A new leftist bloc has now voted 123 to 107 against the administration`s programme, prompting its collapse.
The move could lead to a new government led by the Socialist Party, likely to focus on alleviating austerity.
Portugal`s left alliance flexes musclese
The Socialists came second in the elections but have since forged agreements with the Left Bloc and the Communist Party, making an alternative coalition possible.
Portugal`s President Anibal Cavaco Silva must decide either to ask the Socialists to form a new government, or to allow the incumbents to stay in charge until new elections are held.
Speaking during the debate in parliament, Socialist leader Antonio Costa said his proposed coalition would "guarantee conditions of stable governance".
Pro- and anti-government supporters rallied outside parliament as the vote happened.
Portugal was one of the countries hardest hit by the crisis in the eurozone, accepting an international bailout in exchange for sweeping cuts.
The current government has warned that the left-wing coalition risks turning Portugal into another Greece.
