The measure, which required a two-thirds supermajority of the European Parliament to pass, declared there was a "clear risk of serious breach" of European values by Hungarian Prime Minister Viktor Orban.
A breach of EU values justifies a reaction at EU level and this is what the procedure under Article 7 of the Treaty on European Union aims to achieve.
The vote takes the first steps under Article Seven of the EU Treaty, known by some in Brussels as the "nuclear option", which could ultimately strip Hungary of its EU voting rights.
Poland has said it would veto any possible sanctions on Hungary.
It was the first move of its kind in the European Union against a member state, garnering two-thirds of the votes.
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Mr. Orban's government introduced a law that criminalised representation of asylum seekers by lawyers and activists with accusations of silencing independent media and curtailing academic freedom also been levelled against him.
Dutch Greens MEP Judith Sargentini, who spearheaded the vote, smiled broadly and breathed a sigh of relief before embracing her supporters in parliament in the French city of Strasbourg. "The European Parliament rightly stood up for the Hungarian people and for the EU".
However, Hungary has other supporters within the EU.
On Tuesday Weber said the European Union might need to consider launching the sanctions procedure, under Article 7.1 of the bloc's Lisbon Treaty, if Budapest did not address the criticisms.
The European Commission initiated similar proceedings against Warsaw in December and three months later the Hungarian parliament adopted a resolution supporting Warsaw in its fight against the bloc, saying the commission does not have "the right to meddle" in the domestic affairs of member states and that it was "unjustified" in initiating Article 7 proceedings.
Hungarian Foreign Minister Peter Szijjarto, echoing Orban's longtime position, called the Wednesday's vote "petty revenge" against Hungary for its tough anti-migration policies.
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His typically feisty performance before EU lawmakers has boosted Orban's standing among nationalists at home and also among anti-immigrant parties that are expected to increae their presence in the next European Parliament (EP).
The vote represents a particular challenge for EPP's German head Manfred Weber since he announced his bid for the presidency of the EU's executive Commission next year.
Critics say Hungary's electoral system favors the governing parties; media freedoms and judicial independence are dwindling; corruption and the enrichment of Orban allies with European Union and state funds are on the rise; asylum seekers and refugees are mistreated; and there are efforts to limit the activities of nongovernmental organizations. "They made it clear that human rights, the rule of law and democratic values are not up for negotiation", she said.
"We believe that there can be no compromises on the rule of law and democracy", Kurz told ORF television.
"The European Parliament rightly stood up for the Hungarian people and for the EU".
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