The issue for Australian governments is spending, not revenue. Their approach to fiscal discipline appears increasingly loose. We now question whether many states have exceptionally strong financial management on a global scale.

State budgets are under pressure from a slowing economy, rising community expectations, and increasing infrastructure needs. If these conditions worsen or fiscal discipline weakens, credit quality may decline. The rising likelihood of this occurring was the behind our decision to revise the outlooks on the Government of Australian Capital Territory (ACT), the State of New South Wales (NSW), and the State of Tasmania (Tasmania) to negative from stable between September and November 2024.

While states have high credit ratings and have collected record tax revenues since the pandemic, they have failed to rein in pandemic-size spending, choosing instead to prioritize voter-friendly expenditures.

S&P Global Ratings recognizes that some spending is essential due to inflation and to cater for the country's growing population.

This report examines the performance of state finances since the onset of the pandemic in fiscal 2020 and fiscal 2023. Given forward estimates in budgets cover four years, it isn't possible to compare the most recent 2024 outcomes with pre-pandemic expectations.

Table 1

Operating Revenues Have Boomed Since The Pandemic

Total state operating revenues were A$146 billion higher than states budgeted for prior to the pandemic in their 2019-2020 budgets (see chart 1 and 2). That's enough to fund the construction of Victoria's East and North Suburban Rail Loop sections, the North-East Link, and Melbourne Metro with change left over. For Sydneysiders, it would have funded NSW's entire infrastructure spend over the past six years or another seven Sydney Metro lines.

Total operating revenue growth in 2024 suggests this trend will continue.

Chart 1

Chart 2

Most of this outperformance came in fiscals 2022 and 2023 when revenues were almost 20% (A$138 billion) higher than the states expected. Strong iron ore and coal prices, conveyance duties and employment growth drove state royalties and taxes substantially higher. Meanwhile, high inflation also bolstered states' budgets, with a sharp rise in goods and service taxes (which the federal government collects and passes on to the states as grants).

Surprisingly, given pandemic lockdowns and the huge economic and fiscal consequences, operating revenues were higher in fiscals 2020 and 2021 than the states predicted prior to the pandemic. This was mainly thanks to the State of Western Australia (Western Australia) and its iron ore bounty, which more than offset revenue contractions in many other states such as the State of Victoria (Victoria).

Unsurprisingly, there was a clear difference between commodity haves and have-nots. Western Australia and the State of Queensland (Queensland) accounted for two-thirds of the budgetary overperformance, largely thanks to higher royalty revenues (see chart 3).

Chart 3

Western Australia's revenues between fiscals 2020 and 2023 were A$48 billion higher than forecast prior to the pandemic, with Queensland coming in a close second with A$47 billion of additional revenues thanks to record coal prices. Queensland's outperformance was extreme in fiscal 2023, with revenues more than A$30 billion above pre-pandemic expectations. This 40% boost to revenues (relative to pre-pandemic budget) delivered Queensland the largest operating surplus by a state in history, according to media reports.

Non-mining states didn't miss out. They still benefited from domestic economic conditions. Revenues were A$50 billion greater than predicted between fiscals 2020 and 2023. This outperformance came in the post-pandemic boom. Revenues climbed A$58 billion in fiscals 2023 and 2024, after contracting by A$8 billion in fiscals 2020 and 2021. Revenues in fiscal 2023 were about 22.5% higher, on average, than states' pre-pandemic forecasts.

NSW pulled in a collective A$29 billion more between fiscals 2022 and 2023 than it expected after breaking even in fiscals 2020 and 2021. This was almost triple that of Victoria (A$11 billion) over the four-year period. Victoria's budget, though, included a large one-off A$7.9 billion asset transaction from its joint venture agreement with VicRoads. Without this, Victoria's revenues were just 5% (or A$3.3 billion) higher over the four-year period. That would have placed Victoria below the State of South Australia (South Australia) in terms of revenue outperformance, despite South Australia's much smaller economy and population.

