People sit on a ledge looking toward the city centre skyline and Opera House in Sydney
People sit on a waterfront ledge looking toward the Sydney city centre skyline and Opera House amidst the easing of the coronavirus disease (COVID-19) restrictions in Sydney, Australia, May 26, 2020. Reuters

Australia's Labor government is set to reveal a vast improvement in the budget bottom line next week as its coffers bulge with tax windfalls, yet the outlook will be a sober one as fiscal challenges loom large.

Treasurer Jim Chalmers has spent weeks using "restraint" and "responsible" to describe his second budget since coming to power in May last year.

There will be some money to offset cost of living pressures, particularly on energy prices, and perhaps a long-delayed rise in unemployment benefits. Chalmers has flagged more support for renewable projects and a ramp up in defence spending with an eye to China's expanding influence in the region.

Yet, he is well aware that too much fiscal largesse could stoke inflation just when the Reserve Bank of Australia (RBA) has aggressively lifted interest rates to fight it.

Instead, the aim is to bank any budget savings, and there are plenty to go around. High prices for Australia's commodity exports have delivered a windfall from mining profits, while job gains boosted income tax and lowered welfare payments.

As recently as October, Chalmers had forecast a deficit of almost A$37 billion ($24.47 billion) for the year to end June 2023. Now, analysts expect it to be closer to A$5 billion.

Indeed, the running 12 month total is actually in surplus, a big deal for a budget that has not been in the black since 2008.

The previous Liberal National government had "Back in Black" mugs made in 2019 when it came within a whisker of a surplus, only for emergency pandemic spending to blow a record-breaking hole in the accounts.

Any surplus would be fleeting, however, given resource prices are well off their peaks and the domestic economy is slowing in the face of decade-high interest rates. The latter have also sharply raised the cost of funding the government's near-A$1 trillion in debt.

Labor has also promised to honour a commitment by the previous government to slash income taxes from 2024/25, cuts that are projected to cost a budget-busting A$254 billion over the first 10 years.

The cuts are not especially popular with the public given the vast majority go to the higher paid, but Labor is loath to break an election promise and seems boxed-in.

More money is needed for healthcare, particularly to fund a national disability scheme, and there are election pledges on childcare and infrastructure.

Defence is set for the biggest increase since World War Two amid plans to spend A$368 billion out to the 2050's on nuclear powered submarines from the UK and United States.

"Spending on interest payments, pensions, medical benefits, defence, aged care and hospitals are all expected to rise consistently above the rate of inflation," said Stephen Halmarick, chief economist at CBA.

"To place the budget on a more sustainable footing over the medium-term will require an increase in revenue flow and/or more spending discipline."

In short, Australia, like most developed economies with aging populations, is finding deficits are the new normal.

($1 = 1.5119 Australian dollars)