Economic insights from the 2025 Federal Budget

Pre-election budgets typically contain little news. And this one didn’t disappoint.
 
The income tax cuts were the major surprise. Certainly they will be welcome, notably by low-income earners. But they were modest in size and more ambitious reform of the tax system is needed. The major spending announcements had been largely pre-announced.
 
The Budget has moved into deficit for this financial year, with ongoing deficits projected for the future. Some measures (such as the income tax cuts) have been legislated.  The Federal Government didn’t pass the entire Budget through Parliament before the election, so changes are possible.
 
Future Budget decisions are likely to result in higher defence spending due to geopolitical shifts. The potential for lower revenue outcomes could create challenging decisions on spending.
 
Economic assumptions
The Budget forecasts across financial years for economic growth, unemployment, and wages growth appear reasonable although the inflation forecasts may prove to be too high.
 
The Government expects a pickup in economic growth this year, driven by a revival in private-sector spending. Stronger disposable income growth will help household consumption rise and a turn in the residential construction cycle is on the cards. Slower growth in public-sector spending will be a partial offset.
 
The forecast decline in net migration (down 100,000 to 335,000) for this financial year seems reasonable. Future declines may depend upon the strength of the jobs market (a low unemployment rate typically attracts more overseas workers).
 
Changes in United States trade policy introduce significant uncertainty, having a potentially large impact upon the global and domestic economy. Financial markets are vulnerable to this growing uncertainty.
 
Fiscal policy
When talking about fiscal policy the focus is typically on announcements from Canberra. State governments though have been a significant part of the fiscal story in recent years, partly due to high infrastructure spending.
 
Fiscal policy was very supportive to the economy in this financial year, playing a major role in helping the economy avoid recession. Federal Government share of fiscal policy is forecast to provide a further modest boost in the coming year. We will find out what support might be provided by the states over the next few months.
 
Given the low unemployment rate, weak productivity growth, and slowing immigration, it is unclear how higher private-sector spending and ongoing strong government spending can coexist without creating inflationary pressure.
 
But there is enough uncertainty about the outlook that it is prudent for the Government to take out some economic insurance by providing an additional further fiscal boost. The Australian Government’s low debt level allows for a supportive fiscal policy.
 
This Budget is unlikely to have any impact upon the cash rate. Often there is no direct link between what happens with fiscal and monetary policy. Interest rates will be influenced by a wide range of factors, including what happens with consumer spending and US trade policy.
 
The economic impact of this Budget is likely to be modest. Our view is that there will be another one or two quarter percentage point rate cuts this year providing inflation declines in line with our forecast.
 
Budget balance
The move to a budget deficit followed a couple of years of budget surpluses.
 
In 2023 and 2024 booming income growth in the economy led to tax revenue coming in a lot stronger than anticipated.
 
Some of this additional revenue was spent, but more was saved resulting in a budget surplus. This year (and forecast years) income growth in the economy is likely to be slower, and more additional revenue has already been spent. The result is a budget that has moved from surplus to deficit.
 
The size of the budget deficit for 2025-26 is defensible given the likely state of the economy.
 
A greater concern is that the Federal Budget is in a structural deficit (ie, unless the economy booms the budget is likely to be in deficit for years to come). It is not currently a concern as the size of Australia’s structural deficit this year is mid-pack among peers. But at some stage the Government will either need to rein in spending or find ways to boost revenue.
 
Government spending
Health makes up around 16% of Federal Government spending and was one area that received additional spending in the Budget. That included more money for bulk billing, urgent care clinics and women’s health. The cost of medicine will also fall with more funding for the Pharmaceutical Benefit Scheme.
 
Government spending as a share of the economy has increased noticeably in recent years. The ratio of government spending to GDP now stands at 27 per cent, the highest since at least 1971 (outside of the COVID years). While future spending growth is forecast to be modest that is always subject to change.
 
Indeed, some areas such as the National Disability Insurance Scheme (NDIS) are projected to grow substantially faster than national income growth.
 
There will also be growing pressure to expand defence spending. Historically higher defence spending has been funded by either higher taxes or increased debt.
 
The higher level of spending requires stronger revenue growth. Currently the high terms of trade (due to elevated commodity prices) and the low unemployment rate is providing the additional revenue. But this positive backdrop won’t last forever.
 
The structure of the current tax system means more of households’ disposable incomes may end up going to tax. So while the income tax cuts in this Budget are welcome in the long term more fundamental tax reform is required.
 
Government debt
The Federal Government’s gross debt to GDP ratio is forecast to be around 35 per cent by the end of June. By international standards that is not a scary number, with Australia near the top of the OECD class.
 
But gross debt has been rising over the past decade. And there are good arguments that the Government should be looking to reduce debt further over time.
 
US Think Tank, The Brookings Institute, found that recessions can increase government debt to GDP by up to 15 per cent. So another recession could see Australia move from being a low debt country to one that is middle of the pack compared to peers.
 
As a small open economy with a small domestic capital market Australia needs low debt to make global financial markets comfortable to lend to us during both good times and bad.
 
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BOQ Federal Budget Specialist