Federal Budget 2025-26

Cost-of-living relief at the expense of fiscal repair

From the Chief Economist

The 2025-26 Federal Budget was firmly targeted at helping households ahead of the soon-to-be-announced election, with additional tax cuts and new spending all about easing the cost of living. But this came at the cost of fiscal repair and business assistance. Some minor fiscal repairs were welcome, but not enough to prevent net debt from rising further or the structural deficit from worsening.

As with all the Albanese Government Budgets, the broad strategy has been to give back upside surprises to the bottom line. This means the overall fiscal profile is largely unchanged from that outlined in the Mid-Year Economic and Fiscal Outlook (MYEFO) in December last year, although there is some additional “off-balance sheet” spending which make the overall impact of the fiscal policy on the economy slightly more stimulatory. A $27.6 billion underlying cash deficit in the current fiscal year grows to a $42.1 billion deficit next year. The deficit is expected to improve slightly to $35.7 billion in 2026-27 and remain similar in the next two years as well.

Over the five years to 2028-29, there will be an extra $34.9 billion of additional spending or tax cuts, which has been facilitated by $36.4 billion of upward revisions due to the better than forecast economy.

The political barriers to keeping spending tight were lower in this Budget than the last three, given the inflation forecasts were right in middle of the Reserve Bank’s target band at 2.5 per cent by the June quarter. Economically though, with deficits forecast for many years, and the economy not entirely out of the inflation woods, indiscriminate cost-of-living help, such as the electricity rebates and a policy to lower the cost of PBS prescriptions, were not well enough targeted.

Personal income tax cuts and an expansion of the low-income threshold for the Medicare levy, at a cost of $17.7 billion over the three years to 2028-29, were the Budget’s centrepiece. Starting on 1 July 2026, they are mild enough and far enough away to not worry the Reserve Bank and will have the welcome impact of lowering average tax rates for workers, giving back some of bracket creep that would otherwise have eaten into households' disposable incomes. The change marginally lowered the projected tax to GDP ratio to 23.4 per cent by 2027-28, after it had been forecast at 23.5 per cent by that year in MYEFO.

Two policies developed and enacted recently by the Government have lowered spending cost growth for the National Disability Insurance Scheme and the Aged Care sector, a recognition that some areas of spending needed to be brought under control. But at the same time, there was $8.5 billion more devoted to Medicare and $1.8 billion for infrastructure investment. Real growth in payments is forecast to rise by only 3 per cent in 2025-26 and 0.5 per cent in 2026-27 which implies an extremely disciplined Government in the next two financial years despite the many demands on Government.

A new policy with no cost to the Budget is the elimination of non-compete clauses for workers earning less than the high-income threshold in the Fair Work Act which is currently $175,000 per annum. This should ease the movement of employees across the workforce, a factor that should marginally assist labour productivity growth and have positive wage implications for some affected workers.

Disappointingly, there was no substantial assistance to make Australian businesses more competitive in the global economy. Nor were there tax incentives for innovative practices. On tax, the Government continues to avoid structural reform meaning a high proportion of Australia's tax revenues come from income, as opposed to consumption, which results in disincentives to earning.

We would like to have seen the Treasurer acknowledge the need for a better tax system in the current tough environment and lay out some ambitions for the next term of Government. The trade war, geopolitical strife, climate change and ageing population are all hurdles that are taking a toll on the business sector, which means pro-productivity reforms are increasingly important.

Cash balance remains in deficit, while off-balance sheet spending remains at a record high

An underlying cash deficit of $27.6 billion (or 1.0 per cent of GDP) is estimated for 2024-25, a further $656 million deterioration from the MYEFO released in December. This follows a $15.8 billion surplus in 2023-24.

The underlying cash deficit is expected to be at its worst at $42.1 billion in 2025-26 (or 1.5 per cent of GDP). This was a $4.8 billion improvement compared to MYEFO mainly due to a stronger-than-forecast economic outlook.

The budget deficits reduce across the forward estimates, but remains elevated at $36.9 billion in 2028-29, as economic factors are assumed to be less of a positive driver, while spending builds.

