NSW state budget preview: the property tax canary in the coal mine

NSW is the only state still suffering from fiscal long COVID, and a slowing property market threatens its long journey back to surplus.

Pity the NSW Budget’s bottom line. It’s the only state budget still suffering from fiscal long COVID, with 8 years of successive operating deficits. Now Treasurer Daniel Mookhey faces fresh challenges in the form of cost-of-living pressures and a slowing property market.

NSW is Australia’s big property state – the one which relies most on stamp duty revenue, so it’s also where economists, journalists and politicians will be taking a reading on the likely fiscal impact of rising interest rates and tax changes announced in the federal Budget.

Timing, as they say, is everything – even for state Treasurers.

It’s a salient lesson in the downside of long, gradual fiscal recoveries. The longer the path of recovery, the greater the chance something unforeseen will disrupt it before full health is restored. Treasurer Mookhey’s Budget plans have hit two material disruptions.

The first is renewed cost-of-living pressure in an election year. Petrol prices and interest rates are taking their toll on household budgets. The Treasurer has noted that NSW residents, with their larger than average mortgages, are harder hit by the Reserve Bank’s recent hikes to the cash rate than homeowners in other states.

The second disruption is revenue write-downs, due to the slowing property market. In a recent speech to the McKell Institute, the Treasurer outlined a $5 billion reduction in estimated stamp duty revenue over the next four years. To this he added a $3 billion write-down of land tax.

Coal royalties could make up some of this ground, and payroll tax collections will be up. But not enough to offset the property tax weakness.

But there is good news. While the NSW budget has yet to emerge from the deficit it went into as the pandemic hit, there are signs of progress. The likely 2026-27 deficit of around $1 billion should be less than half the 2025-26 figure. It is all part of the long, hard journey back to a surplus in 2027-28.

The property tax roller-coaster

NSW is the epicentre of property market volatility. The state gets 10 per cent of its revenue from stamp duty on land transfers. Property taxes have been climbing as a share of the overall tax take.

Stamp duty is particularly volatile because it is a transaction-based tax. Tax revenue can rise and fall with property prices but is also extremely sensitive to the volume of transactions. Both these variables are working against the NSW Treasurer.

Sydney and Melbourne are leading the current price falls. And even before the federal Budget, 2026 was looking like the weakest in at least the last 5 years for property sales.

December’s Half-Yearly Review revised stamp duty upwards for the 2025-26 year, with revenue around 15 per cent higher than the year before. The same document forecast a further $800 million increase in the coming 2026-27 year. Tomorrow’s Budget will change all of that. Revenue will likely be substantially down in the coming year, with longer term revenue effects as any future recovery comes off a lower base.

The key question the NSW government will be mulling over is whether these changes are transitory or permanent. As e61 board member Guy Debelle put it last week, betting against the Australian housing market has famously been a fool’s errand. But after 15 years of cheap debt post-GFC, we could now be seeing structural headwinds to the housing market. That could threaten one of NSW’s key revenue sources going forward.

It’s far too early to predict the impact of the federal government’s proposed changes to CGT on the NSW housing market. At this point in time, when the changes have yet to be legislated and implemented, it all comes down to perceptions and mood. But as any realtor will tell you, confidence can play an important role when it comes to the property market.

GST adds another layer of uncertainty

The share NSW gets from the GST can fluctuate in ways that are hard to predict. A State’s share of the GST is in large part determined by what happens in other States. In that sense, all States are exposed to the vagaries of commodity prices and royalty revenues in Western Australia and Queensland via the GST formula.

NSW’s GST relativity is forecast to fall from 0.86 in 2025-26 to 0.82 in 2026-27. This means NSW will receive 82 cents for every dollar it would get if GST were distributed to states based on population alone. These reductions are driven by the Commonwealth Grants Commission’s (CGC’s) assessed decrease in NSW’s spending needs post-COVID, as well as a period of falling commodity prices tempering WA and QLD’s revenue raising efforts in recent years (noting that the CGC formula operates with a lag).

