Assume a balanced Budget

The Budget’s return to balance in a decade’s time is premised on unrealistic assumptions, avoiding difficult policy decisions

This week’s Budget details spending increases, income tax cuts, and, somehow, a return to a balanced budget after a decade of deficits. That aspiration is built on fanciful assumptions. A few tweaks toward reality reveals a budget closer to $100 billion in deficit in today’s dollars in a decade’s time.  

The Budget predicts that Australia will have a budget deficit every year until 2035-36, with the structural budget deficit estimated to be 1% of GDP in the coming years. But these estimates are premised on a world where no new spending is required, productivity growth reverts to around its 20-year average, and no income tax bracket creep is given back.  

We view these assumptions, and related spending and taxing plans, as unrealistic and have analysed the impact of making them more credible using the PBO Budget tool and the latest Budget numbers.  

Firstly, in a world with heightened geo-political risks and a more transactional United States, it appears inevitable that defence spending will need to increase. 

Current defence spending is around 2% of GDP, with a plan to increase to 2.33%. The opposition is reportedly considering committing to 2.5% of GDP, while US officials have called for Australia to increase to 3% of GDP.  

We estimate that updating budget plans to increase defence spending to 2.5% of GDP from 2027 will make the Budget deficit more than double in size in 2035 (Figure 1A).    

Secondly, the productivity growth assumption embedded in Budget forecasts is unrealistic. Australia’s recent sluggish productivity growth has been well-discussed. Recent RBA analysis highlights that labour productivity grew only 0.2% per annum over the six years to June 2024. And any tariff war will threaten this further. However, the Budget embeds a productivity growth assumption of 1.2% per annum.

While some recent actions—such as plans to ban the use of non-compete clauses—are a step in the right direction, Australia’s path to revived productivity growth is unclear.  

We estimate that the Budget deficit worsens by 0.4% of GDP in 2035 (Figure 1A) if we use a slightly lower, but still ambitious given the current climate, productivity growth assumption of 1.0% per annum. 

Finally, the Budget forecasts assume that no income tax cuts occur over the coming decade, allowing bracket creep to drive revenue improvements. However, both major parties have routinely provided income tax cuts to return bracket creep. It is extremely unlikely there will be no cuts over the coming decade, as evidenced by Tuesday’s Budget announcing new income tax cuts only nine months after the revised Stage 3 tax cuts came into effect. 

If governments were to repeat historical trends and give back bracket creep over the coming decade through tax cuts, we estimate the Budget deficit would be worse by 1.9% of GDP in 2035 (Figure 1A).  

It’s possible that governments may not fully give back all bracket creep, but even returning the majority of it has significant consequences for the Budget path.

Collectively, we find that more realistic assumptions on these three key areas leads to a significant worsening of the Budget position, from –0.3 to –2.9% of GDP in 2035 (Figure 1B).  

Why does a balanced budget even matter? 

A balanced Budget in any given year is not necessarily important in and of itself. What is most important for prudent fiscal management is credible spending and taxing plans that lead to a reasonable stock of government debt. Some degree of government borrowing is likely, to support government investment and transfers through time.

However, if this stock of debt is too high, or plans not credible, then government’s ability to respond to future crises through borrowing will be restricted. In the meantime, high borrowing can crowd out private sector investment by increasing interest rates and creating uncertainty about future taxation.     

While the current government has delivered two successive budget surpluses and decreased debt, these were largely due to chance – driven by a positive terms of trade shock and inflation. In the face of a Trump led tariff war and potential global economic slowdown, Australia cannot rely on luck and a buoyant terms of trade to save it in the future.  

e61 and UNSW recently highlighted the need to get the Budget back in shape. This would allow policymakers to respond to geostrategic risks and start addressing flatlining productivity. 

What can policymakers do?  

The major parties appear hesitant to grasp the nettle on Budget repair. At its simplest, addressing the structural budget imbalance requires raising taxes or decreasing spending. The current implicit strategy appears to rely on non-credible increases in income tax through bracket creep, and to cross our fingers and hope no new significant expenditures arise. In addition to being unrealistic, this approach creates uncertainty for households and firms.

By being clearer and more transparent on the underlying assumptions that the Budget is based on, we can have a more thoughtful discussion about the options for fiscal policy. 

by Aaron Wong

Aaron Wong is a senior research economist at e61. His research focuses on the intersection of labour and urban economics, using micro data to understand how location shapes the decisions made by Australians on where to live and work. Aaron previously worked at the Reserve Bank of Australia, where he analysed Australia’s housing markets, contributed to economic forecasts and examined financial risk to the RBA’s domestic portfolio. He holds a Bachelor of Economics (Honours) and Bachelor of Commerce from the University of New South Wales where he graduated with First Class Honours and the University Medal in Economics.

For more information, please reach out to Aaron via email at aaron.wong@e61.in

by Lachlan Vass

Lachlan is a Research Manager at e61. He leads work at the intersection of economics, data and public policy, with a current focus on firms and productivity. Lachlan’s work experience spans the private and public sectors, both in Australia and internationally. In these roles he led teams bringing economics and novel data together to help inform, advise and solve policy issues across a range of policy areas, including social policy, financial markets, trade and labour markets. Lachlan holds a Bachelor of Commerce (Economics) and Honours (Economics) from the University of Melbourne.

For more information, please reach out to Lachlan via email at lachlan.vass@e61.in

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