Iran war boosts Canberra revenue but state and territory debt triples in under a decade amid inflation surge

The conflict in the Middle East is now regarded as good for the Commonwealth but bad for the states and territories whose debts have tripled in less than a decade to house population growth fuelled by immigration.

While more government debt during a time of higher inflation means heftier interest payments, the Commonwealth is expected to rake in $30 billion more revenue by 2028-29.

The 2020s, starting with the COVID pandemic, have been an expensive era for governments from financing lockdowns to providing cost-of-living relief during yet another inflation outbreak arising from a global oil crisis.

S&P Global Ratings is now forecasting the states and territories will see their collective gross debt soar to $820 billion by 2028 — triple the $270 billion level of 2019.

“A larger population also requires more infrastructure spending - roads, railways, water, and waste management, for example,” sovereign credit analyst Anthony Walker told The Nightly.

“Population growth also boosts state revenues - for example, through higher GST shares, property taxes, and economic activity.

“However, revenue growth lags immediate spending needs.”

Unlike the Federal Government, which has a AAA credit rating, the states and territories mainly have AA+ ratings, being less able to raise revenue.

Higher inflation is set to benefit the Commonwealth more than the states and territories, who would be more reliant on GST revenue from Canberra.

“Higher inflation boosts revenues. The Commonwealth, which has greater taxation powers, generally generates more of the revenue uplift than states,” Mr Walker said.

The ballooning of state government debt is on top of the Federal Government’s forecast $1.2 trillion gross debt by 2028-29, which Treasury predicts will comprise 36.4 per cent of the economy.

While higher inflation means higher government bond yields, economist Chris Richardson said the Federal Budget would be $30 billion better off by that financial year.

The war in the Middle East is keeping crude oil prices above $US100 a barrel ($142) and forcing motorists to pay more than $3.20 a litre for diesel.

But Iran’s attacks on Qatar’s LNG plants and the blockading of the Strait of Hormuz are also putting up prices for liquefied natural gas, Australia’s third-biggest export.

Inflation also shrinks existing debt

For the Federal Government, that means more revenue from company taxes and the Petroleum Resource Rent Tax on oil and gas, with coal and gold prices also increasing.

“In effect, the world just gave Australia a pay rise, and the Government gets a chunk of that,” Mr Richardson said.

“And although the ceasefire has also reduced the fire under fuel prices, there’s enough damage to infrastructure and ongoing uncertainty to ensure the pay rise the world has granted us disappears slowly rather than fast.”

Higher inflation, while bad for workers, often inevitably leads to bigger pay increases, even if they lag behind the Consumer Price Index.

This in turn leads to more income tax revenue for the Commonwealth.

“That first factor is boosting the size of the pie being taxed, and the second is increasing the taxman’s share,” Mr Richardson said.

Higher inflation means higher bond yields to attract investors but Mr Richardson pointed out this also shrinks debt.

“Inflation also shrinks existing debt, as that debt can now be paid off in ‘inflated dollars’,” he said.

Natural gas is Australia’s third-biggest export after iron ore and coal, which ANZ economists Sophia Angala and Adam Boyton said would translate into higher export earnings from June onwards.

“The lag largely reflected the structure of long-term LNG contracts, which are linked to the price of oil with a lag of three to six months,” they said.