EY Australia State Budget Monitor FY27

Australia’s fiscal challenge: more spending, more debt and less room to move

Australia’s governments are facing a more constrained fiscal outlook as structural deficits, rising debt, higher interest costs and record infrastructure pipelines reduce the room to respond to future economic shocks. The latest EY Australia State Budget Monitor examines the pressure points across state and territory budgets and the reforms needed to restore fiscal sustainability.

In brief

• Australia does not face an immediate sovereign debt crisis, but governments are entering a more volatile decade with less fiscal room to move.
• Structural deficits, record infrastructure pipelines, rising interest costs and weaker revenue resilience mean fiscal sustainability is becoming a practical economic constraint, not just a budgetary aspiration.
• As a priority, Australia’s governments must restore fiscal sustainability by bringing greater discipline to recurrent spending, strengthening fiscal rules and accountability, improving the quality and sequencing of infrastructure investment, pursuing structural tax reform and boosting private sector productivity.

Progress towards global fiscal consolidation has stalled as economic risks mount

The conflict in the Middle East and economic protectionism have reverberated around the world, adding to already elevated levels of geopolitical and economic uncertainty.  This is affecting government finances by weakening economic activity, which is eroding revenue and creating pressure for governments to provide cost-of-living support to households. Meanwhile, high inflation and economic uncertainty are leading to higher government expenditure and borrowing costs on rising levels of debt. This is occurring at a time when fiscal buffers are weak in many countries and fiscal consolidation has largely stalled.¹

These changes underscore the need to place government finances on a sustainable footing, ensuring fiscal capacity is available to support the economy given the many uncertainties ahead.

According to the Organisation of Economic Co-operation and Development (OECD), gross borrowing by OECD governments reached $US17 trillion in 2025, up from $US16 trillion in 2024, and is projected to rise by a further $US1 trillion in 2026. Much of this increase in borrowing is necessary to refinance existing debt and is accompanied by higher yields. Gross borrowing as a share of OECD Gross Domestic Product (GDP) was around 23 per cent in 2025, down slightly from 24 per cent in 2024 and is projected to rise once again to 24 per cent in 2026.²  Based on current spending and revenue trajectories, global government debt is projected to surpass 100 per cent of global GDP by the end of the decade, a rise of 8 percentage points from 2025. It is expected to be driven by the world’s two largest economies, the United States and China.³

Australia’s gross debt across the Commonwealth and state governments compares favourably. Gross debt is forecast to fall slightly to 50.6 per cent of GDP in 2026 from 51 per cent in 2025 and remain around this level until 2031 as spending pressures weigh on public finances. ⁴  But this is after several years of higher revenue collections from high commodity prices and strong economic activity. Arguably, the debt outcomes could have been lower.

High levels of government spending are pushing up the public sector share of GDP

The public sector’s share of the Australian economy has remained near a record high at around 29 per cent of GDP since mid-2024, which is well above the 20-year pre-pandemic average of 24 per cent. This reflects both government consumption and investment (across the Commonwealth and state and local governments) remaining elevated. There appears to be a structural shift, with a higher share of jobs in government-funded sectors as demand for health, aged and home care, and disability services rises. This implies a permanent increase in government spending as a share of the economy as all levels of government collectively need to fund much of it.

The number of new jobs created across the health, education and government sectors as a share of the total increase in employment has fallen from 74 per cent over the year to March 2025 to 32 per cent over the year to March 2026. Despite this, the public sector’s share of the economy has not decreased.

Budgets show ongoing deficits unless fiscal discipline is introduced

Public spending is expected to continue increasing from already elevated levels, with FY27 Commonwealth and state budget forecasts showing both large recurrent spending plans and asset investment programs over the next four years.

In a continuation of the long-term trend, expenses are expected to be higher than revenue for Commonwealth and state governments collectively over the forecast period until 2031. There has been a deficit – a gap between revenue and expenses – since the Global Financial Crisis in 2008. The gap is currently around 3 per cent of GDP.⁵

The Commonwealth Government net operating deficit is expected to be $39 billion in FY26 and $18 billion in FY27. There is no return to surplus forecast across the period to FY30.

States and territories collectively face large operating deficits of $9 billion and $6 billion respectively in FY26 and FY27, down from nearly $12 billion in FY25. The states and territories are expected to return to a collective surplus of just under $2 billion by FY28, and a nearly $10 billion surplus by FY30. This means that expenses are expected to be greater than revenue for a further two years, extending a run of deficits which began in 2020.