In total across the forward estimates, there was a small $1.2 billion improvement in the budget deficits compared to MYEFO.

The underlying cash balance is not telling the full expenditure story. ‘Investments in financial assets for policy purposes’ or ‘off-balance sheet’ spending remains around record high levels over coming years and in 2025-26, this is expected to add $23.1 billion to the cash deficit in net terms. This includes student loans, loans to the states and equity transactions into government businesses.

Debt continues to grow over the forecast period

Gross debt is expected to reach $940 billion or 33.7 per cent of GDP in 2024-25, which relatively unchanged compared to MYEFO. Gross debt continues to grow over the forward estimates reaching over $1.2 trillion or 36.8 per cent of GDP in 2028-29.

The persistent budget deficits are expected to drive net debt higher over the forward estimates. Net debt is projected to increase from $556 billion or 19.9 per cent of GDP in 2024-25 to $768 billion or 23.1 per cent of GDP by 2028-29.

Net interest payments are expected to rise from 0.5 per cent of GDP in 2024-25, peaking at 0.9 per cent in 2027-28. Interest payments have decreased compared to MYEFO due to lower yields and less borrowings.

Compared to MYEFO, the Government has been able to issue new debt on average at a slightly lower interest rate, with the assumed yield on 10-year government bonds revised down from 4.4 per cent to 4.3 per cent given recent movement in global yields.

Economic forecasts indicate a soft landing for the Australian economy

Real GDP estimates were unchanged across the forward estimates, apart from 2024-25, with the impact of Ex-Tropical Cyclone Alfred lowering growth by ¼ of a percentage point to 1.5 per cent. Treasury expects growth to pick up to 2.25 per cent in 2025-26 before reaching 2.75 per cent in 2027-28. This is driven by a pick-up in household consumption, dwelling investment and business investment. Public final demand, which has recently been a strong driver of growth, is expected to moderate.

These growth forecasts are close to the Reserve Bank’s, apart from 2026-27, where the Reserve Bank expects growth to reach 2.2 per cent, compared to Treasury’s 2.5 per cent.

The continued resilience of the Australian labour market has led to a smaller than expected rise in the unemployment rate. Treasury now forecasts the unemployment rate to peak at 4.25 per cent in 2024-25 compared to 4.5 per cent in MYEFO and remain at this level until 2028-29. This is in line with Treasury’s 4.25 per cent estimate of the Non-Accelerating Inflation Rate of Unemployment (NAIRU) and low by historical standards.

The Consumer Price Index (CPI) forecast was revised down by ¼ of a percentage point in 2024-25 compared to MYEFO to 2.5 per cent given headline inflation was lower than expected in the December quarter at 2.4 per cent. This is close to the Reserve Bank’s forecast of 2.4 per cent by June 2025. The Government points out that electricity rebates from both the Commonwealth and state governments, along with the additional indexation of Commonwealth Rent Assistance reduced headline inflation by ¾ of a percentage point through the year to the December quarter of 2024.

However, the CPI forecast in 2025-26 was revised up by ¼ of a percentage point to 3 per cent as the impact of the energy rebates fall away. This is lower than the Reserve Bank’s forecast of 3.2 per cent by June 2026. Inflation then remains sustainably within the Reserve Bank’s target band from 2026-27 onwards.

Wages forecasts remain relatively unchanged across the forward estimates, with a small upward revision to the Wage Price Index (WPI) compared to MYEFO of a ¼ percentage point in 2025-26 to 3.25 per cent. Given the near-term outlook for inflation, Treasury expects real wages to grow ½ per cent in 2024-25 - a ¼ of a percentage point higher than at MYEFO.

Population growth has been revised slightly higher this financial year, which is now expected to be 1.6 per cent compared to 1.5 per cent expected in the 2024-25 Budget. The upward revision stems from stronger net overseas migration than previously expected. Growth is forecast to be slightly lower in the following year as net migration moderates, increasing by 1.3 per cent in 2025-26 compared to 1.5 per cent in the 2024-25 Budget.

Treasury left the long run productivity assumptions unchanged at 1.2 per cent, which is below the long run average growth rate of 1.5 per cent.