The Federal Budget - due to be handed down on May 12 – will be one of the toughest in recent memory. At a time when the Australian economy was already grappling with rising inflation, the global energy crisis is unleashing a new wave of price rises, with supply disruptions threatening industry and households alike. These will impose new and significant costs on a budget already struggling with surging spending, an insecure tax base and structural deficits.
This year’s budget therefore needs to achieve two goals simultaneously. It must find resources to support the economy during the acute phase of the energy crisis in the middle of the year, while also addressing the structural problems around the sustainability of spending, tax and debt levels.
This research note examines the economic environment surrounding this difficult trade-off. It covers the economic challenges raised by the energy crisis, their immediate impacts on the budget through emergency measures, and the long-term challenges of spending and tax reform. How the May budget manages the trade-offs will be critical in shaping the economy’s ability to survive the energy crisis and return to stability in 2027.
Inflation accelerated again late last year, rising from 3.2% in the middle of 2025 to 3.7% by February 2026. With CPI above its 2-3% target band and moving in the wrong direction, the RBA has been forced to raise the cash rate twice to 4.1% at its March 2026 meeting. At the same time, businesses are facing sharp increases in input costs, which rose 3.5% across 2025[1]. Inflationary pressures have been particularly pronounced in two industries - with construction input costs rising by 3.4% and manufacturing input costs by 11.6% year on year to Q4‑25.
This existing inflationary problem will be exacerbated by the energy crisis. Ongoing geopolitical tensions in the Middle East are disrupting global fuel supply chains, with impacts already being felt in Australia. As the conflict drags on, shipping through the Strait of Hormuz has slowed significantly, trapping around a fifth of global oil and gas supply inside the Gulf. These constraints have already pushed global oil prices higher, which in turn is contributing to rising fuel and petrochemical input prices in Australia.
The negative impacts on industry are likely to be widespread. Australia is heavily reliant on imported fuels and on industrial commodities such as fertiliser, plastics and other industrial chemicals that are derived from oil and gas. In 2023-24, the Australian economy consumed around $133 billion worth of these petrochemical derivatives, with households, manufacturing, construction and mining the most intensive users.
As a result, these sectors are highly exposed to price increases stemming from the energy crisis. As higher costs are passed through supply chains, they are likely to place further upward pressure on inflation, potentially driving already elevated inflation significantly higher in the months ahead.
To understand the economic implications, Treasury modelled two energy‑crisis scenarios for the Australian economy in March 2026.
Importantly, these forecasts only consider the economic effects of rising prices for petrochemicals and assume the physical availability of these commodities is unaffected. Unfortunately, their availability is also a live concern. Australia primarily imports fuels and petrochemical derivatives from refineries in Asia, which in turn rely on oil and gas from the Middle East as feedstock. With these supplies blocked, Asian refinery production levels are rapidly declining, with the peak effects expected to be felt from June. The National Fuel Security Plan[2] issued in mid-March has put in place arrangements for fuel rationing if supply levels fall below required demand.
If disruptions worsen, the effects will ripple through the economy and put millions of dollars in export value at risk. Higher prices are expected to lift freight, agriculture and manufacturing input costs, contributing to broader inflationary pressure as these get passed onto downstream industry and households. Insufficient volumes of supply, and the rationing it would necessitate, would cause activity slowdowns in many parts of the economy. These developments highlight the ongoing vulnerability of Australia’s fuel security and the economic risks posed by external shocks.
The energy crisis will weigh heavily on this year’s federal budget, which is facing mounting spending pressures due to the energy shock. In the early weeks of the crisis, the government has already deployed several targeted assistance mechanisms, including:
Additional crisis-related spending is also expected on budget night. The Treasurer has indicated that cost-of-living relief will be extended to help households impacted by rising inflation, while the fuel excise reduction is likely to be extended beyond June. If the fuel supply situation deteriorates and warrants forms of rationing - as countenanced in levels three and four of the National Fuel Security Plan - then additional industry support is likely to be required. While the full budgetary cost of the energy crisis cannot yet be quantified, it is expected to be substantial, potentially running into tens of billions of dollars per year and continuing for the duration of the crisis.