In stark contrast to all other states, Western Australia is expected to record an eighth successive general government operating surplus of $3.5 billion in FY26, with broadly similar surpluses expected over the following four years.

State and territory governments have failed to get spending growth down and their budgets into more sustainable positions, even while revenue growth has been robust. Over the last decade (FY17 to FY26), state government revenue has been stronger than forecast, growing at an average rate of 6.4 per cent per annum collectively. Spending, though, has increased by an equivalent 6.8 per cent per annum on average over the same period.

Employee expenses continue to rise and consistently come in over budget

Employee expenses accounted for an average of around 39 per cent of total expenses from FY17 to FY26 and are one of the main reasons governments have consistently underestimated their outgoings.

The rise in general government employee costs reflects both higher numbers of government employees and wage increases. From FY16 to FY25, the number of state and territory total public service employees grew by 29 per cent, with the largest increase in the Australian Capital Territory (ACT), which grew by 49 per cent. This was followed by Victoria at 40 per cent, while the Northern Territory had the smallest rise at 15 per cent over the same period. ⁶

Strong population growth over recent years has been one of the drivers; however, government employee cost growth has been well above Australian population growth of 14 per cent over the same period. In addition, over the same period the average wages of state government public service employees rose by 33 per cent, faster than the public sector wage price index growth of just over 26 per cent. Queensland and Tasmania experienced the strongest rises, at around 40 per cent.

The 2026-27 state and territory budgets collectively forecast general government employee expenses to grow by an average of just 3.4 per cent over the next four years, well below the long-run average rate of around 6.0 per cent. This reflects a continuing pattern of all states and territories underestimating employee expenses, evident throughout our analysis since 2015. The average forecast error rate across the states has ranged from 4.3 per cent in New South Wales to 11.3 per cent in Tasmania.

Realistic spending forecasts are critical so that fiscal pressures can be properly evaluated and decisions made to ensure budgets are sustainable.

Revenue has been stronger than expected, but risks for write-downs are rising

A slowing economy and high inflation present downside risks to state and territory government revenue collections. The recent slowdown in dwelling prices and deteriorating sentiment in the housing market have led to downward revisions to transfer duty collections. For instance, transfer duty revenue forecasts in the most recent NSW budget were revised down by $5.3 billion over the four years to FY30 (compared to the December budget update).

The contribution of stamp duty to own-source revenue⁷ varies by jurisdiction. On average, across all states and territories, stamp duty is expected to account for around 15 per cent of total own-source revenue in FY27, ranging from 17 per cent in Victoria to 7 per cent in the ACT and the Northern Territory.

The major banks expect national house prices to fall by around 1 per cent on average in 2026.⁸ Based on historical relationships, this could cut stamp duty revenue across the states and territories by approximately $1.5 billion in FY27.⁹ A 2 per cent fall in prices could increase the revenue loss to around $3 billion in FY27. This underscores the importance of sustainable spending and adequate fiscal buffers to protect budgets from economic shocks.

Mineral royalties have been strong in recent years but are another highly volatile revenue source for state and territory governments given movements in commodity prices, sales and the Australian dollar. Western Australia is most vulnerable, with iron ore royalties expected to be $7.1 billion in FY27, accounting for 13 per cent of total revenue. A $US10 fall in the price of iron ore would reduce royalties by around $930 million.

Coal royalties are a major revenue source for Queensland and New South Wales, and in FY27 are expected to be approximately $6.9 billion (or 7 per cent of total revenue) and $3.4 billion (or 2.6 per cent of total revenue), respectively. For NSW and Queensland collectively, a 10 per cent fall in the average price of export coal is estimated to reduce royalty revenue by around $1.7 billion.

Similarly, petroleum royalties contribute heavily to Queensland and Western Australia’s revenue, and are expected to be $1.9 billion and $570 million, respectively, in FY27.¹⁰ It’s not all downside risk though. The conflict in the Middle East has driven energy prices higher, leading to estimates of higher revenue for these states (and for the Federal Government). For both states combined, a US$10 rise in the price of oil is estimated to increase royalty revenue by around $310 million.

Importantly, over the medium to long term, the impact of deviations in states’ own source revenue is mitigated by the equalisation arrangements in the distribution of the GST to the states and territories. For example, a large fall in stamp duty revenue in one state in a given year, all else equal, means it will receive more GST over the next five years.