In time, the NSW share might rise again, reflecting the fall in stamp duty revenue as well as the rise in mining royalties in other states. But that will take time and is notoriously hard to predict. And, of course, the whole approach to GST distribution could change, informed by the Productivity Commission’s current review.

Steadily rising spending pressures

The great mismatch in state budgets is between these volatile, unpredictable revenue sources and steadily rising spending pressures. Large chunks of revenue can seem to disappear overnight. But spending pressures are ever-present, stubborn and constantly growing.

In the federal Budget, payments swing with the economic cycle. A strong labour market leads to lower outlays on unemployment benefits; high income growth reduces other means tested payments. For states, the spending drivers are predictable but unrelenting. Population growth and public sector wage costs make it hard to deliver spending growth much below 4 per cent per annum on a consistent basis.

If there is a formula for budget sustainability at the state level, it is keeping spending growth below revenue growth for a sustained period. Estimating what ‘average’ revenue growth will be – in a world of stamp duty, coal royalties and GST shares – is part of the challenge.

A reasonable rule of thumb for our largest states is to keep spending growth consistently below 5 per cent per annum. NSW achieved that for seven years, from 2010-11 to 2016-17. This helped get the operating surplus as high as 1 per cent of Gross State Product. Then COVID happened.

The good news is that Treasurer Mookhey has placed a lot of emphasis on spending growth. And he has some early results to show for it. In 2023-24, spending growth was 3.8 per cent. In 2024-25, it was lower still at 1.8 per cent.

Spending growth for the current financial year will most likely nudge, or slightly exceed, the 5 per cent mark. Beyond that, the Budget will project unrealistically low spending growth numbers for future years, as all state budgets do. But so far, the hard numbers (actuals, not forecasts) tell a positive story for NSW.

Unfortunately, the challenge of maintaining spending discipline will not get any easier. Cost-of-living relief aside, the biggest driver of spending pressure is the ageing population. NSW is old relative to the national average and is continuing to age further. The NSW Government’s own long-run estimates suggest health care expenditure will rise from 29 per cent of spending to 38 per cent in 2061.

The CGC assesses that by virtue of its age structure, NSW needs to spend more on health than Victoria to deliver equivalent service levels. On the other hand, NSW needs to spend less than other states to deliver equivalent services because of its relative size and urban concentration.

A comparison of these assessed amounts (what each state would need to spend to deliver the average service) and the amounts spent, suggests NSW is the lowest cost deliverer of health services of any State by a wide margin.

On this measure, NSW spends about $570 less per person on health than an adjusted state average, while Queensland spends $365 per person more. NSW will need to maintain that cost advantage if it is to successfully manage health spending pressures into the future.

Even absent demographic pressures, health costs are likely to rise because of wages, new technology and public expectations about quality and access. Previous work by e61 and McKinnon demonstrated that health spending pressures tend to rise as a share of the economy, as the population ages. Revenue generally does not.

The long journey to fiscal recovery

Treasurer Mookhey has said that tomorrow’s Budget will be about relief and reform. His challenge is to get the balance right between those two, in an election year with dwindling property revenue.

But there is a third ‘R’ that is arguably more important still – recovery. Specifically, the long and gradual recovery of the Budget from NSW’s unique case of fiscal long COVID.

Despite still being in operating deficit, NSW is arguably better positioned than any state other than Western Australia. Its debt to GSP is relatively modest at around 14 per cent and likely to start falling from next year. The mega projects funded by asset recycling are essentially complete, allowing the capital program to fall back to around 2 per cent of GSP – something more like business-as-usual levels.

And the Treasurer has an emerging track record on spending restraint.

With continued spending discipline, despite revenue write-downs, and structural spending pressures, tomorrow’s Budget can still credibly chart a course back to relative fiscal health in the next two years.

Whether events unfold as the Budget predicts is another question. It depends partly on whether the developing property market weakness is a cyclical event, or a structural break. Working out whether the hits to revenue are just head colds or something a little more serious will be Treasurer Mookhey’s ongoing challenge.