Portugal’s tax system has been a subject of international scrutiny, ranking 29th out of 38 OECD countries in the individual tax category of the International Tax Competitiveness Index 2023. The country’s high top income tax, levied on a narrow set of earnings, is a significant factor contributing to this unfavorable rating. This tax raises revenue with a high efficiency cost, and is further complicated by complex tax credits that undermine the income tax base.
These tax credits apply to a wide range of consumption goods, leisure activities, and trade union membership fees, distorting economic behavior and increasing compliance costs. Ideally, personal tax deductions should be limited to investment costs that increase taxpayers’ taxable income or prevent them from falling into the welfare net. However, Portugal’s current system deviates from this ideal, eroding the personal income tax base.
In addition to these issues, Portugal’s tax-relief scheme for returning tax residents sets ambiguous incentives for emigration and return. The scheme excludes 50 percent of employment income from income tax for Portuguese emigrants in the first five years after their return. While this may incentivize return, it also fuels expectations of future benefits, potentially encouraging out-migration.
Portugal’s personal income tax system also levies high tax rates on an unusually narrow set of high earners. The country’s top income tax rate is 53 percent, inclusive of the 5 percent solidarity tax rate. This rate increases to 58.2 percent when employee social contributions are included, making it the third-highest in the OECD.
Furthermore, Portugal’s top income tax rate applies at an unusually high threshold of EUR 250,000 in annual income, 13 times the average wage in 2022. This approach is inefficient for raising government revenue, as it incentivizes high earners to earn less while leaving the revenue raised from everyone else unchanged.
To improve its tax system, Portugal could attract talent and improve earnings incentives by setting a ceiling for social contributions and reducing income tax rates more broadly. Closing the value-added tax (VAT) gap and eliminating special tax credits could also provide room to reduce the tax burden on labor or pursue alternative reforms that would increase labor productivity and real wages.
In the long term, reducing government spending and the total tax burden on labor could positively influence residents’ locations. Another option would be to boost labor productivity and gross wages in Portugal by attracting investment through corporate tax reform and making it easier for residents to relocate to better jobs.
For more detailed analysis of Portugal’s tax system and potential reform options, you can download the Portuguese-language primer from the Tax Foundation.