The 2026 tax reform increases disposable income and lowers income tax, but the biggest benefits are directed towards higher incomes. At the same time, the number of citizens paying income tax is reduced, the redistributive operation of the tax system is slightly reduced and a significant fiscal cost is created. This, among others, is recorded in the working paper on "Assessing the Distributional and Fiscal Impacts of Cyprus's Personal Income Tax Reform" by Aris Avgoustis, Charalambos Michael and Georgiana Fotiadou, which was published in the working essay series of the Central Bank of Cyprus.
The study explains that, although tax policy is the responsibility of the government and not the central bank, changes in taxation affect the economy through the change in household disposable income. When different social groups earn more income, the way they consume, save, or repay their loans changes. These changes affect demand in the economy, the transmission of monetary policy and, in some cases, financial stability, in particular when linked to the level of private debt. The analysis concludes that, despite the overall increase in disposable income, the reform serves to a limited extent the declared goal of a fairer distribution of national income, as the lower income groups reap few benefits.
The study was based on microsimulations of the European EUROMOD model, using confidential data from the EU-SILC surveys and the Household Budget Survey. Three main interventions were examined: the reform of tax brackets, the introduction of income tax exemptions for dependent children and students, as well as the tax deduction for mortgage interest or rent of the first residence. The tax deduction for "green" investments was not included, due to a lack of reliable data.
The study estimates that the total fiscal cost of the measures analyzed amounts to about €240 millions per year, an amount that is very close to the official government forecasts. Although the costs are considered manageable under the current conditions of budget surpluses, the authors point out that any tax relief also entails an opportunity cost. In other words, the same resources could have been used for other public policies, such as investments in education, innovation, infrastructure or the strengthening of social protection. The study does not attempt to estimate the overall macroeconomic impact of the reform. However, under certain assumptions, it estimates that the increase in disposable income will lead to an increase in private consumption, resulting in a small increase in revenues from VAT and other consumption taxes. The overall impact on GDP is estimated to be positive but limited, as a large part of private consumption concerns imported products, reducing the multiplier impact on the Cypriot economy. One of the most important findings concerns the composition of taxpayers. Based on data from the Tax Department for 2022, 43% of taxpayers declared taxable income below the then tax-free limit of €19,500. Simply put, almost one in two taxpayers did not already pay income tax and therefore the increase of the tax-free allowance to €22,000 does not substantially change their tax burden. This explains why the lower income strata show almost zero direct benefits from the reform.
In addition to evaluating the reform, the study opens the debate on how to utilize the fiscal space created by continuous government surpluses. The authors argue that part of the available resources could be directed to productive public investment, improving public services, and supporting the green and digital transitions, enhancing the country's long-term growth prospects. The study also points out that the new tax credits, which are based on total family income, are changing the philosophy of the tax system. Although the targeting of beneficiaries is improving, the process becomes more complex, as a check of the total family income and the relevant supporting documents is required. According to the international literature, similar results can often be achieved with greater transparency through direct social transfers, which are considered easier to manage and more effective in supporting households in real need.
Another result of the reform is that the number of citizens who will pay income tax is limited. Simulations show that taxpayers with a positive tax liability are reduced by about 22%. This development narrows the tax base and may further increase the dependence of state revenues on a relatively small percentage of high-income taxpayers. Based on 2024 incomes, taxpayers with an obligation to pay income tax are reduced from 245,199 to 190,631. This is a decrease of 54,568 persons or 22.3%, while as pointed out with the adjustment to the incomes projected for 2026, the corresponding decrease is estimated at 21.6%. A central element of the reform is the restructuring of the tax brackets.
The tax-free allowance is increased from €19,500 to €22,000, while all the limits of tax rates are moved upwards. The most important intervention concerns the fourth tax bracket, which is expanded from the range of €36,301–€60,000 to the range of €42,001–€72,000. The original government proposal provided for an even greater expansion, up to €80,000, however during the debate in Parliament the range was limited. Despite this change, the authors estimate that an even smaller expansion of this bracket would limit tax breaks for high incomes and significantly reduce fiscal costs.
On the other hand, higher incomes benefit significantly more. The average annual increase in disposable income amounts to only €5 for the lowest income decimal, while it reaches €1,057 for the highest. Even as a percentage of disposable income, the largest increases are found in the upper strata. The ninth income decile shows an average increase of 2.9%, while in the highest decile the corresponding increase is 2%. On the contrary, households that are approximately in the middle of the income distribution receive comparatively smaller reliefs.
