Home » Portugal -the State grows, the economy languishes

Portugal -the State grows, the economy languishes


Portugal is the third EU country after Greece and Ireland to need financial bail-out in order to avoid bankruptcy of the State. How did things go so wrong and for what reason – is it only the fault of the international financial crisis, or – more probably – bad management of public finances from the Potuguese government? Ricardo Campelo de Magalhães answers those questions in the light of a detailed analysis of Portuguese fiscal policy.

Tax Policy strategy

Despite the economic crisis, Portuguese state is trying to maintain its revenue. For that purpose, a major fiscal shock is inflicted to taxpayers: all major taxes went up in 2010, are raised in 2011 and it is foreseeable that the same will occur in the near future. If some measures were taken to reduce the deficit on the expenditure side, the mantra remains that “we are the state, so we all need to unite to help the state”, that is, both taxpayers and civil servants.

The following is the account of the main changes in the main taxes for 2010 and its effects in 2011.

Income Tax

The State Budget for 2011 brought a whole new array of measures to increase taxes, despite the severe reduction of the tax base, both from unemployment – at a record level of 11% – and from a reduction in per capita income – according to IMF, 11.75% down from the 2008 maximum and 4.27% down from 2009 (in current USD prices).

As part of the Stability and Growth Program passed in May 2010, a new maximum bracket applicable to taxable income exceeding €150,000 was introduced, with a tax rate of 46.5%. Also, for the brackets bellow €17,979 the rate was increased 1 percentage point and for the other brackets, 1.5%.

After the tax hikes in mid-year (that went into effect immediately, in what some rightly considered an attack on the Principle of Certainty), several other measures were taken to further increase tax revenue. Deductions (on education, healthcare and housing) were intended to be severely restricted, but during negotiations to approve the budget it was agreed that those restrictions would only be imposed on the two top brackets, lowering significantly their effect on the deficit. On the other hand, fiscal benefits are now limited (to €100 or bellow), except for the two lower brackets.

Independent Workers were also affected and pay now a single rate of 29.6% (from sector rates of 24.6%, 28.3% and 32%). Also, if a single company represents more than 80% of the independent worker income, the client company owes an extra 5% in taxes. Finally, losses from independent workers and rental income can only be deducted within the 4 following years.

Socrates was Guterres’ environment minister and for some years environmental items received special tax treatment. However, with this budget, this no longer holds. Biodiesel (6.75% of diesel) is no more exempt, leading to a 2.5 cents increase in diesel price from this tax (for a 4.5 cents total, together with the VAT raise). Also the 30% deduction one could make with renewal energy equipments is now substituted by fiscal benefits (which, as mentioned before, are limited to all but for the two lower brackets, that people making less than €7,250 per year – not big consumers of those equipments). Please also note that these benefits can only be used once every four years.

Socialist governments were always very keen on culture. However, in another effort to raise income, literary, artistic or scientific prizes that were previously excluded from taxes are now only exempt if they do not surpass 10 times the minimum wage (€ 4,850). Also, subsidies to high-performing athletes and cash prizes for sport results that were previously excluded from taxes are now only exempt if they do not surpass 10 times the minimum wage.

Judges admitted to go on strike for the first time in Portuguese democracy. Suffering from several pension cuts (detailed in the budgetary chapter, under the budget cuts title), and suffering from the 10% wage cut and from the new top bracket rate (with taxes up from 42% to 46.5% in one year), they are also the most affected by the end of the tax exemption on housing subsidies, which in practice almost halves them.

Numerous other changes include dependants who had undergone civic or military service not being anymore considered as dependants for tax purposes, the obligation to state the fiscal number of the dependants and, most significantly, the end of banking secrecy.

In the Anti-corruption package, the government had already authorize itself to access accounts whenever there were debts to Social Security. With the Decree 70/2010, anyone who receives social benefits like the Family Subsidy, the Unemployment Social Benefit, or the Social Inclusion Subsidy must first “voluntarily, specifically and unequivocally” allow access to any fiscal or bank information. Finally, with the budget, even the smallest tax debt authorizes the administration to access the accounts – both balances and transactions – of those taxpayers present in a newly created account database at the Central Bank. Many legal advisors consider it a violation of the Constitutional Principle of the “Private Intimacy Reserve” (Article 26), but few obstacles remain to the complete end of any banking secrecy in Portugal.

