Federal Budget 2026-27

A bold budget, but broader reform needed

From the Chief Economist

The 2026–27 Budget is bolder than we have seen in recent years. It narrows the fiscal deficit by pulling back on spending and lifting revenue. It is supported by stronger tax receipts driven by higher commodity prices and inflation linked to the Middle East conflict.

Notable changes include curbing concessional treatment of capital gains and property-related tax deductions. The resulting revenue gains are largely directed to a new annual $250 tax offset for individuals.

Refashioning the National Disability Insurance Scheme (NDIS), with $37 billion in expenditure reductions over four years, is the primary source of Budget savings. New spending is concentrated in health and national security and includes $18 billion for public hospitals, $6.8 billion for defence, and $5.9 billion for additional Pharmaceutical Benefits Scheme listings. A package of smaller productivity-enhancing reforms, including a national licensing scheme and harmonised payroll tax administration, is estimated to reduce the regulatory burden by $10.2 billion annually.

While the measures are directionally sound and move toward more equitable tax treatment between wage income and other sources, they fall short of what could be considered substantive reform. Treasury’s decision to lower productivity growth assumptions over the forward years underscores the constrained and uncertain outlook.

Stronger revenue and policy changes have allowed the Government to revise down projected underlying cash deficits compared with the Mid-Year Economic and Fiscal Outlook (MYEFO). The estimated deficit for the current year is $28.3 billion, down from $36.8 billion previously. The deficit is expected to widen modestly to $31.5 billion in 2026–27 and remain around that level over the following two years, with a return to balance projected only by 2034–35.

However, increased “off-balance sheet” spending, particularly related to the Australian Naval Infrastructure, means the headline cash deficit is projected at $64.1 billion in 2026–27, slightly higher than the $62.7 billion forecast at MYEFO. Even so, the overall increase in spending is more contained than expected.

These fiscal settings are being implemented against a difficult economic backdrop. Inflation is expected to rise to around 5 per cent this quarter, while the 2026–27 GDP forecast has been revised down to 1¾ per cent from 2¼ per cent, despite stronger near-term revenues.

Cost-of-living support for households is temporary and relatively modest, centred on the $2.6 billion three-month fuel excise reduction and the $250 “Working Australians Tax Offset” (WATO). The latter, costing around $3 billion annually, will not be realised until households lodge tax returns for 2027–28.

In a capacity-constrained economy facing an energy price shock, the Government has been careful to avoid adding fiscal stimulus so as not to complicate the Reserve Bank’s task. While the Treasurer has signalled an intention to pursue further personal income tax cuts beyond the WATO, no firm commitments have been made.

The Budget falls short on broader tax reform. It does not materially reduce the tax burden on income and earnings, nor does it introduce significant corporate tax changes to stimulate investment or materially lift productivity. There is also no movement on consumption tax, which would be necessary to create room for a more growth-oriented rebalancing of the tax system.

Changes to capital gains tax, while aimed at addressing housing inequality, extend to other asset classes, including start-ups, potentially increasing the tax burden for emerging businesses. Treasury has indicated it will consult on how to minimise unintended consequences.

Measures to support innovation are modest but welcome. Enhancements to the R&D Tax Incentive, including improved access to refundable offsets for start-up businesses, and expanded venture capital incentives from 1 July 2027 should provide some support. The increased generosity of the R&D cap is a positive step, although an uncapped approach would have provided a stronger signal for innovation.

There are also targeted measures for small business, including making the $20,000 instant asset write-off permanent, introducing loss refundability for start-ups from 1 July 2028, and a permanent two-year loss carry-back for firms with turnover up to $1 billion from 1 July 2026.

Overall, the Budget improves the near-term fiscal position and reflects a more disciplined policy stance, but it stops short of delivering the scale of structural reform needed to materially lift investment, productivity, and long-term growth.

Major policy changes

Improvement to cash balance, but deficits remain while off-balance sheet spending continues to rise 

An underlying cash deficit of $28.3 billion (or 1 per cent of GDP) is estimated for 2025-26, a $8.5 billion improvement from the MYEFO released in December. This follows a $10 billion deficit in 2024-25. 

The underlying cash deficit is expected to increase to $31.5 billion in 2026-27 (or 1 per cent of GDP). This was a $2.8 billion improvement compared to MYEFO mainly due to better than expected economic and financial conditions, which increase tax revenue, partly offset by higher payments due to policy changes.

The budget remains in deficit across the forward estimates and is forecast to be $25.3 billion in 2029-30, reflecting the projected decline in commodity prices, while spending pressures persist.