Victoria's sluggish performance highlights the shock the pandemic and multiple government-imposed lockdowns caused in fiscals 2020 and 2021. Victoria's revenues contracted by A$8.3 billion (or 5.8%) during these years when compared with its pre-pandemic forecasts. For reference, the Northern Territory (a much smaller economy) experienced the second largest contraction over this period, with revenues falling less than $0.2 billion (or 1.5%).

The outlier for strong revenue outperformance over the past four years was ACT. Its revenues fell by A$0.1 billion (or 0.4%) compared with its pre-pandemic expectations. More accurate or generous forecasts in the 2019-2020 budget than other states may explain this. Another reason might be that its GST (Goods and Services Tax) share was lower in the fiscal years 2021 and 2022 than what it had expected.

Spending Soars

States continue their spendthrift ways. States insist they are making "difficult decisions" or "hard choices". At the same time, spending continues to rise rapidly, and new projects are regularly announced. This suggests the focus is more on determining the amount of spending and borrowing, rather than identifying savings. Some states still blame the pandemic; while others point fingers at the "cost-of-living" crisis, or others like the central bank.

Spending soared at the onset of the pandemic when interest rates fell to record lows, and states chose to support their economies and households to avoid large and prolong recessions.

That was 2020, this is 2025. Many governments continue to borrow and spend at rates similar to those seen at the height of the pandemic. The consolidated fiscal cash deficit in 2024 was budgeted to be larger than that delivered at the height of the pandemic in fiscal 2021. The pandemic is over, but pandemic-size budgets aren't.

A prime example was the 2024-2025 Queensland budget which contained generous measures such as A$1,000 energy rebates, 50 cent public transport fares, 20% discount on car registration, and concessions for new first homeowners on stamp duty. The election debate saw even more lavish promises. These included the continuation of fare discounts, free school lunches, and state-owned petrol stations if the former government was re-elected.

Similarly, Tasmania is entering its largest spending period in its history. The Government estimates its operating margins will move into deficit in fiscal 2025. Its infrastructure spending rose by 60% in fiscal 2023, and its fiscal cash deficit is budgeted to almost triple between fiscal 2022 and 2025.

Victoria continues to use its growing revenues from new taxes like its Covid debt levy to fund new spending. Higher operating and capital expenditure are also delaying its forecasted fiscal consolidation.

The ACT hasn't returned its cash operating position to surplus since the onset of the pandemic because it continues to focus on what it refers to as the community's well-being.

The relaxed approach to fiscal consolidation is causing us to increasingly question our views that many states have exceptionally strong financial management on a global scale. While politically appealing, higher spending is increasing credit risk across the country, reducing headroom to address shocks. This underpinned our decision in late 2024 to revise to negative from stable the outlook on three states. During this period, we lowered our financial management assessment of ACT and Tasmania; our outlook on the rating on NSW reflects risks to its financial management assessment.

In fiscal 2023, operating expenses in Victoria, NSW, Queensland, Western Australia, and Tasmania increased by 21% to 26% compared with their pre-pandemic expectations. Northern Territory was the best performer compared with its budget. Operating expenditure rose by 5%, followed by ACT by 9%, and South Australia by 13%.

New spending has engulfed strong revenue growth. Between fiscals 2020 and 2023, total state operating expenses were about A$212 billion higher than states budgeted for prior to the pandemic in their 2019-2020 budgets (see chart 4 and 5). In other words, states spent A$66 billion more than they collected in additional revenues during the four years to fiscal 2023. This drove a large hit to operating margins (see chart 6).

Chart 4

Chart 5

Chart 6

Understandably, operating expenses rose by A$61 billion in fiscal 2020 and 2021 as states fought the spread of COVID-19, increased health spending, and supported communities and businesses that were suffering during lockdowns and closures. In fiscal 2022, spending shot up even higher, by A$78 billion more than states expected, as NSW and Victoria imposed additional lockdowns and some governments entered election mode.

Unlike many subnational governments around the world, Australian states haven't slowed their spending since the pandemic. Operating expenses in fiscal 2023 were still A$73 billion more than pre-pandemic expectations. Cost-of-living pressures during tight elections, public wage negotiations and rising headcounts, and ballooning populations have further squeezed operating accounts in recent years.

