On state debt and the financial responsibilities of the federation
By Jason Gay
Australian federalism divides political power between the Commonwealth and the States. That division has advantages. State governments are closer to many of the services people use every day, including hospitals, schools, roads, public transport and emergency services.
Financial responsibility, however, becomes more complicated when eight state and territory governments and the Commonwealth can each create substantial public debt.
From the perspective of an ordinary taxpayer, government debt does not become less real because it appears in a different Budget.
The Parliamentary Budget Office forecasts state and territory gross debt of about $649 billion in 2026–27, rising to approximately $771 billion by 2029–30. Combined with Commonwealth borrowing, total national gross debt is forecast to exceed $2 trillion by the end of that period. State public debt interest payments alone are forecast to rise from approximately $24.7 billion to $35 billion.
Again, these figures do not establish that every dollar of state borrowing is irresponsible. States build infrastructure with long lives, and there are sound arguments for financing some of those assets over time. A railway used by people for fifty years need not necessarily be funded entirely by taxpayers in the year construction begins.
The question is whether the federation needs stronger collective rules around how much debt its governments can create.
This is not an entirely new idea.
Australia’s Constitution already contains an unusual provision dealing specifically with state debt. Section 105A allows the Commonwealth and States to make binding agreements concerning state public debts, including their management, repayment, sinking funds and the borrowing of money by the States or by the Commonwealth on their behalf.
Australia also has a history of attempting to coordinate government borrowing through the Australian Loan Council. Earlier arrangements placed greater emphasis on borrowing limits, although the modern system shifted towards transparency and financial-market discipline. Loan Council Allocation reporting requirements were subsequently removed from the Uniform Presentation Framework in 2019.
The constitutional architecture therefore already recognises that state borrowing can become a national matter.
A stronger fiscal system could revive that principle in a modern form.
At its strictest, the rule might prevent States from independently creating new net debt. Borrowing for approved purposes would instead occur through a national process. A State wanting to finance major infrastructure would present the project, financing requirement and repayment plan for assessment.
That is a significant restriction upon state autonomy and should not be treated lightly.
States are sovereign governments within their constitutional areas of responsibility. If the Commonwealth effectively controlled their access to capital, it could gain enormous practical influence over state policy. A Commonwealth government hostile to a particular State could potentially use financing arrangements as leverage.
Any national borrowing framework would therefore need to be protected from Commonwealth political control just as firmly as it was protected from state political pressure.
The Independent Fiscal Commission proposed in earlier papers could play a role. Rather than Canberra deciding whether Queensland, Victoria or Western Australia was permitted to borrow, an independent process could apply nationally agreed criteria.
Those criteria might distinguish between recurrent and capital expenditure. Borrowing to meet an ongoing wages bill is fundamentally different from borrowing to construct an asset expected to serve the public for generations.
The rules might also consider the financial return or wider economic benefit of infrastructure, the State’s existing debt position, its capacity to meet repayments and the effect of borrowing across the federation as a whole.
There is also the question of foreign borrowing.
Global capital markets are interconnected, and Australian governments issuing securities cannot realistically guarantee that every ultimate holder of that debt will be Australian. A simple prohibition on any foreign ownership of public debt would therefore be difficult and potentially counterproductive.
A more practical principle would concern who may create the obligation and on what terms. States should not independently enter financing arrangements that create unusual sovereign obligations to foreign governments or expose taxpayers to unnecessary currency, refinancing or geopolitical risks without national scrutiny.
The aim should not be economic isolation. It should be financial coordination.
There is a further argument for national oversight. The Commonwealth already plays an enormous role in state finances. Federal financial relations account for a substantial share of Commonwealth spending and state revenue, supporting services including health, education, infrastructure and community programs.
The financial affairs of the two levels of government are therefore already intertwined.
A State experiencing serious fiscal difficulty would not exist in a vacuum. Pressure would inevitably arise for Commonwealth assistance. That creates what economists sometimes describe as a moral hazard: if one government expects another ultimately to help carry the consequences of excessive borrowing, the incentive for restraint can weaken.
A strong system would try to deal with that risk before a crisis rather than during one.
Yet state borrowing rules must also avoid the opposite danger. If States are unable to finance worthwhile infrastructure, Australia could underinvest in transport, hospitals, water, energy and other assets. Poorly designed debt restrictions can be just as damaging as excessive borrowing.
This again argues for rules based upon purpose and sustainability rather than a simplistic belief that all debt is identical.
The objective should be a federation in which each level of government can perform its constitutional responsibilities but no level can quietly transfer unlimited financial obligations to future Australians.
The Commonwealth and States are politically separate governments.
They are not financially separate peoples.
A Queensland taxpayer, Victorian taxpayer or Western Australian taxpayer is also an Australian taxpayer. Whatever name appears at the top of the bond, the resources required to service public debt ultimately come from the same national economy.
A mature federation should therefore be capable of discussing public debt as a national responsibility.
Federalism divides power.
It should not divide responsibility.
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