Portuguese Tax Cuts and Pension Bonuses: Expert Analysis on Economic Impact and Structural Challenges

On Thursday, the Portuguese government is set to formally approve a package that includes a financial bonus for pensioners and a reduction in income tax (IRS) brackets for workers during a Council of Ministers meeting.

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Pensioners earning up to 1,611 euros will receive an extraordinary top-up of between 100 and 200 euros in December, representing a total state expenditure of 400 million euros.

The IRS income tax will be reduced up to the sixth bracket, allocating another 400 million euros. Due to the progressive tax scale, higher income brackets will also benefit. This tax adjustment is scheduled for implementation in November.

During parliamentary proceedings, Prime Minister Luís Montenegro emphasized that the IRS tax cut is specifically designed to “support the middle class.”

“Families can’t take any more”

The Portuguese centre-right AD coalition government unveiled these initiatives last week during a parliamentary debate on a motion of no confidence, which was ultimately rejected. Prior to the vote, Prime Minister Luís Montenegro defended the cabinet’s social and economic policies, highlighting recent measures aimed at mitigating the impact of soaring fuel prices.

On the day prior to the announcement, diesel prices in Portugal hit an all-time high, while petrol reached its peak since the onset of the conflict in Ukraine. The sharp increases sparked public outrage, culminating in a slow-moving protest march toward Galp’s refinery in Sines, where demonstrators carried signs reading, “families can’t take any more.”

Economist João Rodrigues dos Santos acknowledges the measures as a legitimate “give-back to those who need it most,” though he expresses strong reservations regarding their execution.

“I consider these to be budgetary policy measures that ought to be more structural in nature and formally integrated into the State Budget,” states the professor who leads the Economics and Management academic area at the European University.

“While the government certainly has good intentions, I believe this is not the most effective way to manage budgetary policy. Can public policy truly rely on annual fluctuations and the availability of surplus funds?” he questions.

Rebate mechanism

Indeed, fiscal revenues have increased. Tax lawyer Tiago Caiado Guerreiro explains that rising prices naturally lead to higher state tax collections.

“VAT revenue from fuel increases as fuel prices rise because the taxable base expands in size,” notes the tax specialist, referencing the consumption tax.

“This is simply another reimbursement mechanism, in this case through the IRS, and I completely agree with this approach,” argues Tiago Caiado Guerreiro.

“As for the pensioner bonus, while it carries political weight, it is hardly surprising given the notoriously low pension levels currently existing in Portugal,” the tax lawyer concludes.

João Rodrigues dos Santos concurs that the state has generated substantial VAT revenue from elevated fuel prices, an amount he notes could reach approximately 700 million euros according to government estimates. However, he reminds readers of the concurrent reduction in the Tax on Petroleum Products (ISP).

“It is true that this influx of revenue should be offset by cutting the ISP, specifically to ensure the state does not profit fiscally from higher fuel costs,” he clarifies.

Nonetheless, the rise in VAT revenue extends beyond fuel to encompass various other consumer goods.

“In the end, if the state benefits from increased tax intake due to inflation and higher costs for families, it is only fair that a portion of this extraordinary fiscal windfall is returned to taxpayers,” he asserts.

High taxes and many brackets

Both specialists agree that taxation levels in Portugal are excessively high.

“Any measure that aims to reduce taxes or directly increase household income is generally something I support,” states Tiago Caiado Guerreiro.

The tax lawyer emphasizes that the IRS income tax structure “is excessively burdensome in Portugal. Essentially, working individuals are heavily penalized by the current tax rates.”

On his part, João Rodrigues dos Santos champions a simplification of the IRS system.

“The system could benefit from fewer brackets and a less aggressive rate of progressivity, as the current framework is incredibly restrictive,” he argues.

And cutting VAT?

The opposition, however, is championing an alternative approach: VAT reductions. The Socialist Party (PS, centre-left) is demanding zero VAT on essential goods, while the far-right Chega party has also announced plans to submit a similar proposal.