Victoria Has Led The Way In Outlays

Victoria's operating expenses were A$69 billion (or 20%) higher over fiscals 2020-2023 than its pre-pandemic expectations. NSW spent A$56 billion (or 14%) more. Both states were more affected by the pandemic than other states due to their self-imposed lockdowns. While these decisions may have saved lives, they came at a cost, which is still being felt. We lowered Victoria's financial management assessment in late 2020 when the initial estimates of the cost of the pandemic became clearer. This contributed to our decision to downgrade it by two notches to AA from AAA.

Despite coming through the pandemic relatively unscathed, Queensland and Western Australia still increased spending by about A$34 billion (or 13%) each during this period. This hasn't affected our financial management assessments. Unlike other states, Queensland and Western Australia's net position was still better off because they recycled their ample royalty revenues into new initiatives. Further, we viewed Queensland's financial management as weaker than that of several other states prior to the pandemic due to historical spending and its higher debt levels.

In addition, the conservative commodity price forecasts adopted (notably Western Australia and Queensland when forecasting commodity prices) can themselves be an indicator of financial management. Using conservative forecasts can help to keep spending demands by ministers in check. This also avoids repeating the mistakes of the central government after the 2008 global financial crisis when overly optimistic commodity forecasts were repeatedly revised down.

In saying this, Queensland's 2024-2025 budget released in the lead-up to the October 2024 election estimated its operating expenses rose by a massive by 51% between 2019 and 2024, far outstripping all other states. Queensland's expense growth over this period was almost 20% higher than the second place ACT. We expect Queensland to strongly curtail this growth over the next few years. Failure to do so could increasingly squeeze the 'AA+' issuer credit rating we have on it.

Wages Don't Explain Rising Costs In the Past

Employee expenses and headcounts have surged, but they aren't the main reason behind the cost escalation between fiscals 2020 and 2023 (see chart 7). Total employee expenses rose by about 20% during this period--twice as much as forecast in pre-pandemic budgets. While this increase compared with pre-pandemic budgets is significant, it may be overstated. Many states have undisclosed provisions or contingencies categorized under "other expenses" to avoid revealing their positions before negotiating agreements.

Between fiscals 2020-2023, total employee expenses for the states exceeded budget by A$31 billion (or 6%). This accounted for just 14% of the A$212 billion of additional operating expenses during this period. Victoria, Tasmania, and ACT saw the largest increases in employee expenses since the pandemic.

Wage pressures are building. We see downside risk from heated, ongoing wage talks. In 2024, several unions secured multi-year deals, with annual hikes exceeding 4%-5%, while others threaten strikes if their demands are not met. NSW abolished its wage cap which led to several generous wage agreements, and is adding pressure from unions seeking more. In fiscal 2024, ACT, Queensland, Tasmania, and NSW's employee expenses rose by 10%-15%.

Chart 7

Booming Population Requires Infrastructure Investment

Prior to the pandemic, states expected infrastructure spending to peak at A$64 billion in fiscal 2020. They now forecast it to breach A$100 billion in both fiscals 2025 and 2026. The onset of the pandemic saw infrastructure delays as states entered lockdowns and supply chains were constrained. In fiscal 2020, infrastructure spending was A$10 billion (or 17%) below budget. This trend reversed in fiscal 2023, where infrastructure spending was A$28 billion (or 53%) higher than pre-pandemic forecasts; and capital expenditure delivery was overbudget by about 3%.

The change in attitude to infrastructure spending came during the pandemic when states sought to support economies, and gained access to cheap money. This didn't impinge on our view of financial management at the time. It made sense to spend on productive enhancing infrastructure when interest rates were low, and prevent a worse economic slump.

The cost of some projects, however, blew out for various reasons. These include the rising cost of labor and materials, supply chain issues, unforeseen geotechnical obstacles, and poor budgeting by states that committed to projects before they were fully costed or accurately scoped.

