Jim Chalmers pushes ambitious budget as Middle East war fuels inflation

War in the Middle East is threatening to push inflation in Australia above 5 per cent, as Treasurer Jim Chalmers argues the turmoil only strengthens the case for bold budget reforms.

New Treasury scenarios warn that surging oil prices and broader disruptions will drive up costs and slow economic growth, with the conflict leaving Australia's economy smaller for years if it drags on.

In an address in Melbourne on Thursday, Mr Chalmers will outline how the May federal budget will respond to the crisis with a focus on "substantial" savings, productivity and tax changes to make the system fairer for younger Australians.

Mr Chalmers stressed that rising global volatility demands "more reform, not less," according to an advanced copy of the speech seen by the ABC.

War could push inflation above 5 per cent

Mr Chalmers said Treasury had modelled a shorter term and "more prolonged" scenario for oil prices, with a third more "drastic" possibility still under development.

The first scenario assumed oil prices stay at $100 per barrel until mid-year and then gradually return to pre-conflict levels by December, while the second assumed a peak of $120 per barrel that took three years to recover.

Mr Chalmers said inflation would peak 0.75 per cent higher in the short-term scenario and 1.25 per cent higher in the prolonged one.

"It means the prospect of inflation peaking in the high fours or even higher this year is very real," he said.

In the short-term situation, Australia's economic output, known as Gross Domestic Product (GDP), would be 0.2 per cent lower around mid-year, but recover "quickly".

In the second scenario, Treasury estimated GDP would be 0.6 per cent lower in 2027.

Mr Chalmers signalled the government would have "more to say" about its plan for fuel security "in the coming days".

Fuel security and the broader impacts of the Middle East conflict will be the focus when state premiers, territory chief ministers and Prime Minister Anthony Albanese meet for a national cabinet on Thursday morning.

Spending cuts to 'make room' for private spending

Mr Chalmers said the government's budget preparations were focused on three "ambitious" reform packages on savings, productivity and taxes.

He said the reforms were being "designed to work together" with savings to "make even more room" for the private sector to grow, as well as reduce the budget deficit.

The Reserve Bank has pointed to higher-than-expected private sector spending as a factor in the board's decision to hike the cash rate, which rose to 4.1 per cent on Tuesday.

The Coalition has linked this to government spending, arguing Labor must stop "pouring" public funds into the economy.

Shadow treasurer Tim Wilson said on Wednesday that public spending was "crowding out" the private sector.

"What we need is a treasurer who's going to take responsibility, control spending and make sure that he's not actively stoking an inflation agenda, as he is right now, because Australians are paying it through $27,600 a year more on the average mortgage," Mr Wilson said.

In his speech, Mr Chalmers argued the government had already made a "lot of progress" on budget sustainability since taking office, including $114 billion of savings and re-prioritisations.

But he acknowledged more must be done over the next four years and through the medium term, signalling "substantial savings options" were being worked on for the May budget.

"This will build on the savings we've made to date, addressing some of the fastest growing structural spending pressures and making difficult decisions in other areas," he said.

Tax changes to focus on intergenerational fairness

On productivity, Mr Chalmers said the government was implementing a sustained effort to unlock investment in three key areas of housing, the net zero energy transition and AI infrastructure.

He also said tax reform was an "important part" of Labor's productivity agenda.

"We are working on more tax reform in the budget — how much we can do in May depends on fiscal considerations, international developments and cabinet deliberations," he said.

Mr Chalmers said tax policy would be guided by "clear principles," including how the current "outdated" system unfairly weighed on younger Australians and future generations.

"Any changes would have a substantial focus on our intergenerational responsibilities," he said.

Mr Chalmers said reform would also focus on "better incentivising productive business investment," but only "if we can afford to".

Lastly, he said tax changes would aim to make the system "simpler and more sustainable".

A Senate committee report on the operation of the capital gains tax system appeared to pave the way for Labor to pare back discounts that the short inquiry found skewed home ownership toward investors.

Middle East war reason to 'go further' on reform

Mr Chalmers said the conflict in the Middle East showed how quickly the global economic outlook could change.

"But it is also a stark reminder of why addressing our three key economic challenges is so urgent," he said.

"All this economic uncertainty and volatility is a reason for more reform, not less.

"It's a reason to go further, not slower."

Mr Chalmers argued Australia approached those challenges from a "position of strength" with an enviable labour market, world-leading super system and "abundant natural advantages" in energy and resources.

"But we are not complacent about the risks in a global economy that is perilous and unpredictable," he said.

"We will make hard decisions in May."

Mr Chalmers said the government's task was not just to respond to shocks, but to position Australia to "succeed through them".

"It will be an ambitious budget because ours is an ambitious government, and this is an ambitious country," he said.