Corporate Income Tax

As part of the Stability and Growth Program passed in May 2010, the rate applicable to taxable profits over € 2 million was increased by 2.5%. Hence profit below € 2 million are taxed at the normal rate of 25% and the part exceeding € 2million at 27.5 %.

After several months of discussions about the “sovereign crisis”, the state budget introduced several further tweaks to “make the rich pay”.

Holding companies lose their fiscal exemption on the profits of their subsidiaries, except if they own more than 10% of the capital and the income had already been subject to taxes.

The banking sector paid a very low effective tax rate: in 2009 it was 4.3% of the profits and 18% of the taxable profits, well below the normal 25% + 1.5% of municipal surtax; the difference between the two effective rates being the deduction of losses of owned companies and the use of several fiscal benefits. Both of those numbers are frequently used in parliament to attack the banking sector, especially in a year the state is spending billions to try to keep BPP and BPN afloat. Thus, special contributions were created to further penalize the banking sector: 0.01% to 0.05% on passive minus equity and 0.0001% to 0.0002% on off-balance derivatives. Details are not known, as its implementation is to be defined within a specific law, still not published at the moment of the printing of this yearbook (and yes, it will have retroactive effects on 2011 taxes).

In last year’s budget (2010), after the closing of IREF’s yearbook, bonus got an autonomous tax. The rate is 35% for general companies and 50% for banks, if the bonus represents more than 25% of the person yearly income and its value is above €27,500.

Regarding fiscal and banking secrecy, the fiscal administration not only may access any account as is the case with the Personal Income Tax, but furthermore banks are mandated to communicate any debit or credit movements on those accounts every July, without any request.

For owners of medium or small companies, the legal spread they can fiscally deduct from lending to their own companies was raised from 1.5 to 6 percentage points (on top of the 12-month Euribor). This is a major way to avoid corporate income tax for those companies, but it is also a powerful tool for the state to find “wealth manifestations” and therefore expand the tax base.

Last but not least, benefits received could not exceed 40% of the owed taxes in 2009; this ceiling was cut to 25% in 2010 and is now set at 10%.

Value-Added Tax

As forecasted in the previous yearbook, the rate of this tax went up during 2010. When 2010 started, the rates were 5% on the “first need” goods bracket, 12% on the intermediary bracket and 20% on the “normal” bracket. On July 1st, the rates were increased to 6%, 13% and 21%, a measure included in the Stability and Growth Program passed in May 2010. In 2011, the government will not wait for July: as of January 1st, the rates increased again, this time to 6%, 13% and 23%.

Many products were to be “upgraded” from lower brackets to the “normal” bracket, but budget negotiations in parliament combined with pressure from some conglomerates forced the government to apply the change only on gymnasiums, fire related products, and flowers. During 2010, the VAT on car tax was finally abolished, but the car tax itself was raised accordingly, rendering the change neutral. Several basic services, like energy and transportation, increased 3.5% to 4.5% in January, due to the VAT increase and the inflation expectations.

Private Solidarity Societies (mostly Christians) will no longer be able to deduct the VAT they pay on several goods and services, like construction and car purchases. The same applies to all religious confessions, except the Catholic Church (as that would imply a violation of the Concordata with the Vatican).

Other factor to consider is the difference between the new Portuguese top rate and the Spanish top rate: 23% vs. 18%. This difference will put further pressure on shops near border cities and will lead shopping trips to Spain to be a stronger trend in coming months. Madeira and Azores continue to have lower VAT rates than continental Portugal.

Budgetary Policy

One of the main objectives of the Prime Minister is to avoid IMF intervention at all costs. For that, he raised taxes, cut spending, raised extraordinary revenues and sold Portuguese state debt directly to Brazil, Venezuela, East Timor and China. The opposition claims it is because he cannot accept IMF’s scrutiny, both related to his numerous “boys” and to some judicial matters, while the Prime Minister claims it is a matter of national pride and of “Portugal being able to rule itself”. In response, the opposition demanded elections when the IMF intervenes. As of the printing of this yearbook, the intervention has not been made, but it is seen as inevitable.