There is little appetite among states to reassess projects yet to be started because cost have spiked and interest rates are high. New business cases could weaken the case to deliver some projects. Some states have relied on out-of-date costings to justify the perceived net benefits. Cost blowouts that highlight poor budgeting and governance practices could affect our view of financial management.

We believe much of the new infrastructure being rolled out, but not all, has become necessary to cater for Australia's booming population and to support the energy transition.

Cash Deficits Have Widened By A$100 Billion, Borrowing Needs Remain High

Higher operating expenses and infrastructure spending have driven cash deficits A$101 billion wider between fiscals 2020 and 2023 than pre-pandemic forecasts (see chart 8). Cash deficits are important. They provide an accurate and objective reflection of the overall borrowing needs of a state and show its true financial position.

Chart 8

Cash deficits and rising debt levels do not necessarily indicate poor financial management by states. These trends are typically viewed negatively from a credit rating perspective if driven by operating expenses. They suggest governments are borrowing to cover everyday costs like social welfare, wages, utilities, rent, and interest. However, they do not inherently reflect mismanagement.

Jurisdictions like Australia generally run cash deficits as states are responsible for most of the country's public infrastructure, and the central government maintains corporate and personal income tax powers. Infrastructure spending that supports population growth and grows the productive capacity of an economy would generally be credit positive. If rising fiscal deficits stemmed from cost blowouts and poor budgeting, our view would differ.

Higher operating expenses than states expected have been the main driver of widening cash deficits. Operating expenses contributed about A$66 billion (or two thirds) of the wider deficits between fiscals 2020 to 2023. Infrastructure expenditure was about A$39 billion higher than pre-pandemic budgets over this period.

The lax approach to fiscal consolidation manifests in the repeated delays in the forecast narrowing of cash deficits (see chart 8 above). Compared with the 2020-2021 pandemic budgets, which outlined how states planned to move on from the pandemic, states forecast the consolidated cash deficit in fiscal 2024 to be 50% higher. It is not until fiscal 2028 that states expect to achieve the A$40 billion deficit they forecast would occur in fiscal 2024.

Western Australia and Queensland were standouts, with stronger than predicted cash balances from fiscals 2020 to 2023. Western Australia was the only state to record, on average, cash surpluses during this period. It was also the only state that lowered debt levels during this period, in this case by 10%.

Victoria's debt levels more than tripled between fiscals 2020 and 2023 (see chart 9). NSW's debt increased 263%, with the other states increasing 125%-150%. By the end of the forward estimates in fiscal 2028, Tasmania (440%) expects to increase its debt by proportionally more than Victoria (420%) since fiscal 2019.

In nominal terms, gross debt could roughly triple between fiscals 2019 and 2028 to reach about A$850 billion.

Chart 9

Fiscal Discipline Will Be Key To Rating Trends

The key reason behind our three negative outlooks on Australian states is weakening financial management. Rising expenses and the prolonged fiscal recovery, especially in operating accounts, is reducing headroom in these state credit ratings.

States could be entering a second round of rating actions following those related to the pandemic. The average state rating could fall closer to 'AA' than 'AA+'. Even if this occurs, state ratings will still be very high on a global scale.

Editor: Lex Hall

Related Research

• Subnational Government Outlook 2025: Australian States Face Budgetary Backslide, Jan. 22, 2025
• Research Update: New South Wales Outlook Revised To Negative On Delayed Improvement In Budgetary Performance; 'AA+/A-1+' Ratings Affirmed, Nov. 27, 2024
• Research Update: Australian Capital Territory Outlook Revised To Negative On Weakening Fiscal Controls; 'AA+/A-1+' Ratings Affirmed, Sept. 11, 2024
• Research Update: State of Queensland 'AA+/A-1+' Ratings Affirmed; Outlook Stable, Sept. 9, 2024
• South Australia (State Of), Sept. 2, 2024
• State of Western Australia 'AAA/A-1+' Ratings Affirmed; Outlook Stable, Aug. 26, 2024
• Research Update: Australian State Of Victoria 'AA/A-1+' Ratings Affirmed; Outlook Stable, July 29, 2024
• Tasmania (State Of), June 12, 2024