In total across the forward estimates, there was a $44.9 billion improvement in the budget deficits compared to MYEFO.

The headline cash balance includes ‘Investments in financial assets for policy purposes’ or ‘off-balance sheet’ spending and includes student loans, loans to the states and equity transactions into government businesses. It continues to increase to record high levels over the coming years but was not revised significantly from the MYEFO update.

The structural budget position is projected to deteriorate to -1.6 per cent of GDP in 2025-26 and remain in deficit until 2033-34. It is projected to gradually improve, reaching a surplus in 2035-36, with a further improvement in 2036-37.  In the medium term, the structural budget balance has improved compared to MYEFO. This mainly reflects the savings from the NDIS reforms.

Debt continues to grow over the forecast period

In 2025-26, gross debt is expected to reach $982 billion or 33.1 per cent of GDP. This is relatively unchanged compared to MYEFO. But gross debt continues to grow over the forward estimates, reaching a record high of over $1.2 trillion or 35.6 per cent of GDP in 2029-30.

As persistent budget deficits take their toll, net debt rises over the forward estimates, but slightly lower compared to MYEFO. Net debt is projected to increase from $556 billion or 18.8 per cent of GDP in 2025-26 to $768 billion or 21.9 per cent of GDP by 2029-30.

Compared to MYEFO, government bond yields have risen globally due to economic uncertainty, meaning new or refinanced debt will be issued at a higher interest rate. The assumed yield on 10-year government bonds has been revised up from 4.4 per cent at MYEFO to 4.8 per cent.

As a result, net interest payments are expected to rise from nearly $20 billion or 0.6 per cent of GDP in 2026-27, to $32 billion or 0.9 per cent of GDP in 2029-30.

Elevated inflation and Middle East conflict leads to downward revisions to economic growth

Capacity constraints in the Australian economy and the conflict in the Middle East led to the Consumer Price Index (CPI) forecast in 2025-26 being revised up by 1¼ of a percentage point compared to MYEFO at 5 per cent in the year to the June quarter 2026. This is close to the Reserve Bank’s forecast of 4.8 per cent.

The CPI forecast in 2026-27 was revised down by a ¼ of a percentage point to 2½ per cent compared to MYEFO, as oil prices start to reduce and labour market conditions ease. The timing of inflation moving within target is similar to the Reserve Bank’s forecast (2.4 per cent by June 2027).

Real GDP is estimated to moderate from 2¼ per cent growth in 2025-26 to 1¾ per cent in 2026-27, as higher inflation and interest rates weigh on households and businesses. This is revised down by ½ of a percentage point compared to MYEFO. Treasury expects growth to pick up to 2¼ per cent in 2027-28, driven by stronger household consumption and a recovery in real incomes. Public final demand, which has been a strong driver of growth, is expected to remain flat.

Growth will recover to its long run average levels of 2½ per cent in 2028-29. Linked to this, Treasury left the long run productivity growth assumptions unchanged at 1.2 per cent, but pushed out the timing of reaching the long-term assumption to 5 years from 2 years in 2025-26 Budget. This is higher than the Reserve Bank’s 0.7 per cent assumption.

These growth forecasts are optimistic compared to the Reserve Bank’s, which expects growth to reach 1.3 per cent by June 2027, compared to Treasury’s 1¾ per cent. 

Unemployment rate forecasts are relatively unchanged compared to MYEFO given the resilience of the Australian labour market. Treasury forecasts the unemployment rate to peak at 4.5 per cent in 2026-27 in line with MYEFO, before easing to 2¼ per cent in 2029-30. This is in line with Treasury’s estimate of the Non-Accelerating Inflation Rate of Unemployment (NAIRU) which remained at 4.25 per cent.

Wages forecasts remain relatively unchanged across the forward estimates, with a small upward revision to the Wage Price Index (WPI) compared to MYEFO of a ¼ percentage point in 2026-27 to 3½ per cent. However, Treasury expects real wages to grow by 1 per cent in 2026-27 - a ½ of a percentage point higher than at MYEFO. This follows a 1¾ per cent fall in real incomes in 2025-26 given the higher near-term inflation outlook.

Population growth has been revised slightly higher this financial year, which is now expected to be 1.4 per cent compared to 1.3 per cent expected in the 2025-26 Budget. The upward revision stems from stronger net overseas migration than previously expected, with an extra 35,000 people. Growth is forecast to ease to 1.2 per cent as net migration moderates, in line with the 2025-26 Budget.