Treasurer Jim Chalmers pulled one unexpected rabbit out of his hat in Tuesday’s 2025-26 federal budget.

This was a 1 percentage point cut in the bottom marginal tax rate, from 16% to 15% from 1 July next year, and a further 1 percentage point cut to 14% from 1 July 2027, resulting in a tax cut of $2548 (or $50 per week) on average across all taxpayers in the 2027-28 fiscal year (compared with what they would have been paying otherwise), at a cost to the budget of $17 billion over the five years from 2024-25.

While most of the other “announcements” in the budget had been well and truly flagged in recent weeks, this was a genuine surprise.

But otherwise, the 2025-26 budget is notable for how little difference it makes to either the near- or medium-term outlook for the Australian Government’s financial position.

The budget forecasts an “underlying” cash deficit of $27.6 billion in the current (2024-25) financial year, which is $656 million less than projected in last December’s mid-year economic & fiscal outlook; a deficit of $42.1 billion in 2025-26 (which is $4.8 billion less than projected in MYEFO); deficits totalling $145 billion over the forward estimates period, the four years to 2028-29 (which is $1.2 billion more than projected in MYEFO); and deficits totalling $308 billion over the 10 years to 2034-35 (which is $73 billion more than projected in MYEFO).

The “underlying” cash deficit excludes the “off-budget” spending (officially called “investments in financial assets for policy purposes”) which are projected to total $85 billion over the four years to 2028-29, resulting in “headline” deficits totalling $237 bn over this period.

As a result of these larger “underlying” and (more relevantly) “headline” deficits, net debt is forecast to rise to $768 billion (23.1% of GDP) by 30 June 2029, which is $4.2 billion (0.3 percentage point of GDP) more than projected in MYEFO; and to $956 billion (21.3% of GDP) by 30 June 2035, which is $88 billion (2.1 percentage points of GDP) more than projected in MYEFO.

How did they do it?

As in each of his three previous budgets, Jim Chalmers was able to do what he did in this budget largely as a result of “good fortune”. Favourable “parameter variations” (that is, changes in economic and other assumptions which go into putting the budget figures together) boosted the “bottom line” by a total of $37.0 billion over the four years to 2028-29. Of this, $34.9 billion was absorbed by “policy decisions”, to spend more or to tax less.

This is in contrast with the government’s approach in its first three budgets, in which it saved (or as the treasurer likes to say, “banked”) most of the windfall gains conferred by higher-than-assumed commodity prices (which boost company tax collections) or stronger-than-expected employment growth (which together with “bracket creep” or “fiscal drag”) boost company income tax collections. Thus, in this year’s budget, the treasurer could only claim to have “saved” 69% of favourable “parameter variations”, compared with 80% previously.

In other words, while the government was commendably disciplined in the first two years of its term in resisting the temptation to spend “windfall” revenue gains, that discipline has eroded as the windfalls have shrunk (and as the next election has loomed closer). And while the government has made savings from “re-prioritising” spending, those savings have been directed towards new spending, rather than budget repair.

The real budget problem

The 2025-26 budget leaves unaddressed the critical issue which has been apparent since before the last election – which is that federal government spending is almost certain to be about 1½-2 percentage points of GDP higher, over the next 10 years (and in all likelihood beyond then) than the average between 1975 (the end of the Whitlam years) and 2019 (just before the onset of COVID-19),

There are three reasons for this. First, the Australian public clearly want more spending on health, aged, disability and child care (and any political party which says they can’t have it will not get elected to government). Second, there is a bipartisan consensus that, whether the public wants it or not, they are going to get more spending on defence. And third, as a result of the $530 billion increase in net debt since the onset of the global financial crisis, and the $460 billion increase in net debt in prospect over the next decade, the government is going to have to spend a lot more on interest.

And with one obvious exception — on which more below — it’s difficult to see how spending can be cut in other areas sufficiently to offset the increase in spending in the areas shown in the above chart. (Cutting the number of public servants — as proposed by the Opposition — won’t do that: wages and salaries of government employees, including military personnel, represent just 6.4% of total cash payments).

Ideally, both sides of politics would, between now and the next election, be having an “adult conversation” with the electorate as to what would be the least economically damaging, and fairest, ways of raising the additional revenue required to pay for the additional spending that the public wants, or which both political parties agree the public is going to have.

But there’s a greater probability of my spotting a thylacine on my front lawn of a morning, than of that happening. And the result of that is that budget deficits will continue over the medium term, until they are eventually offset by the interaction between rising nominal incomes and unindexed personal income tax scales, putting a disproportionate burden on younger wage and salary earners, whose incomes are taxed at higher rates than older people whose income accrues disproportionately in more lightly taxed forms (payments out of superannuation funds, trust distributions, divdends and capital gains).

