2026-27 State Budgets show fiscal consolidation has stalled as interest bills climb

• Fiscal consolidation has largely stalled, with states and territories still facing operating deficits despite stronger-than-expected revenue.
• Gross state and territory debt is forecast to reach nearly $844 billion by FY27 and $1 trillion by FY30, while interest bills are becoming one of the fastest-growing budget pressures.
• Governments need stronger spending discipline, better-sequenced infrastructure investment, structural tax reform, and clearer fiscal rules to rebuild budget resilience.

Australia’s governments are not facing an immediate debt crisis, but rising spending, ongoing deficits and growing debt mean stronger fiscal discipline, tax reform and clearer fiscal rules are needed to rebuild resilience, according to EY Australia’s 2026-27 State Budget Monitor.

The review finds structural deficits, higher debt servicing costs, geopolitical uncertainty and downside risks to revenue are reducing governments’ fiscal flexibility.

EY Regional Chief Economist, Oceania, Cherelle Murphy said Australia’s debt levels remain manageable, but the budgets show why rebuilding fiscal capacity has become more urgent in a volatile global environment.

“Australia is not facing an immediate debt crisis, but persistent deficits, rising debt and higher interest costs are reducing the room governments have to move,” Murphy said.

“Fiscal sustainability is becoming an economic constraint, not just a budget objective, because it affects whether governments can respond to shocks, fund essential services and invest in the reforms that lift long-term growth.”

The budgets show a $1 billion improvement in the net operating balance from FY26 to FY29 compared with last year, but operating deficits continue and progress towards fiscal consolidation has largely stalled.

Public spending across local, state and federal governments has remained around 29 per cent of GDP since mid-2024, well above the 20-year pre-pandemic average, while state and territory spending has grown faster than revenue over the past decade.

States and territories collectively forecast operating deficits of $9 billion in FY26 and $6 billion in FY27 before returning to surplus later in the forecast period.

Gross debt across all states and territories is expected to reach nearly $844 billion by FY27 and $1 trillion by FY30, with borrowing for both recurrent spending and large infrastructure programs.

Murphy said interest costs are one of the fastest-growing areas of government expenditure and one of the clearest indicators of the budget trade-offs now facing governments.

“In FY27 alone, states and territories face an interest bill of nearly $27 billion, while combined Commonwealth and state government interest expenses are forecast to reach $57 billion. This is more than Commonwealth spending on the NDIS in FY26. The bill is expected to grow to nearly $80 billion by FY30, just above the projected cost of the Age Pension in that year,” she said.

“Rising interest costs make budget choices more important, because every additional dollar spent servicing debt is a dollar that cannot be directed to services, reform or productivity-enhancing investment,” Murphy said.

“Australia needs infrastructure, and the task is to sequence and prioritise investment so projects can be delivered efficiently without adding unnecessarily to capacity pressures or future debt servicing costs.”

States and territories have committed more than $402 billion in asset investment over the next four years, the largest program on record, with infrastructure spending revised up by a combined $7.8 billion compared with last year’s budgets.

“While infrastructure investment is needed, ongoing cost pressures, labour shortages and capacity constraints create risks of further spending growth, higher borrowing requirements and rising debt,” Murphy said.

Even while revenue has been stronger than forecast, growing at an average rate of 6.4 per cent over the past decade for the states and territories combined, expense growth has been higher at an average rate of 6.8 per cent over the same period.

Murphy said restoring budget sustainability will require action on both spending and revenue.

“This is not about austerity for its own sake; it is about rebuilding resilience and fiscal capacity so governments can make deliberate choices, protect services and support growth when conditions become more difficult,” she said.

“The longer structural deficits are left unaddressed, the harder the eventual choices become, which is why acting earlier gives governments more options and reduces the risk that today’s spending decisions place a larger burden on future taxpayers.”

-ENDS-

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