Mid-Year Economic and Fiscal Outlook highlights the need for a fiscal circuit breaker 

In brief

• MYEFO shows a small improvement in the deficit of $1.3 billion in the 2024-25 year will be undone as the economic slowdown takes hold.
• There were $23.0 billion of downgrades to the underlying cash balance forecasts over the three years from 2025-26. Underpinning the deterioration over coming years is higher spending by government on everything from medicines to defence.
• Elevated inflation and interest rates, along with slower global growth, led to a downward revision to the growth estimate for 2024-25 to 1.75 per cent, from to 2 per cent at the Budget in May.
• Many of the measures included in this mid-year budget update could be categorised as fixing the problems of today, not planning for a more productive future. We need a plan to jump start productivity growth through major reforms, or we will face higher taxes and cuts to essential services in the future.   

From the Chief Economist

It has long been known that this financial year would be the one when the federal government’s finances would worsen, and in the Mid-Year Economic and Fiscal Outlook (MYEFO) we learned that the outlook is also worse. 

A small improvement in the deficit of $1.3 billion in the 2024-25 year – due mainly to the strong labour force – will be undone as the economic slowdown takes hold. There were $23.0 billion of downgrades to the underlying cash balance forecasts over the three years from 2025-26. Underpinning the deterioration over coming years is higher spending by government on everything from medicines to defence.

The frustration for Australian business is that, despite the long-held knowledge that the government’s finances are becoming more structurally unsound, nothing is being done to reverse it.

It means the government is even further away from bringing its expenses and revenue back into balance than just six months ago when the 2024-25 Budget was released. It means the projected debt burden is larger, so there’s less flexibility to fix the problems of the future. It means that rather than taking pressure off inflation, the government is leaving it all to the Reserve Bank. That equates to a higher cash rate than might otherwise be the case if the fiscal position had been tightened. 

Monetary policy can indeed do all the work to bring inflation down, but not without consequence. The third of households with mortgages – and therefore many of the business sectors’ customers – are being squeezed. Across the economy, private consumption is not growing.

Elevated inflation and interest rates, along with slower global growth led to a downward revision to the growth estimate for 2024-25 in MYEFO to 1.75 per cent, from to 2 per cent at Budget. This is more pessimistic than the Reserve Bank’s forecast of 2.3 per cent growth in 2024-25 and follows very disappointing economic figures for the September quarter. Household consumption is expected to remain more subdued than usual, with forecasts revised down in 2024-25 from 2 per cent to 1 per cent in MYEFO. This is much lower than the Reserve Bank’s forecast of 2 per cent in 2024-25 and 2.6 per cent in 2025-26. 

Inflation estimates were unchanged, sitting at 2.75 per cent in both 2024-25 and 2025-26. In contrast, the Reserve Bank estimates that headline inflation will move back above the inflation target in 2025-26 to 3.1 per cent as the electricity rebates end.

As the labour market has remained remarkably resilient, employment growth forecasts have been revised up by 1 percentage point from just 0.75 per cent in Budget to 1.75 per cent in MYEFO. Meanwhile, the expected unemployment rate has remained at 4.5 per cent in 2024-25 and 2025-26, which is just above Treasury’s Non-Accelerating Inflation Rate of Unemployment (NAIRU) assumption of 4.25 per cent, and in line with Reserve Bank forecasts. 

Net migration is expected to remain elevated, 2023-24 actual arrivals were around 50,000 higher than forecast, while there has been a significant upward revision for 2024-25 levels from 260,000 to 340,000.

The underlying cash balance, which is now expected to be $26.9 billion in 2024-25, compared to $28.3 billion at the time of the Budget in May, is not even telling the full expenditure story. That’s because ‘investments in financial assets for policy purposes’, or ‘off-balance sheet’ spending, has risen to a record high and is expected to stay close to these levels over the coming three years. This category includes equity transactions into government businesses and net loans to the states and to students. In 2024-25, these are expected to add $20.8 billion to the cash deficit in net terms.  Over the four years between 2024-25 and 2027-28, the upgraded net spending on these ‘off-balance sheet’ policies is just short of $12 billion. 

Together, this means the government will have to issue an additional $49 billion in bonds in 2027-28. And that is just the upward revision over the last six months. Total bonds on issue are expected to be $1.2 trillion by June 2028. 

Australia’s rising debt burden means the total interest expense on debt in 2027-28 is expected to be nearly $40 billion, which is close to the annual cost of funding the NDIS last year. It comes at a time when many other countries are also dealing with larger fiscal burdens and so the supply of sovereign bonds is rising globally. Demand for these bonds is not unlimited and if investor demand wanes, prices will fall, and the interest rate on the debt will rise more than currently projected.

This mid-year budget update included previously announced policies for more generous childcare subsidies, pay rises for childcare workers and slightly slower growth in aged care payments and the NDIS. There were measures to implement aspects of the Universities Accord. There was also additional spending to enable the energy transition, build infrastructure and veterans’ resources, as well as many other worthwhile causes. 

Many of these measures could be categorised as fixing the problems of today, not planning for a more productive future in a more volatile world. The latter would be the most effective way for the government to lift the prosperity of the Australian people and grow its way out of the debt burden, while giving Australia a buffer in case of future crises.   

We need a plan to jump start productivity growth through major reforms – including to tax, trade and education. The alternative is we face higher taxes and cuts to essential services in the future.  Or an even bigger interest bill for the next generation.

Ideally this would take the form of a wholesale review of the state and federal tax architecture. But at the very least, we would like to see reform of the corporate tax system to include targeted tax incentives that encourage research and development, and the commercialisation of intellectual property. 

We also need to address the burden of unnecessary and avoidable compliance costs.  Simplifying the tax system and reducing compliance costs will enable Australian businesses to focus more on growth and less on navigating complex regulatory requirements.

There are also substantial opportunities to drive productivity growth through microeconomic reform. Supply chain and trade productivity stagnation can be addressed through investments in trade modernisation and paperless trade. We note the current government’s agenda in this space and think it’s an important area for greater focus.  Particularly in light of international supply chain disruptions that have occurred, and may occur in the future, due to changes in the trade and tariff policy landscape.

And it’s not all up to government. In education, for example better outcomes for learners could come from the use of AI to develop learning so that it can be consumed in personalised manner with more flexible pathways.

Australian business needs the political debate to focus on these broad but critical issues as we approach the election.