Record high infrastructure program continues to grow 

The solid pipeline of infrastructure investment has continued to grow as state and territory governments continue to upwardly revise their cost estimates and add projects to the pipeline. This has occurred through a period of strongly rising construction costs and capacity constraints in the economy, which have led to cost overruns and delays in projects.

States and territories have a combined asset investment program of over $402 billion over the next four years (FY27 to FY30), which is another record high – it was $400 billion in our last update (FY26 to FY29). Comparing FY26 to FY29, the asset investment program has been revised up by nearly $7.8 billion since the 2025-26 State Budgets.

The peak in the asset investment program was expected to occur in FY26 in our last update, but this has been delayed to FY27 and totals $105 billion in this financial year alone. This is an increase of over $8.5 billion compared to FY26. The asset investment program is then expected to ease to just over $95 billion in FY30. There is an elevated risk that the asset investment program could be even higher than forecast over the next few years, with the predicted peak in spending pushed out once again given ongoing capacity constraints and the impact on fuel and materials costs from the conflict in the Middle East. There is also an elevated risk of this occurring in Queensland given the projects associated with the Brisbane 2032 Olympics.

Including the Commonwealth Government’s asset investment program, this brings the total spend to $144 billion in FY27, or around 4.5 per cent of nominal GDP – above its long-run average level.

In FY27, public infrastructure investment as a percentage of Gross State Product (GSP) is forecast to average 3.7 per cent across the states and territories, up from 3.5 per cent in FY26. Tasmania and the Northern Territory have the highest levels of investment in FY27 at 5.9 and 4.4 per cent of GSP respectively, while ACT is the lowest at 2.3 per cent.

The issue is not whether Australia needs infrastructure; it clearly does. The issue is whether governments can deliver record programs at the same time without worsening capacity constraints, cost escalation and debt pressures.

Debt levels continue to rise to fund elevated public spending

According to the International Monetary Fund (IMF), total gross debt as a per cent of GDP was 51 per cent in 2025 for the Commonwealth and state governments combined, compared to 50.9 per cent the same time last year. The IMF expects this ratio to remain relatively steady at around 50 per cent through to 2031.¹¹

Australia’s debt levels are below many international peers, with the average gross debt to GDP ratio expected to be nearly 127.5 per cent by 2031 for the G20 advanced economies. This does not present a significant sovereign risk, but the speed of accumulation is noteworthy and Australia cannot be complacent.¹²

State gross debt levels for the total public sector continue to rise with the collective debt bill hitting nearly $844 billion by FY27, from just under $300 billion in FY19 – a 180 per cent rise. Debt levels are forecast to keep growing in the four years ahead – breaking through $1 trillion by FY30 or a staggering 230 per cent higher than in FY19. This is on top of the Federal Government’s $1.2 trillion of borrowings by FY30. State government gross debt is expected to grow by an average of just over 7 per cent over the next four years, down slightly from 8 per cent in our last update. Queensland leads the growth in debt at an average of 11 per cent per year, followed by South Australia at 10 per cent and Tasmania at 9 per cent. Given the uncertainty around the economic outlook, rising yields and fiscal pressures, borrowing at forecast levels may prove difficult and more costly.

Net debt – which is gross debt liabilities minus liquid financial assets – as a percentage of GSP captures the amount governments owe compared to the size of the economy and is an indicator of their ability to service that debt. The higher the indicator, the greater the burden of servicing the debt. For all states and territories, apart from Western Australia, the proportion of general government net debt to GSP is expected to remain close to record high levels across the forecast period. In FY27, Victoria has the highest net debt levels to GSP at nearly 25 per cent, followed closely by the Northern Territory at just over 24 per cent, while Western Australia has the lowest ratio, at 5.7 per cent.

Interest costs continue to be one of the fastest growing expenses for governments and in an environment of rising interest rates, this burden gets heavier. This draws government funding away from other services and reinforces the need to reduce debt levels. In FY27 alone, the states and territories are facing an interest bill on borrowings of nearly $27 billion on general government debt, up from $23 billion in FY26. This interest bill is expected to rise to nearly $38 billion in FY30. When combined with the Commonwealth Government, that interest expense rises to $57 billion in FY27. This is an increase of nearly 14 per cent or $7 billion from FY26, but compared to FY19, it is 135 per cent higher. For context, the Commonwealth Government spent $35 billion on Medicare, $53 billion on Defence, and $54 billion on the National Disability Insurance Scheme (NDIS) in FY26.¹³