After being elected, in November 2009, Portuguese Prime Minister Socrates stated “the main concerns of government’s economic policy are economic recovery and employment, which is not compatible with a tax increase”. In February 2010 he added: “we will do a fiscal consolidation based on budget cuts and not on tax increases, because that would be negative for Portuguese economy”. In April he assured there would not be a VAT increase and that a €6,000 million new Lisbon airport, a €2,000 million third Lisbon bridge and a €7,700 million TGV railway system would stimulate the economy. In June he rejected a wage cut for the state employees. In September the government still planned a railway system with a price tag of €2,765 million.

Main Receipt Increases

As described in the Fiscal Policy, and contrary to what the Prime Minster had promised, both Income Taxes and the VAT increased. But the government for 2010 and 2011 implemented many other increases.

Most increases were in the health care sector. To give a bit of a perspective, when one uses health care services in Portugal, one must pay a fee: not the real cost, but a fraction, to control over-consumption. Those fees rose across the board. For example, vaccines to go to tropical countries were 15 cents. They are priced at €100 now. And not only they are higher, now they are paid by more people: unemployed, pensioners and those transported with urgency must now also pay the bill, if their income is above the minimum wage (currently at €485). In practice, that implies that a person transported in an ambulance needs not only a clinical note, but also a proof of “economic insufficiency”. Finally, doctors whose service to the state was smaller than the duration of their specialization studies must now pay the state some compensation.

Many incomes already taxed under Personal Income Tax but exempt from Social Security contributions will now cease to be exempt. Also, when hiring someone, companies must now transmit the information to the Social security at least 24 hours before the contract is signed (24 hours after in special conditions) to make sure the Social Security will stop paying the benefits related to unemployment.

All kind of fees increased. For example, the fee paid to “unblock” your car after being taken by the police increased from 50% to 100%. Judicial fees were also raised considerably across the board. A last example would be toll free highways. Before October, the state paid an amount per vehicle to the private owners of the highways, with the users paying nothing. Now, the state pays a fixed amount and charges a toll to the users. As a result, the private owners (whose executive president was also Guterres’ minister, like the current prime minister) receive more – risk free -, users in less developed areas pay tolls, and the state loses more than it was losing before, due to the (expected?) decrease in users and the remaining fix payment to the private company.

Main Budget Cuts

Some measures implemented in mid-2010 will be maintained. These include a cut in some benefits and ability to hold more than one job, admissions restrictions to civil servant jobs, non-renewal of workers under contract and a 25% cut in family subsidy in the lower brackets, while eliminating it on the top Personal Income Tax brackets.

According to the 2011 state budget, some cuts will be considerably expanded, while many were implemented to fulfil the deficit reduction target. The most surprising extension was the admission freeze, according to which now any public administration that needs a new employee will have to recruit internally within the state employees.

From the new measures, the most surprising was the wage cut. All state employees who receive more than €1500 per month will be subject to a wage cut, from 3.5% to 10%, accompanied by a reduction in benefits, overtime and night compensations and summer and Christmas subsidies. Career progressions will be frozen, while prizes for performance will not be granted.

Table 1: Detail of wage cuts (averaging 15%)

Levels of wage per month Percentage cut
€1500 to €2000 3.5%
€2000 to €2500 3.5% to 6%
€2500 to €4200 6% to 10%
above €4200 10%

On the Azores islands, governed by a powerful Socialist that may succeed Socrates in the party leadership, a special subsidy was given to state employees in the 1500 to 2000 bracket. Seen as a slap in the face of the prime minister, the expense passed despite doubts on constitutional grounds (equality!).

In January unions entered with several (at least 14) injunctions to stop the wage cuts. The cuts were classified as unconstitutional on the grounds that the private sector is not cutting accordingly (equality). Government answered with “un-postponable public interest”, a move the unions considered as the final proof of the illegality and unconstitutionality of the decision. It is now to the courts to decide whether state employees can have their salary cut or not throughout 2011. Communists and Leftists presented the issue to the Constitutional Court.

