The European Parliament has voted to pursue disciplinary proceedings against Hungary - the first time MEPs have called for such action.
EU politicians have called on member states to decide whether whether the country is at risk of breaching the EUs founding values.
The motion was backed by 448 votes to 197 - achieving the two-thirds majority that was required.
It comes amid a crackdown in Hungary by the far-right government led by Viktor Orban in areas such as immigration.
A report debated by MEPs has accused the country of various breaches of EU values.
MEPs said their key concerns surround issues such as judicial independence, freedom of expression, corruption, rights of minorities, and the situation of migrants and refugees.
Action can be taken under Article 7 of the Treaty of the European Union if four-fifths of EU member states find there is a "clear risk of a serious breach of the EU values in Hungary".
If European Council members ultimately decide to take action, Hungary could face sanctions such as the suspension of its membership rights - including voting rights in the Council.
'Stop watching from the sidelines'
Dutch MEP Judith Sargentini, who authored the report into Hungary, said: "Now it is up to the European leaders to take their responsibility and stop watching from the sidelines as the rule of law is destroyed in Hungary.
"This is unacceptable for a Union that is built on democracy, the rule of law and fundamental rights."
I am so proud that my Hungary report has the support of the European Parliament, but this is foremost about the rights of Hungarian citizens.
I thank my colleagues that stand for the protection of democracy and the rule of law, above their interest in party politics.
— Judith Sargentini (@judithineuropa) September 12, 2018
Orban yesterday defended his government's actions.

Hungary's Prime Minister Viktor Orban delivers his speech at the European Parliament. Picture by: Jean-Francois Badias/AP/Press Association Images
He told MEPs: "You think that you know the needs of the Hungarian people better than the Hungarian people themselves.
"Hungary shall continue to defend its borders, stop illegal immigration and defend its rights – against you, too, if necessary."
Yesterday, a report by a team of independent human rights experts found that new laws in Hungary are fueling "hostility, xenophobia, and discrimination" against migrants.