More concerningly, given elevated debt levels and interest rates, the combined interest bill is expected to grow to nearly $80 billion in FY30. This is just above the Commonwealth Government’s projected cost for the Age Pension in FY30 (at nearly $77 billion).¹⁴

Strong levels of debt issuance as yields rise and credit ratings fall

State governments will collectively issue nearly $113 billion of debt over the next 12 months and the Commonwealth a further $125 billion. While state issuance is around $3 billion lower than the previous year, it is expected to rise again in FY28 to $120 billion, reflecting ongoing spending pressures and large infrastructure pipelines.^15,16 Debt issuance is also highly concentrated, with Queensland and Victoria accounting for 54 per cent of state borrowing, rising to almost 75 per cent when New South Wales is included. This is down slightly from last year given rising debt levels in the smaller states and territories.

At the same time, borrowing is becoming more expensive. Government bond yields in Australia have risen to their highest level since 2011, mirroring a global trend as governments issue increasing amounts of debt to fund fiscal deficits and refinance existing obligations.¹⁷ Higher inflation risks, geopolitical uncertainty and reduced demand from central banks have all contributed to upward pressure on yields.

Rising Japanese government bond yields to multi-decade highs are encouraging investors to repatriate capital, reducing demand for foreign government bonds. In May 2026, Japanese investors sold the most US sovereign bonds in almost four years.¹⁸ As Japanese investors have historically been major buyers of Australian government debt, this shift could place further upward pressure on bond yields.

It’s also important to point out that the states and territories pay a higher interest rate compared to the Commonwealth Government given their higher perceived risk and the downward trend in credit ratings.

As debt levels have grown, state credit quality has fallen to its lowest point since 2000, with S&P Global noting that the average state credit rating is a touch below AA+.¹⁹

As flagged every year in this publication, a deterioration in government finances or lack of political will to turn budget positions around increases the risk of downgrades by credit rating agencies. This risk has materialised for two states and territories over the past year. Rating agency S&P Global downgraded the ACT’s credit rating to AA from AA+, bringing the territory in line with Victoria as the lowest rated state and territory.²⁰ Tasmania also had its credit rating downgraded by Moody’s from Aa2 to Aa3, the lowest of all Australian states. Days later, S&P Global also downgraded Tasmania to AA, on par with Victoria and the ACT. ²¹  Both rating agencies stated the downgrades for the ACT and Tasmania were due to persistent operating deficits and the growing debt burden.

NSW and Queensland remain on notice by rating agency S&P Global with both states on a negative outlook, while carrying a stable outlook from Moody’s. A negative outlook suggests that these states may face a further erosion in their credit ratings given rising expenditure and infrastructure spending, despite the strong lift in revenue over the past few years.²² Following the release of the Queensland Budget in June 2026, S&P Global warned the state’s public service costs and huge infrastructure spend ahead of the 2032 Olympics put it at risk of being downgraded.²³

Meanwhile, the state with the highest debt levels, Victoria, carries a stable outlook from both rating agencies, despite net debt heading towards $200 billion by 2029. However, S&P Global has warned that Victoria could face another downgrade if the state fails to keep a tight rein on expenditure and delivering its planned savings measures.²⁴

Higher spending by the states and territories in response to the oil shock and political pressure to provide ‘temporary’ cost-of-living support also presents a downside risk to the budget bottom line and state credit ratings.²⁵  As the conflict in the Middle East drags on and inflation remains stubbornly high, these measures appear to be more permanent.

The growing debt of the states and territories and deterioration in credit ratings also put Australia’s AAA credit rating at risk, given there is an implicit assumption that the federal government would support states and territories in financial distress.²⁶

Both spending and revenue need to be addressed as a priority

Structural deficits need to be addressed to ensure sustainable budget settings and equity across generations. This requires changes to both spending and revenue as a priority.

Spending reviews should be a priority to ensure value for taxpayer money and that the stated objectives of programs are being achieved in the most cost-efficient manner. This would be more effective than efficiency dividends or blunt budget cuts to agencies in an attempt to streamline the public service.