Pensions (including the lowest, at €246 per month, received by more than 400 000 persons) will be frozen. All pensions above € 1,607 were affected by the reduction in deductions to Personal Income Tax, while the ones that exceed € 5,000 were also subjected to a new contribution of 10% on the “surplus”. Also, one will no longer be able to receive both a pension and a state-paid wage. People receiving the “Social Inclusion Subsidy” will experience a 20% cut. Not only the social benefits will lose purchase power (if not nominal value), they will also be granted to fewer beneficiaries, as the state now requires further information on financial resources and general assets and crosses information to decide to whom social and school support shall be given.

Health Care Services cut 5% in the budget of their cabinets and hospitals also reduced the size of their boards, from 5 to 4. Furthermore, medicine support decreased across the board. This decrease is total if the medicines are not subject to medical prescription, if they were receipted in a non-electronic format, or if the beneficiary is caught abusing the benefit (in this case, just for 2 years). The diagnostic examinations will also be limited, but the details of such limitations are only to be known later, especially what is meant by examination “without benefit to the patient”. The most important health-related measure however is the possibility open to state employees to opt-out the state health-care insurance, ADSE, which is also likely to reduce its benefits during 2011.

Education services cut 17% of its central services budget and 20% of their managers. Adjunct directors were also cut and most wage supplement cuts (from € 600 to € 750 it went to € 200 to € 750). Teachers no longer receive extras for night work after 20 o’clock, but after 22, like other state employees. The high school curriculum no more includes “Project Subject”, and “Accompanied Study” was reduced to the students who need it most (to compensate, the government decided that students will not be failed during mandatory education). Also, private schools now receive 30% less funds (as all households pay taxes, whether their kids go to private or public school, all have the right to education, therefore the state pays many private schools a subsidy per student). The plan to close state-run schools in rural areas (known as “grouping”) will continue and an undisclosed reduction in the number of teachers is also included (Portugal is 3rd in number of teachers per thousand students, only behind Lithuania and Greece). Regarding higher education, 4000 students will lose their scholarship.

Madeira and Azores will experience a transfer cut. The PIDDAC program will suffer a cut equivalent to 0.2% of GDP. Police cars cannot go on patrol longer than 80 kilometres from their police stations (in Braganza; distances seem to differ according to districts). 50 of the 13 740 “Public Institutes” will also be cut (though it was pointed that many were already non-existent!).

Main Extraordinary Measures

With bond rates growing to unbearable levels, the main focus on the short run was to convince old political allies to buy directly Portuguese debt. Socrates started with Brazilian President Lula da Silva, continued with oil-rich East Timor, finished 2010 with the rulers of Portuguese former colony of Macau, China and started 2011 with a trip to Qatar. Numbers were not made public, but are certainly in the billions.

Angola also agreed to pay most of its debts to Portuguese companies in July, at the time valued at € 2,000 million. Venezuela also agreed to help buying computers and using Portuguese shipyards in October, an agreement estimated at € 1,500 million. Venezuela had already agreed to buy 2500 mass-produced houses, an agreement valued at € 685 million. The first Libyan Portuguese Expo in February, ongoing agreements with Petrobras (Brazil), Sonangol (Angola) and ENI (Italy) and several other agreements are key to supply Portugal with oil for years to come. Finally, Portuguese “Cash for Clunkers” ended in December 2010, leading to lower state expenses and less expected car sales for 2011 (with this distortion, in 2010 were sold 38.8% more cars than in 2009).

On 30 December 2010 was published the decree by which the pension fund of Portugal Telecom – the previously state-owned telecommunication operator – was transferred to the state, along with € 2,700 million (a fund whose deficit increased from 59 to 1,530 million during 2009). Privatizations were referred on the SGP, and they will include 17 companies, including the mail service and the recently bailed out BPN (although no bidder was found for the latter in a first attempt). For the years 2010 to 2013, the expected incomes are respectively 1200, 1870, 1580 and 1350 million Euros – in a total of € 6 billion, almost enough to pay 2011 government-estimated interest on “public” debt.

Several infrastructure projects were postponed, including Oporto’s underground second phase (marked at 1200 Million). Also postponed was the bill on the bailout of BPN, marked at € 5,500 million. Early in 2011, the state has injected € 500 million, but most of the debt will be passed to societies created for that purpose and its cost to future budgets. With all the previously described effort to cut the deficit by € 4,500 million in 2011, it would be political suicide to reveal the true cost of the bailout at once, like Ireland did.

