Proposal to Cap State Spending at Inflation Rate Could Halve Taxes by 2036

Between 2023 and 2026, state expenditure excluding interest, investment, and PRR funds is projected to increase by 22 billion euros, a rise of 22.6%. This growth rate is nearly double the increase in prices during the same period. The budget for 2027 forecasts an additional increase of 5.4 billion euros, or 4.5%, while inflation is expected to be 2.5%. If state spending were limited to growing only at the pace of inflation in 2027, the government would save 2.4 billion euros. These savings could theoretically reduce IRS revenue by 11.5% or IRC revenue by 25%, lowering the overall tax burden from 35.0% to 34.3% of GDP.

The proposal does not advocate for spending cuts but rather for aligning expenditure growth with price increases. This approach would maintain the planned pension increase of approximately 1.5 billion euros while freeing up an additional 1.5 billion euros for other areas. The argument notes that between 2024 and 2026, public spending grew by 25% while the economy expanded by 19%, a disparity described as the highest since 1985. Conversely, between 2015 and 2019, current expenditure as a percentage of GDP fell from 44.1% to 39.7%, demonstrating that such fiscal discipline is achievable.

Over a four-year period, or potentially eight with two mandates, the plan suggests the state could stop expanding in real terms and return the surplus to workers and investors. The proposal outlines a path to eliminate crisis-era tax rates, reducing the corporate income tax (IRC) to 15% and the maximum personal income tax (IRS) rate from 53% to 25%. By 2036, this could result in a GDP that is one-fifth larger, adding approximately 100 billion euros annually or 9,000 euros per person. The calculations indicate that even without assuming this growth, the reform is funded solely by the spending rule; however, economic expansion would ensure that lower tax rates generate equivalent revenue.

The first step involves abolishing extraordinary taxes introduced during the crisis. This includes the solidarity surcharge on high-income earners, which raises the maximum IRS rate to 53% but generates only about 50 million euros annually. Additionally, the proposal targets the state surcharge on corporate profits, which can push the effective tax rate for large companies earning over 35 million euros to 28.5%. The plan argues that these taxes discourage large enterprises, noting that Portugal has fewer large companies than the European average and that such firms offer significantly higher wages.

The second pillar is fixing the corporate tax rate at a flat 15% for all companies. This aligns with the rate already paid by small and medium-sized enterprises on their first 50,000 euros of profit and matches the global minimum for multinational groups. The transition would see the rate drop to 16% in 2027 and reach 15% in 2028, eliminating the state surcharge while retaining the municipal surcharge of up to 1.5%.

The third component is a reform of personal income tax to establish a single rate of 25% on income exceeding the annual minimum wage, which is set at 12,880 euros in 2026. While the marginal rate would be uniform, the system remains progressive because the first portion of income is exempt. The transition would occur over four years: the top rate would drop to 40% in 2028, 30% in 2029, and 25% in 2030. By 2031, a single rate would apply with the minimum wage as the exemption threshold. Due to continued savings from the spending rule, the final rate could potentially be set at 23.5%.

If this rule were extended for ten years, annual savings by 2036 could reach 6.6% of GDP, or approximately 32 billion euros. This surplus would allow for a further reduction of the single IRS rate to 15%, matching the corporate tax rate, creating a unified tax structure for both individuals and companies. The remaining margin could be used to reduce public debt or allow spending to grow in line with economic expansion.

The proposal cites evidence suggesting that reducing taxes on businesses and personal income significantly boosts economic growth. Studies indicate that a 10-point increase in the effective corporate tax rate reduces investment by 2.2 percentage points of GDP, while each point reduction attracts roughly 3% more foreign capital. Furthermore, research suggests that workers bear about half the burden of corporate taxes through lower wages. Regarding personal income tax, high marginal rates are shown to deter work effort and risk-taking. The plan argues that a single rate would benefit Portuguese workers similarly to how special regimes currently attract foreign talent.

Estimates suggest this reform could add between 0.25 and two percentage points to annual growth. With an additional one point of growth, the country's GDP by 2036 would be 10% larger, with taxes on this new wealth covering more than half the cost of the reform. With two points of growth, the GDP would be 20% larger, making the reform self-financing. The proposal addresses concerns about aging populations and rising pension costs by suggesting that as public sector workers retire, they should not be automatically replaced in administrative roles, allowing efficiency gains to offset demographic pressures.

Sources: Observador.