Albanese Government’s Budget spending splurge runs risk of fuelling inflation

Federal Government spending growth will continue vastly outpacing economic activity during an era of weak productivity, sparking fears of even more interest rate rises as cash handouts add to price pressures.

The spending is expected to intensify until the next election due in 2028, with Labor splurging rather banking the multi-billion-dollar company tax revenue boost from higher LNG prices during the Iran war.

Commonwealth payments are expected to hit $829.6 billion in 2026-27, marking a 5.3 per cent increase from the previous financial year with only deficits forecast until 2030.

This is higher than the 4.6 per cent increase in inflation, which is projected to climb to a three-year high of 5 per cent by June.

The increase in Federal Government spending is almost double Australia’s 2.6 per cent economic growth rate last year and the mid-point of the Reserve Bank’s 2-3 per cent inflation target.

Productivity was flat during the December quarter, potentially making any increase in government spending above 2 per cent inflationary, amid predictions the RBA cash rate could rise two more times in 2026 to a new 18-year high of 4.85 per cent.

“If productivity growth’s zero, then anything above 2.5 per cent I think is inflationary,” University of New South Wales economics professor Richard Holden said.

“Anything above 2 per cent risks being inflationary, anything above 2.5 per cent is definitely inflationary.”

When spending growth was adjusted for inflation, Treasurer Jim Chalmers promised Labor would deliver real spending growth of 1.5 per cent over the eight years to 2030.

“This is the lowest average growth rate in any eight-year period for almost three-and-a-half decades and less than the 30-year average,” he told Parliament on Tuesday night.

Even so, a 1.5 per cent real increase in real spending, as promised, is still higher than Australia’s weak annual productivity increase of just 1 per cent last year.

Weak productivity means businesses often pass on the costs to customers, further fuelling inflation as the government spending also adds to price pressures.

Since Treasury’s update shortly before Christmas, new announcements are expected to cost the Budget another $5.3 billion during this financial year, including fuel tax relief.

Recent policy announcements are tipped to add another $6.5b to spending in 2026-27.

Government spending as a proportion of the economy will hit 26.8 per cent during the next financial year, which outside COVID will still be the highest since the 1985-86 financial year.

Gross debt was tipped to hit $1.1 trillion in 2027-28 – making up 34 per cent of gross domestic product – as another $2.3b in extra spending, announced since December last year, came into effect.

This would be occurring despite Treasury predicting a $19 billion uplift in company tax revenue, mainly from higher liquefied natural gas prices flowing from the war in the Middle East.

The increased revenue from higher commodity prices is expected to produce smaller Budget deficits than Treasury had forecast in December’s Mid-Year Economic and Fiscal Outlook.

A $28.3b deficit is forecast for 2025-26, which is $8.5b smaller than the $36.8b predicted just five months ago.

A narrower deficit is also forecast for 2026-27, with $31.5b now expected instead of $34.3b, marking a smaller difference of $2.8b as the revenue boost from higher liquefied natural gas prices wore off.

The war has caused fuel prices to spike, leading to $3.9b being spent in temporarily halving fuel excise to 26.3 cents a litre until June 30.

Treasury is now expecting inflation to hit 5 per cent by June for the first time since 2023, during the last aggressive Reserve Bank hiking cycle.

This is even more dire than the RBA’s prediction this month of a 4.8 per cent consumer price index, or a level even further above the central bank’s target.

“Inflation is spiking all around the world – and Australia is not immune from these global price rises,” Dr Chalmers said.

But in a worst-case scenario, the Treasurer told Parliament his department had forecast crude oil prices hitting a record-high $US200 a barrel for three years, which would be double present levels of $US100 a barrel.

Without fuel tax relief, this could potentially see average diesel prices climb to $6 a litre, sparking a food inflation crisis, given they had hit $3 a litre in March before the excise cut.

Dr Chalmers said Australia would avoid a recession, as occurred during COVID, but unemployment would spike to pre-pandemic levels above 5 per cent as inflation hit 7 per cent for the first time since 2022.

This would be known as stagflation, given inflation would be double the RBA’s 2-3 per cent target, and the jobless level would be above 4.5 per cent considered to be full employment.

Treasury, however, is expecting crude oil prices to stay around $US100 a barrel until the end of June before falling to $US80 a barrel by June next year, which would still be above the pre-war level of $US65.

From that point, a new $250 Working Australians Tax Offset is coming into effect on July 1, 2027, providing relief to 13.3 million income taxpayers, at a cost of $3b a year.

Former Reserve Bank economist Zac Gross, who is now a senior lecturer in economics with Monash University, said the tax offset would help with living costs, like electricity rebates did in previous Labor Budgets.

“Do they add to spending and inflation? Yes. Is the effect large? It’s basically a rounding error,” he said.

By the end of the next financial year, Treasury is expecting inflation to moderate to 2.5 per cent, or the mid-point of the Reserve Bank’s target.

This is despite the tax offset coming into effect a year after $268 in tax cuts come into effect as the marginal tax bracket for those earning $18,200 to $45,000 falls from 16 per cent to 15 per cent.

Another $268 in tax cuts comes into effect in July next year as that tax bracket is reduced to 14 per cent.

A dilution of the 50 per cent capital gains tax discount to 33 per cent and restricting negative gearing to brand new homes from July 2027 is also expected to save $1.4b in 2028-29.