These additional crisis costs will need to be borne by a federal budget that was already struggling with structural spending pressures. According to the Mid-year Economic and Fiscal Outlook (MYEFO) issued in December, the government projects a deficit of $36.8 billion in 2025-26[6], with structural deficits forecast for the next decade as spending programs outpace revenue.
One of the major drivers of the structural deficit is spending on care functions. These have experienced significant growth in recent years due to policy changes and are anticipated to continue exerting pressure on the budget. Over the coming decade, spending on care functions is forecast to grow by between 5-6% per year (and 7.9% for the NDIS).
In response to rising pressures on care spending, the government has proposed major reforms to the NDIS. These reforms aim to save $15 billion a year, reduce participant numbers by around 160,000, and lower the projected 2030 cost from $70 billion to $55 billion by slowing annual growth to 5%.[7] Under the proposed changes, eligibility for the NDIS would be tightened for both current and new adult and child participants through evidence‑based functional capacity assessments. People with mild to moderate conditions, particularly children, would be shifted to a new Thriving Kids programme co‑funded with the states.
Long-term pressures from care spending alongside the short-term impact of the energy crisis leaves the budget highly dependent on foreign borrowing. National net debt is expected to rise throughout the forward estimates, increasing from 34.8% of GDP ($1 trillion) in 2025-26 to 37.9% of GDP ($1.3 trillion) by 2028-29.[8] At the same time, interest payments on public debt are expected to rise due to mounting debt levels, tighter monetary policy, and increasing geopolitical uncertainty.
Australia’s 10‑year bond yield briefly hit 5%, the highest since 2011, after conflict in the Middle East pushed global oil prices sharply higher.[9] Rising crude oil prices raised fears of fresh inflation, prompting investors to demand higher yields on government debt. Higher yields mean Australia’s future borrowing will become materially more expensive. Economists warn that if higher yields persist, each 0.5 ppt increase could add $4-5 billion to annual interest costs on top of an existing interest bill exceeding $20 billion.[10]
On the revenue side, the energy crisis is placing additional strain on the Commonwealth’s tax base. The decision to halve the fuel excise, initially announced for April and June but highly likely to be extended, will cost around $10 billion per year. Any cost‑of‑living relief delivered through income tax cuts would also materially reduce tax revenues in the coming year.
Compounding fiscal matters, rising fuel prices are also accelerating electric vehicle uptake, contributing to the erosion of the fuel excise tax base. Governments broadly agree that EV road‑user charges will eventually be needed to replace the fuel excise base, but progress has stalled due to disagreement between the Commonwealth and states over whether to adopt a fixed annual charge or a per‑kilometre levy. With this policy not ready for the upcoming budget and further reviews likely, revenue erosion will continue in the short term.
However, the energy crisis is also delivering revenue gains by pushing up prices for Australia’s major exports, including gas, coal and gold. This has generated a revenue uplift, estimated by some at up to $30 billion over two years, as the government captures part of the windfall through higher tax receipts. The net balance between these revenue gains and the fiscal losses associated with the crisis remains uncertain, complicating the near‑term fiscal outlook.
In spite of these uncertainties, the Treasurer has reaffirmed an intention to pursue tax reform in this year’s budget[11]. At the Economic Reform Roundtable held in August 2025, the government outlined three goals for the tax system:
Three parts of the tax system are likely to be in focus:
The federal government has kept all tax reform options on the table, and some movement is likely across all three areas. Initial messaging suggests changes to capital gains tax are likely, although the precise form is yet to be determined, while income and company tax reforms have been extensively canvassed over the past 12 months.
Taken together, current conditions point to a budget shaped by the need to pursue long‑term objectives amid significant short‑term constraints. Elevated uncertainty, rising debt‑servicing costs and expanding spending are reducing the government’s policy flexibility at a time when the energy crisis requires immediate and costly intervention. How the May Budget manages these trade‑offs will be critical to the economy’s capacity to weather the energy crisis and return to stability by 2027.
Hnin Nwe Oo is the Economic Policy Analyst at Australian Industry Group, where she supports the Research and Economics team across a broad range of initiatives. She brings valuable experience in facilitating international trade, most recently at Austrade.
Passionate about economic policy and advocacy, Hnin enjoys collaborating with stakeholders from both the public and private sectors to drive impactful outcomes.
Hnin holds a Master of Business Administration (Strategy) from the Asian Institute of Technology, Thailand.
