Rather than cutting public spending to restore the budget balance and reduce inflationary pressures, it would be better to increase taxation.

Last Tuesday the Reserve Bank (RBA) increased its cash rate by 0.25 percentage points from 3.6 per cent to 3.85 per cent. The RBA’s justification for this interest rate increase was that “inflation picked up in the second half of 2025 to be materially higher than earlier anticipated”. The RBA considers that this acceleration in inflation was in response to aggregate demand increasing faster than expected.

This interest rate increase will increase mortgage repayments for someone with a $600,000 mortgage by around $100 per month – quite an impact on their cost of living. Furthermore, the financial markets are confidently factoring in at least one more interest rate increase in the year ahead.

Not surprisingly the opposition paused their infighting for a short time to blame the government. According to Sussan Ley: “This rate rise … is the direct consequence of Labor’s addiction to spending, which has kept inflation higher for longer and left the RBA with no choice but to keep tightening”.

In fact, as the Treasurer, Jim Chalmers has pointed out, while aggregate demand is increasing too rapidly, this is mainly due to the increase in private demand, not public demand. According to the most recent budget update, the growth rate of real government spending over the seven years to 2028-29, under Labor, averages 1.7 per cent, and 2.1 per cent over the four years to 2028-29. This is significantly less than the annual average growth rate of 3.3 per cent over the past 30 years.

It is true that Australian government expenditure as a share of GDP is higher this year at 26.9 per cent than it has been, but this share is projected to fall back to 26.5 per cent by 2028-29. Furthermore, even if we ignore the exceptionally high level of government expenditure in response to the Covid pandemic, under the Coalition government expenditure averaged 25.0 per cent of GDP over the six years from 2013-14 to 2018-19 inclusive. So the share of government spending under the Coalition was not very different from under Labor.

Also, as has been widely recognised for some time, we must expect that the demands for services by an ageing society will require government expenditure to increase relative to GDP. But in addition, as well as increased aged care, many of us want an improvement in government services generally, be it childcare, education, health, and income support for the poorest people. While we also know that in a more troubled and uncertain world, we will need to increase our defence expenditure, perhaps by as much as 50 per cent.

For many of us, ensuring adequate access to these government services will be more important and do more for our well-being than the last ten per cent or more of our private expenditures.

So when Sussan Ley criticises Labor for spending too much, she should be asked where she will make savings. But she will avoid answering, because she can’t.

The previous Coalition Governments from 2013 to 2022 promised to get the budget back into the black but never did. In their first budget in 2014 they slashed the expenditure on many government programs, but this provoked such a backlash from the electorate that almost all their proposals for major savings were dumped.

After that experience, in order to avoid another such backlash, the Coalition governments basically tried to balance the budget by subterfuge where they deliberately under-funded programs but without owning up.

For example, the queues for hospitals and aged care blew out, some people could not afford to go to the doctor or buy prescription drugs, public investment in universities, the CSIRO and R&D all fell in real terms, equitable school funding as recommended by the Gonski Report was put on hold, and funding for public housing and foreign aid were slashed.

Furthermore, while Labor has sought to improve the funding of these government services, their funding is still inadequate. For example, equitable funding of public schools will still not be fully realised until 2034, two decades after the Gonski recommendations.

But if public demand is not going to be cut, and with the economy operating with excessive total demand, then we need to reduce private demand so that aggregate demand does not exceed our economic capacity. An alternative would be to increase economic capacity through supply-side reforms, but as discussed briefly below, these supply-side reforms typically take longer to have an impact, even if they can be made to work.

There are essentially two ways to reduce private demand. The first is to increase interest rates, which is what the RBA has just done. However, interest rate increases only impact the roughly one third of households who have a mortgage, and the rest of us do not experience any reduction in our spending capacity.

The alternative way for the authorities to reduce private demand is to increase taxation, and with a budget deficit equivalent to 2 per cent of GDP stretching ahead over the next ten years, increased taxation is the obvious way to get the budget and the economy back into balance.

Furthermore, there are a couple of very obvious tax reforms that would make a substantial contribution to restoring that balance.

The first would be instead of taxing only 50 per cent of any realised capital gains, to change that discount from 50 per cent to 33 per cent. That would be fairer as that lower rate of discount would more closely approximate taxing real capital gains at the same rate as other income, and it would raise an additional $6.5 billion of revenue each year.

The other tax reform, which would raise a lot more revenue, and make a major contribution to realising the Government’s Net Zero targets for carbon emissions would be to adopt the proposals put forward by the Superpower Institute for a Polluter Pays Levy and a Fair Share Levy on resource rents (see my article in Pearls & Irritations, 3 February, 2026). Even if households and small businesses were fully compensated for their increased power costs, it is estimated that together these two taxes would raise additional annual revenue of around $31.5 billion, or about halfway to closing the budget deficit.

Finally, it would obviously help reduce inflationary pressures if Australia’s economic capacity was increasing faster, as that would allow demand to increase faster as well. The government has received numerous suggestions as to how to raise the rate of productivity growth which has been low for the last 15 years or so. While many of the suggestions are useful, I doubt that they will make much difference to the rate of productivity growth. The reality is that productivity growth has slowed in all the developed countries, and Australia is no different, because the rate of technological progress has declined, and there is not a lot that governments can do about that.

However, there is one reform impacting the supply-side of the economy that could make a substantial difference to living standards, and that is reforms to improve the supply of housing where people want to live. Housing is by far the biggest expense for most households, and its cost has risen enormously relative to incomes in the last 30 years or so. And we know that if we build upwards and increase urban densities that could make a major difference to housing supply and lower living costs.