To convince the people something is being done, the government agreed to the creation of 2 new Commissions: the Public Finance Council and the Technical Commission for the Private-Public Partnerships. Their precise roles and composition are still to be defined by a government decree, although they were the outcome of a negociation with the main opposition party during the budget negotiations. From what was made public, the stated purpose of the first is to comment on budget and macroeconomic scenarios put forward by political parties, while the second must comment on the Private-Public Partnerships. These partnerships are an instrument used by the last governments to build very expensive infrastructure investments (like hospitals and toll free highways) while postponing the cost for future decades, evaluated by a former Portuguese Court of Auditors judge as € 50 billion, or 2/3 of the total state receipts last year.

Another promise to appease concerns regarding the debt is a ceiling on debt growth. From 2010 to 2013, the debt growth of the non-financial state-owned companies cannot be higher than 7%, 6%, 5% and 4% respectively. But after seeing what happened to the agreement to raise the minimum pension or the minimum wage (the state postponed its promise arguing “force majeure”), and the 2010 track record (according to 2011 budget, 6 of 19 companies saw their debt growing between 7.4% to 798.6%), and considering the lack of sanctions, one must doubt its usefulness.

The state continues to use off-budget institutes to minimize its deficit.

Final Remarks

Political parties can now register fines on them or their leaders as expenses. This way, as with any expenses, they are paid back by the state to the parties as subventions.

Portuguese Court of Auditors in a recent December 2010 official report on 2009 State Accounting stated that it “violated the principles and budget rules of ‘annuality’, unity and universality”, accusing the government of accounting juggling and creativity. Such bold words are not usually used to characterize the behaviour of the one that nominates the president of that institution, namely the Prime Minister.

Portuguese stock index ended the year 2010 with a lost near € 6,300 million (almost 10%), despite the 7.3% of GDP deficit that, according to the government, was to stimulate the economy.

According to the budget, the country still spends more on education than in interest on the “public” debt (6541 vs 6326 million Euro), but it already spends more on the “public” debt than in Defense, Security (Police) and Justice combined (6326 vs 5678 million Euro). And, in January 2011, the country paid on short-term (6-month) debt 6 times what it paid in January 2010 (3.686% vs 0.592%). If the ECB stop buying Portuguese debt (and it bought more than a billion in 2010), the previous mentioned value may skyrocket. In fact, after the first bond emission in 2011 the estimate of the interest on the debt to be paid in 2011 was increased to € 7,134 million. The 808 difference will absorb all the wage cuts the state is still trying to impose.

According to the organic classification, the amount available to the Finance Minister increased 20.1% from 2010 to 2011, while Work and Solidarity experienced a 12.6% decrease, Defense a 11.9% decrease, Education a 11.1% decrease, Justice a 10% decrease and Foreign Affairs a 9.6% decrease.

Combining all the 200 measures taken in 2010 by the government, the expenses will decrease from 124.05% of the receipts to 111.27%. What draconian measures will the government further impose before actually starting to pay some of the mounting debt? When will the government wake up from the Utopian dream of the perfect Social State to the reality of a possible Social Model? The two last elected Prime Ministers fled (Guterres to United Nations High Commissioner for Refugees and President of the Socialist International, Barroso to the Presidency of the European Commission), but the policies remained basically the same. One can only hope things will be different when Socrates decides to do the same.

On the short run, Horta Osório points to exports, privatizations and a more flexible labor market as solutions. Zero base budgeting, privatization of healthcare institutions, Swedish school model, Danish Labor Laws, Hong Kong’ regulatory environment, Spanish VAT levels, and Barroso’s promised fiscal shock (slashing taxes) would all be welcome, but are very unlikely.

Useful links: 1. Portuguese Investment Agency – State Agency: http://www.portugalglobal.pt

2. Portuguese Data – Independent Database https://www.pordata.pt/azap_runtime/?n=1&LanguageId=2

3. External Debt (click “Portugal”) – ECB data http://dsbb.imf.org/Pages/SDDS/ExternalDebt.aspx

4. Portuguese Society for Innovation – Private Company: http://www.spi.pt/en.index

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