The worst public policy decision of the 21st century thus far

One area where federal government spending could be cut without any adverse economic consequences is what I’ve called The worst public policy decision of the 21st century thus far. That’s the corruption of the largest single spending program in the federal budget — the distribution of the revenue from the GST to the states and territories — in order to give the government of Australia’s richest state, Western Australia, a much bigger share of the revenue from the GST than it needs in order to allow it to provide its citizens with a similar standard of public services to those provided to residents of other states and territories (on average) whilst levying on them a similar burden of state taxes and charges.

Budget Paper No. 3 shows that it will cost the federal budget $6 billion to give WA more GST than it should be getting in 2025-26: and that the total cost of this appalling decision to the budget over the 11 years to 2029-30 will now exceed $57 billion (assuming that the cost in 2029-30 will be the same as that forecast for 2028-29), compared with the original estimate (made in 2018 of $9 billion over eight years).

(FWIW I suspect the forward estimates in Budget Paper No 3 are under-estimates by the order of $1 billion a year, but that’s another story).

It continues to amaze me that there isn’t more outrage about this – from both self-styled “progressives” who want the government to spend more on poverty-alleviation measures (such as increases in the Job Seeker Allowance or Commonwealth Rent Assistance), or “security hawks” who want more spending on defence, or even those who just want a smaller budget deficit.

One welcome piece of productivity-enhancing ‘micro’ reform

The budget contained one important piece of productivity-enhancing “micro-economic” reform – a pledge to ban “non-compete clauses” applying to workers earning less than $175,000 per annum. Around three million workers (more than 20% of the workforce) are now subject to these clauses in their employment contracts. The Productivity Commission has estimated that this could increase GDP by $5 billion (about 0.2%) when fully implemented, by enabling more Australian workers to move to higher paying jobs and start their own businesses, allowing growing businesses to access talented workers, and by boosting wages and productivity across the economy.

What does the budget say about the Australian economy?

Treasury says the Australian economy has “turned a corner”, despite warning of “heightened uncertainty in the global economy” and “challenging conditions at home”. It says “a soft landing in our economy is increasingly likely”, with real GDP growth forecast to pick up from 1¾% in 2024-25 to 2¼% in 2025-26 and 2½% in 2026-27 (unchanged from the December MYEFO forecasts), and inflation to fall to 2½% over the year to the June quarter 2025 (down from 2¾% forecast in December). Treasury’s forecast for unemployment has been shaved to 4¼% in June 2025 and for each succeeding June quarter, from 4½% previously,

The pick-up in economic growth is expected to be led by recoveries in household consumption growth (from ¾% in 2024-25 to 2¼% in 2025-26 and 2026-27) and dwelling investment (from 1½% in 2024-25 to 5½% in 2025-26 and 7½% in 2026-27), although business investment is forecast to be more subdued, growing by only 1% in 2024-25 and 1½% in each of 2025-26 and 2026-27 after a 6% increase in 2023-24, Growth in public spending is forecast to fall back to 3% in 2025-26 and 2% in 2026-27 after growing by 4.2% in 2023-24 and an expected 5% in 2025-26. Largely as a result of assumed falls in commodity prices, Australia’s current account deficit is forecast to widen from 1¾% of GDP in 2024-25 to 3¾% of GDP in 2025-26 and 4¼% of GDP in 2026-27.

The forecasts assume that net migration slows from 435,000 in 2023-24 to 335,000 in 2024-25, 260,000 in 2025-26 and 225,000 per annum thereafter.

A downside risk to these forecasts stems from the tariffs being imposed by the Trump regime in the United States., and the possibility of “retaliation” by other countries (including Australia), Treasury estimates that a 25% tariff on all imports of “durable manufactured goods” into the US would reduce Australia’s real GDP by 0.04 percentage point in 2025 and 0.1 percentage point in 2026, and increase inflation by 0.12 percentage point in 2025 and 0.01 percentage point in 2026 — all pretty small — but that the impact would be twice as large if China and Australia “retaliated” by imposing similar tariffs on imports from the United States. Treasury notes that the indirect effects of US tariffs (via their impact on Australia’s more important trading partners, in particular China) are almost four times as large as the direct effects.

Summing up

Apart from the unexpected (though modest) personal income tax cuts, there was nothing in the budget which should come as a surprise to anyone. The budget is unlikely materially to alter financial markets’ expectations about the outlook for the Australian economy, their understanding of Australia’s financial position, or their assessment of the probabilities around further reductions in the RBA’s cash rate.

There will undoubtedly be some pressure on the Opposition to say whether it will match the government’s proposed tax cuts — as it has done almost all of the additional spending which the government has promised this year — and to provide more detail about how much it proposes to cut government spending, and where, something it’s been thus far conspicuously reluctant to do.

But the budget leaves unaddressed the longer-term structural challenge of paying for the additional spending which the public wants, or is going to get whether they want it or not. And that’s a challenge that seems unlikely to be taken up by either side of politics in the short interval between now and whenever the 2025 election is held.