Realistic spending forecasts are important for properly accounting for fiscal pressures and supporting better decision making. Sound budgeting will also eliminate potential ‘fiscal cliffs’, where government programs are only funded until a certain time, despite the likelihood of the program continuing. For example, as the Parliamentary Budget Office (PBO) has warned, the return to surplus in the medium term in the Federal Budget hinges on some unrealistic assumptions. This includes unprecedented restraint in NDIS spending, no further income tax cuts, a shrinking public service and termination of all temporary government programs.²⁷  

Tax reform is also an important part of the fiscal equation as Australia continues to rely heavily on company and personal income tax (over 60 per cent of total tax revenue), and less on the more efficient goods and services tax. Australia’s level of taxation (Commonwealth and state) is just under 30 per cent of GDP, below the OECD average of 34 per cent.²⁸ But the level of taxation does not measure the tax system’s efficiency.

Structural changes, particularly an ageing population, put pressure on revenue with a change in the composition and a narrowing of the tax base. Tax changes in the May Federal Budget for capital gains and property-related tax deductions have been bolder than in previous years, but fall short of substantive reform. For instance, the personal income tax burden and the government’s reliance on it continues to rise despite recent tax cuts, mainly due to bracket creep.²⁹ If there are no policy changes, the PBO expects Australian workers will pay an extra $336 billion in personal income tax by FY37. That is an 86 per cent jump on current levels and would make up over half of the Federal Government’s revenue.³⁰

Cooperation and collaboration with state and territory governments is required to ensure inefficient state taxes, such as transfer duties, are in scope, while ensuring there is suitable replacement revenue.

Strengthening fiscal sustainability targets could provide much needed guiderails

Given the previous lack of political will to curb expenditure growth, strengthening fiscal sustainability targets and metrics to contain government spending and provide clear guiderails, are another important tool. Since the Global Financial Crisis, fiscal sustainability metrics have been watered down, loosely followed or removed altogether, while many remaining fiscal rules were abandoned during the pandemic.³¹

Targets need to be quantifiable and measurable, such as reducing or limiting debt relative to the size of the economy or revenue; limits on interest costs as a share of revenue; commitments to balance the budget or run surpluses over a cycle; ceilings on spending growth tied to revenue growth or inflation; and caps on tax collections relative to the size of the economy.

Tasmania’s Budget has specific targets and timeframes to achieve its Fiscal Strategy which are more detailed and comprehensive than those of the other jurisdictions.³² For example, net debt to GSP for the general government sector is required to be less than 8 per cent by FY33. This enhances transparency and accountability by enabling the community to track the government’s progress.

Reporting and acknowledging public debt levels at the national aggregate level within the Federal Government Budget papers would also assist in providing more transparency and accountability on Australia’s overall debt burden given the implicit assumption that the federal government would support states and territories in financial distress.

The importance of fiscal sustainability in an uncertain and volatile world

Fiscal sustainability is not an abstract accounting goal. It determines whether governments can respond to shocks, fund essential services, invest in productivity and avoid pushing today’s costs onto future taxpayers. The policy task is not austerity for its own sake. It is discipline and prioritisation: realistic spending forecasts, stronger fiscal rules, better value for money from existing programs, more efficient taxes and a clearer distinction between temporary support and permanent commitments.

The importance of fiscal sustainability has become even more apparent over the past year with fiscal risks intensifying as the global economy faces heightened uncertainty. As pointed out by the IMF, credible medium-term fiscal frameworks can help reduce debt and rebuild fiscal buffers, so if required the government has the flexibility to respond to future shocks.³³

This is not simply about reducing debt. It is about ensuring public resources are directed towards investments that lift productivity, expand economic capacity and support future growth. Persistent structural deficits and rising debt can reduce the flexibility to invest in these priorities.

Continued delays in addressing long-term structural deficits will only increase the scale of future adjustments, forcing governments to make more difficult and politically challenging decisions, while placing a greater burden on future generations.³⁴

The benefits of a more ambitious reform agenda will need to be clearly communicated to the community, as the expectations of governments continue to grow. Achieving fiscal sustainability will inevitably involve difficult policy choices and trade-offs.

More restrained and thoughtful spending, fiscal targets and tax reform are needed

Governments must prioritise the following to move finances into structural balance and limit the amount of borrowing:

• limit additional spending without at least offsetting the spend elsewhere – to maximise the use of taxpayer funds – while also undertaking urgent reviews of current spending plans;
• change existing policy to lower spending and find new or more efficient revenue that will persist over time, such as raising the GST and reshaping our company and personal tax system;
• strengthen fiscal sustainability targets and metrics, which are quantifiable and measurable, to contain government spending and provide clear guardrails and accountability; and
• put in place policies to assist the private sector to maximise its productivity and improve our potential growth (which doesn’t necessarily require significant government investment).