However, Tiago Caiado Guerreiro cautions that implementing such a measure would be highly complex.

“Technically, reducing VAT is incredibly challenging because shifting it to a lower band would cause a severe drop in revenue that the government would struggle to absorb. Reducing the rate from 23% to 22% or 21%, as some reports have suggested, is simply not viable,” warns the tax lawyer, noting that future fiscal flexibility may be entirely absent.

“Considering the current international landscape and rising oil prices, European and global economies are likely to experience a slowdown. Consequently, tax revenues are unlikely to maintain a permanently upward trajectory.”

While EU member states determine their own VAT rates, they must adhere to the guidelines outlined in the EU directive on the tax (source in Portuguese).

“Any reduction in VAT, whether shifting from the maximum rate to the intermediate or minimum rate, would require explicit authorization from the European Union,” notes João Rodrigues dos Santos, highlighting that a key drawback of VAT is its lack of differentiation.

“VAT is a flat tax that impacts all citizens equally, regardless of whether they require financial assistance or not.”

Despite these hurdles, the economics professor suggests that a VAT reduction might become “inevitable” as an exceptional response to rising fuel costs, which “will inevitably ripple through the rest of the economy.”

“A broad-based VAT cut, particularly on essential items, is not an unreasonable policy. In fact, it could prove to be the most effective strategy given its comprehensive reach and the fact that the vast majority of Portuguese workers earn very low wages,” he elaborates.

“I think this will take years”

Currently, the global economic outlook remains highly uncertain. Last Thursday, the European Central Bank (ECB) in Frankfurt announced another interest rate hike. ECB President Christine Lagarde simultaneously cautioned about persistent inflationary pressures fueled by the ongoing conflict in the Middle East.

Both experts, in interviews with Euronews, shared a similarly somber outlook for the future.

“I doubt fuel prices will ever return to pre-war levels, given the immense instability across the Middle East and other global regions,” remarks Tiago Caiado Guerreiro, pointing to the war in Ukraine and maritime disruptions in the Straits of Hormuz and Bab el-Mandeb.

“We are living in a period of great instability, and I do not anticipate a rapid resolution. I never expected this conflict to conclude swiftly, and I believe it will take years to unfold,” he adds.

Indeed, the global crisis continues to persist, showing no signs of abating and instead intensifying, according to João Rodrigues dos Santos.

The European University professor believes the government is fully aware of this prolonged scenario.

“Despite holding a budget surplus exceeding 2 billion euros, the current administration has stayed firm in its strategic vision. In my view, this resilience stems from their understanding that the crisis, now in its sixth month, is a long-term reality,” he observes.

The economy is growing, but wages are low

In parliament, the Portuguese prime minister asserted that these fiscal adjustments “are only possible due to Portugal’s strong economic performance and the government’s prudent financial and budgetary management.”

Luís Montenegro further described the nation’s economic trajectory as “the best in Europe regarding overall performance and the highest in terms of job creation.” However, official Eurostat data revealed that Portugal did not rank first in GDP growth during the second quarter, settling in seventh place alongside Cyprus with an increase of 0.8%.

“I believe we are currently in a favorable phase; ranking among the top six or seven performers in the EU is unusual for us, as we typically find ourselves closer to the bottom of the list,” notes Tiago Caiado Guerreiro, highlighting the vital role of sectors like tourism.

However, the tax lawyer warns against excessive celebration.

“Compared to the overall sluggish European economy, Portugal is experiencing decent growth. Yet, the global landscape remains slow, and there is absolutely no reason for premature euphoria,” he advises.

João Rodrigues dos Santos underscores the reality of extremely low wages in the country, indicating that minor adjustments to the IRS will not resolve the core income challenges faced by local families.

“We must not overlook the fact that in Portugal, 75% of social security registrants earn wages of 1,000 euros or less,” the professor emphasizes.

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