Cost of cigarette excise collapse passes $50 billion as income taxes prop up budget

More money will be spent trying to crack down on the nation’s burgeoning illicit tobacco industry as the cost to federal taxpayers of the collapse in cigarette excise passes $50 billion, contributing to a budget deficit that will take at least a decade to turn around.

The 2025-26 mid-year budget update, released on Wednesday by Treasurer Jim Chalmers and Finance Minister Katy Gallagher, shows this year’s deficit will be $5.3 billion lower than they expected when the budget was released in March.

At $36.8 billion, this year’s deficit is still almost four times the shortfall of 2024-25.

A surge in taxes on working people, companies and superannuation accounts contributed to the improvement, which over four years still leaves cumulative deficits of $143.3 billion compared to the $151.9 billion predicted by the government before the election.

Each deficit is slightly smaller than previously expected, thanks largely to stronger tax collections.

In the current year alone, personal income tax has been revised up by $8.2 billion to a record $357.9 billion, while company tax is expected to raise $144.7 billion, a $4.3 billion lift on the budget forecast.

Over the next four years, personal income tax revenue has been revised up by $17.4 billion, while an additional $12.4 billion is expected from the business sector.

But the update also revealed the fiscal disaster created by bipartisan changes to tobacco taxation. Last week, the nation’s illicit tobacco tsar revealed half of all cigarettes are now illegal as smokers seek to avoid high excise rates, which in September reached $1.50 a stick.

Since 2018-19, when changes to excise collection were expected to lift tax collection by a third, the total collapse in forecast excise has now reached $50 billion.

In Josh Frydenberg’s final budget in early 2022, he forecast tobacco excise to raise $13.6 billion in revenue this financial year. Chalmers is now expecting it to be just $5.5 billion, a 20-year low, before falling to $4.4 billion by 2028-29.

So large is the collapse that last year’s budget would have almost been in surplus if not for shortfall in tobacco excise.

The treasurer rejected the calls by some experts for the government to reduce cigarette excise to help reduce the incentive for organised criminals to sell excise-free cigarette.

But he signalled more assistance, on top of the $350 million in extra funding for compliance programs, would soon be forthcoming.

“We understand that we will need to do more than the $350 million that we have provided the law enforcement agencies. We’ve been in discussions with [Home Affairs Minister Tony] Burke and others,” he said.

Government policy changes made the budget $1.9 billion worse off this financial year, but this was offset by an extra $7.3 billion delivered by the stronger-than-expected economy. Over the next four years, government policy improves the budget by $2.2 billion.

The improvement, however, will not transpire into a budget surplus any time soon. The government is still forecasting it to remain in deficit until 2035-36.

EY senior economist Paula Gadsby said the figures showed spending is growing faster than expected revenue over the next four years, keeping the budget in the red.

“Australia’s governments collectively have a spending problem, not a revenue problem. Failing to bring expenses and revenue back into balance means a higher debt burden and less flexibility to deal with future problems,” she said.

In March, gross debt was expected to reach $1.02 trillion, but the update forecasts it will be $993 billion at the end of 2025-26.

The lower debt delivered an $816 million saving this financial year on interest payments and an expected $1.7 billion by 2028-29.

As a share of the economy, government spending is slightly lower than had been forecast at 26.9 per cent. Outside of the pandemic, it is the highest share of the economy since 1986-87.

Government revenue as a share of the economy has been revised up to 25.7 per cent from 25.5 per cent, just 0.1 percentage point lower than was recorded in 2024-25.

It is expecting a $770 million saving this year, and $3.4 billion over the next four years, from lower-than-forecast payments through the fuel tax credit system.

Other savings include changes to the government’s home battery program, worth $6.7 billion over the forward estimates, cuts to external labour and travel (worth $6.8 billion), updating the expected returns on assets held by retirees ($1.9 billion) and a re-profiling of payments out of the Housing Australia Future Fund ($743 million).

The update revealed extra spending including support for Glencore’s Mount Isa copper smelter and the Whyalla steelworks ($491 million) and its revamped superannuation changes targeting low-income earners ($476 million).

The CSIRO, which last month announced cuts of up to 350 research jobs, has been delivered an extra $233 million over this year and next.

Deloitte Access Economics lead partner Pradeep Philip said the government’s focus now had to be on the May budget, which Chalmers has already signalled will drive a series of productivity-enhancing reforms.

“The mid-year update shows that the government in the May budget must create more headroom to make the budget more sustainable and to deal with looming risks [from geopolitical shifts] and unforseen circumstances,” he said.

“Defence spending, national and cybersecurity loom large.”

The Treasury has downgraded expectations for economic growth for the next financial year, slicing GDP from 2.5 per cent to 2.25 per cent.

It has sharply lifted its inflation expectations, from 3 per cent for 2025-26 to 3.75 per cent before easing to 2.75 per cent by the middle of 2027.

The higher inflation means the Treasury is expecting real wage growth, which has been positive for almost two years, to start going backwards this year and into next year.

Unemployment has been revised upward, from 4.25 per cent to 4.5 per cent over the next two years.

Cut through the noise of federal politics with news, views and expert analysis. Subscribers can sign up to our weekly Inside Politics newsletter.