Mr Costello said his budget aimed to help "middle Australia", although the measures included lowering the country's top tax rate from 47 percent to 45 percent.
Government coffers were full from record tax revenues fed by high employment and a boom in profits for Australia's big mining companies.
It's the government's ninth surplus and with debt eliminated the
Treasurer says interest payment savings of A$8 billion a year can be sunk into physical and intellectual infrastructure.
"This is a budget which will build opportunity for the future," Mr Costello told parliament as he unveiled the next-to-last budget before the next national elections in 2007.
He outlined A$36.7 billion in personal tax cuts over four years that he said would benefit more than 80 percent of Australians that will create four marginal tax rates of 15, 30, 40 and 45 cents.
Another A$3.7 billion would be slashed from business taxes over the same period.
Strong growth
Mr Costello predicted the Australian economy would break the A$1 trillion mark in the coming financial year as growth and retail spending pick up. He also said economic growth will quicken to 3.25 percent.
"Australia's impressive economic performance of the last decade is set to continue," he said.
"For the first time, in 2006-07, the Australian economy will grow to A$1 trillion."
Inflation should come back from its current three percent to
2.75 percent, wages should increase around four percent, unemployment is likely to hit 5.25 percent and employment growth should slow to one percent.
The current account deficit is expected to stretch from $56.25 billion to $62.5 billion. Part of that is due to the surge in commodity prices, which climbed 10 percent in 2005-06, coming to an end.
Superannuation overhaul
Another key plank in this year's budget is a plan to simplify and streamline superannuation from next financial year.
Under the government's plan super will evolve from a retirement incomes policy to show more of the hallmarks of a savings policy with people over 60 years of age paying no tax on their superannuation income.
The plan also included hundreds of millions of dollars in extra family benefits and payments, including $248 million in incentives to encourage couples to have more children in a bid to counter a falling birth rate and looming labor shortages.
The maximum family tax benefit of A$4,200 a year will be payable to families which earn up to A$40,000 a year, instead of A$33,000 a year.
And the government is removing the limit on the number of subsidised outside school hours care and family day care places.
Mr Costello says any new service set up by any eligible group will be funded and there will be no limit on funded places, which he says should generate an extra 25 thousand places by 2009.
And from July 1 parents will be eligible to receive the new
Childcare Rebate for 30 percent of out of pocket child care expenses up to A$4,000 per child per year.
In other moves A$735 million extra goes to medical research over five years with A$170 million to establish a new health and medical research fellowship scheme.
The extent of the tax cuts and higher benefits surprised many who expected a more cautious budget after rising inflationary pressures led the central bank to increase its key interest rate last week for the first time in 14 months.
But Mr Costello rebuffed suggestions his budget, by putting more money in people's pockets, would force interest rates even higher.
"The net effect of Australian government action, because it is saving rather than borrowing, is to put downward pressure on interest rates, rather than upward," he said.
Spending initiatives
Among the major spending initiatives in the new budget, Mr Costello announced a $2.3 billion upgrade of road and transport infrastructure, major investments in university research programs and $389 million to combat illegal fishing over the next four years.
Defence and national security also received big spending hikes, including an extra $623 million for ongoing military operations in Iraq and Afghanistan, $1.9 billion for new military transport planes, and more than $10 billion for future defence initiatives.
Mr Costello announced an additional $1.5 billion over five years to combat terrorism and strengthen national security, notably by expanding the staff and activities of the government's main spy agency, ASIO.