengthens public services, while ensuring spending remains aligned with the green and digital transition. The study concluded that while the reform reduces personal income tax liabilities and raises average disposable income, it appears only weakly aligned with the objective of achieving a fairer distribution of national income. “Achieving meaningful distributional improvements would likely require strengthening the social safety net and deploying more targeted fiscal support,” the researchers said. The paper added that society would still be better off overall because of higher average disposable incomes and the reduction in personal income tax burdens. The CBC researchers said the distributional impact of significant tax reforms was also important for understanding how monetary policy works through different households. “By reallocating disposable income across households with different marginal propensities to consume, different savings behaviour and different exposure to interest rate movements, the reform may influence the strength and composition of monetary policy transmission,” the paper said. The study also warned that changes in household income distribution could interact with household balance sheets, borrowing levels and housing market pressures, potentially affecting financial vulnerabilities. Finally, the researchers said their assessment could provide a basis for further analysis of how the tax reform may interact with Cyprus’s wider macroeconomic and financial environment.