Portugal's 2027-2028 Budget Crunch: Higher Taxes Coming

The Portugal Public Finance Council has issued a stark warning: the country's fiscal trajectory will hit a critical crunch point in 2027 and 2028, when spending commitments collide with European fiscal constraints. For residents, businesses, and investors, the implications could reshape everything from public services to tax policy over the next two years.

Why This Matters

• Spending squeeze ahead: Government projections show net expenditure growth capped at 1.2% in 2027 and 3.3% in 2028, but the CFP forecasts actual spending will hit 3.9% and 4.1% respectively—a gap that could force spending cuts or tax hikes.

• Defense bills exempted: Portugal secured EU approval to exclude up to 1.5% of GDP in defense spending from deficit calculations through 2028, offering limited budget relief.

• Compliance deadline missed: Portugal has failed to transpose a key EU budgetary directive due by December 31, 2025, putting the country technically in breach of European law.

• Fuel tax confusion: A €500 M disagreement between the CFP and the Finance Ministry over how to account for fuel tax reversals could determine whether Portugal's 2025 spending is within legal limits.

The "Backloaded" Budget Problem

Nazaré da Costa Cabral, president of the Conselho das Finanças Públicas (CFP), Portugal's independent fiscal watchdog, testified before the Parliamentary Budget Committee that the government's Medium-Term Structural Budget Plan (POENMP) for 2025-2028 is heavily "backloaded"—meaning it allows generous spending increases in the early years but imposes severe restrictions later.

Under the current plan, net primary expenditure can grow substantially through 2026, but must decelerate sharply to meet European Union fiscal rules. The government committed to limiting spending growth to 1.2% in 2027 and 3.3% in 2028. However, the CFP's latest projections, released April 15, show spending on track to expand 3.9% in 2027 and 4.1% in 2028 under unchanged policies—before accounting for newly announced defense investments or additional measures tied to the Recovery and Resilience Plan (PRR).

"These are two very challenging years for the government and for budget decision-makers in general," Cabral emphasized during her testimony. The gap between commitments and reality creates a fiscal tightrope: either the government must find ways to cut discretionary spending, raise taxes, or rely on accounting adjustments to stay within EU limits.

Defense Spending: A Temporary Escape Valve

Portugal has committed to raising defense spending to 2% of GDP by 2025, in line with NATO requirements. The defense budget for 2026 alone is set to increase 14.8% to nearly €3.8 billion, funding new aircraft, naval vessels, drones, cybersecurity systems, and the rehabilitation of 185 Pandur armored vehicles at a cost of €280 M.

To cushion the fiscal impact, Portugal secured a national derogation from the European Commission, allowing defense spending up to 1.5% of GDP to be excluded from deficit calculations between 2025 and 2028. The country also gained access to €5.8 billion in low-interest loans through the EU's SAFE (Security Action for Europe) program, with repayment terms extending up to 45 years and 10-year grace periods.

This flexibility provides breathing room, but it is capped and temporary. By 2029, defense expenses will fully count against Portugal's fiscal targets, adding pressure to an already constrained budget envelope.

What This Means for Residents

The looming spending squeeze could have tangible effects on daily life:

• Public investment cliff: The end of EU Recovery Plan funding means public investment will drop from 4.1% of GDP in 2026 to 2.9% in 2027, potentially delaying infrastructure projects, hospital renovations, and public transport upgrades.

• Tax policy uncertainty: With spending pressures mounting, the government may revisit tax cuts or accelerate the unwinding of fuel subsidies, which could raise prices at the pump.

• Service quality risk: If spending growth is capped below inflation and wage pressures, public services—from healthcare to education—may face staffing shortages or delayed modernization. Healthcare waiting times could lengthen if hiring freezes are implemented to control wage costs.

The CFP projects Portugal's economy will grow 1.8% in 2027, boosted by energy price stabilization and higher income tax refunds, before settling around 1.6% annually through 2030. However, the withdrawal of EU recovery funds is expected to shave 0.8 percentage points off GDP growth in 2027 due to a 20% contraction in public investment.

Despite these headwinds, Portugal is projected to maintain primary budget surpluses through 2030, which will continue reducing the public debt-to-GDP ratio.

Fuel Tax Accounting: A €500 M Dispute

One technical but consequential disagreement between the CFP and the Finance Ministry centers on how to account for the partial reversal of fuel tax cuts originally introduced in 2022 to cushion energy price spikes.

The government temporarily reduced the Imposto sobre Produtos Petrolíferos (ISP)—Portugal's fuel excise tax—and adjusted the carbon tax to ease costs for drivers. In 2025 and 2026, these measures are being gradually unwound. The Finance Ministry projects that a fuller reversal of the ISP discount will generate significant additional revenue in 2025, and counts this toward its fiscal targets.

The CFP disputes this approach, arguing that revenue projections should reflect actual cash collected, not hypothetical receipts from a full reversal that has not yet occurred. The difference amounts to roughly €500 M for 2025, enough to shift the official spending growth rate from 5.9% (as stated in the government's Annual Progress Report) to 6.4% (per the CFP's calculation).

Cabral acknowledged the Finance Ministry's rationale but insisted on a more conservative, cash-based accounting method. "We believe we should stay closer to the revenue that actually entered the treasury, not the revenue that could potentially arise if the reversal were larger or total," she explained.

EU Compliance Deadline Missed

Portugal is technically in breach of European Union law for failing to transpose Directive (EU) 2024/1265, which reformed the bloc's budgetary framework and was supposed to be incorporated into national law by December 31, 2025.

The directive requires member states to update their fiscal governance rules to align with the EU's revised economic governance structure, which entered force in April 2024. Transposing it will necessitate amending at least two major Portuguese laws: the Lei de Enquadramento Orçamental (Budget Framework Law—which governs how Portugal prepares, executes, and monitors its national budget) and the statute governing the CFP itself.

Cabral urged lawmakers to expedite the process, warning that delays undermine Portugal's credibility with European institutions and could complicate future negotiations over fiscal flexibility. "The country is currently in a situation of non-compliance," she stated plainly.

Data Access and Forecast Precision

The CFP also called for improved access to granular fiscal microdata, including detailed IRS (Imposto sobre o Rendimento das Pessoas Singulares—Portugal's personal income tax) and IVA (Value Added Tax) collection records, to refine its forecasting models. While cooperation between the watchdog and the Finance Ministry has improved, Cabral noted that gaps remain, particularly around the classification of discretionary revenue measures—decisions to raise or cut taxes that affect baseline projections.

Better data sharing would allow the CFP to produce more accurate projections and reduce the scope for disagreements over technical definitions, she argued. This is especially critical as Portugal navigates the tight fiscal corridor of 2027 and 2028, where small miscalculations could trigger Excessive Deficit Procedure (EDP) scrutiny from Brussels.

For now, the CFP emphasized that even with the discrepancies in its projections, Portugal is not at immediate risk of breaching the 3% deficit threshold that would trigger formal EU sanctions, thanks in part to the defense spending carve-out.

The Road Ahead

The next two years will test Portugal's fiscal discipline and political capacity to manage competing demands: honoring commitments to NATO and European defense, winding down pandemic-era supports, absorbing the end of EU recovery funds, and staying within strict spending limits—all while maintaining public services and economic growth.

For households and businesses, the key variables to watch are public investment trends, tax policy adjustments (especially on fuel and income taxes), and service delivery capacity in health, education, and infrastructure. The government has little room for error, and the choices made in 2027 and 2028 will shape Portugal's fiscal trajectory for the rest of the decade.