Fiscal sustainability and its impact on GDP growth in Australia

Despite cause for optimism in the short term, achieving Australian fiscal sustainability remains an issue in the face of slowing real GDP growth.

There were three items on the agenda at the federal government’s August Economic Reform Roundtable: Making the economy more productive, building resilience in the face of global uncertainty, and making the budget sustainable.

At first glance, the need for progress on the third of these items might seem less pressing than on the other two. After all, the government has recently delivered back-to-back federal budget surpluses for the first time in almost two decades, and the 2024–25 budget performance has exceeded expectations to date. Relative to many of our peers, Australia’s fiscal position looks in decent shape.

Consider, for example, the government data presented for 41 advanced economies in the latest International Monetary Fund (IMF) Fiscal Monitor. The general government sector combines federal, state and local government fiscal accounts. According to the IMF, the average (GDP-weighted at USD exchange rates) advanced economy general government deficit in 2025 is likely to be around 4.3 per cent of GDP, swollen by a projected US deficit of 6.5 per cent. In contrast, the IMF thinks Australia’s deficit will be 2.6 per cent. By 2030, its estimate is that the average advanced country deficit will have narrowed to four per cent of GDP, while in Australia it will have fallen to half that.

Or take the IMF’s numbers on general government indebtedness — where it puts the average advanced economy debt burden at around 110 per cent of GDP this year. Again, the IMF forecasts Australia’s debt burden to be less than half that, at about 51 per cent of GDP. Likewise, by 2030, it sees the average advanced economy debt ratio rising to more than 113 per cent, vs a modest decline to 49 per cent for Australia.

Inefficient taxation

No worries? Not quite. Australia faces a significant medium-term sustainability challenge, as originally set out in the last Intergenerational Report (IGR 2023). The IGR projected slower real GDP growth over the next 40 years due to lower population growth, slower productivity growth and an ageing society. Lower growth will place sustained pressure on government revenue streams. However, at the same time, existing tax bases are eroding.

For example, IGR 2023 forecast fuel and tobacco excise taxes to shrink due to increases in the uptake of electric vehicles and a decline in per capita smoking rates. Likewise, it reckoned revenues from company tax, GST and other taxes would at best grow no faster than the economy, as slowing global demand for bulk commodities reduced the contribution of future resource revenue to company tax receipts. Only personal income taxes were projected to increase their share of GDP, thanks mostly to bracket creep. Even then, this would be in the context of a shrinking personal income tax base as population ageing lowered workforce participation.

All of which exacerbates the future challenges for a tax mix that already looks unbalanced and inefficient. A tax system’s efficiency depends upon how much it distorts economic activity — for example, by reducing incentives to work or invest. An efficient system requires a tax mix that generates relatively low economic losses per dollar of revenue raised. It should minimise the “marginal excess burden” of taxation. All else being equal, the projected growing reliance on income tax will lead to lower efficiency.

Fiscal sustainability

Meanwhile, spending pressures are on the rise. According to IGR 2023, demographic ageing alone is estimated to account for 40 per cent of the increase in government spending over the next 40 years. It also projects the five fastest-growing payments will rise to half of all government spending by 2062–63, their combined share of GDP growing by over 5.5 percentage points.

An older, wealthier and possibly more risk-averse Australian population has higher expectations for government support across a range of areas from healthcare and disability support to cost-of-living and disaster relief. That implies ongoing demands for further social spending. Meanwhile, more government debt combined with higher interest rates represents another growing source of fiscal pressure.

Put all that together and the result is IGR 2023’s forecast of rising budget deficits over the medium term. Indeed, these pressures are already visible. Earlier this year, Budget 2025 reported that seven spending categories (NDIS, defence, hospitals, medical benefits, aged care, the Child Care Subsidy and interest payments) are now growing faster than nominal GDP.

More fiscal pressures are inbound. The IMF warns that elevated international economic and policy uncertainty, higher bond yields and demands for greater defence spending in an increasingly insecure world will all amplify fiscal risks in the near term. For example, new IMF research reckons a significant rise in geo-economic uncertainty is typically associated with an increase in public debt of around four percentage points of GDP. In this context, securing fiscal sustainability would benefit from progress on three fronts.

Firstly, by establishing a credible medium-term fiscal framework that links spending ambitions with sustainable revenue sources and ensures that projected growth in commitments aligns with available financing. Operationalising this framework should also involve improved evaluation of government spending, infrastructure delivery and procurement policies. There is also a case for considering the adoption of a fiscal anchor, such as a medium-term debt target.

Secondly, through rebalancing the tax system to make the tax base more durable and the tax mix more efficient. Rebalancing could also address growing concerns about intergenerational equity.

Finally, via reviewing and upgrading federal-state fiscal relations. This could include re-examining their respective roles, spending responsibilities and revenue-raising powers. These measures would address Australia’s persistent vertical fiscal imbalance and facilitate the replacement of particularly inefficient state taxes.

Such an approach would not only strengthen fiscal sustainability, but by improving the efficiency and durability of the tax mix and the quality of government spending, would also boost national productivity and resilience.

This article first appeared under the headline 'Show us the money’ in the September 2025 issue of Company Director magazine.