Background: Over four million people in Australia have some form of disability, of whom 2.1 million are of working age. This paper estimates the costs of disability in Australia using the standard-of-living approach. This approach defines the cost of disability as additional income required for people with a disability to achieve a similar living standard to those without a disability. We analyse data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey using a hybrid panel data model. To the best of our knowledge, this is the first study to examine the costs of disability in Australia using a high quality, large, nationally-representative longitudinal data set. Methods: This study estimates the costs of disability in Australia by using the Standard of Living (SoL) and a dynamic model approach. It examines the dynamics of disability and income by using lagged disability and income status. The study also controls for unobserved individual heterogeneity and endogeneity of income. The longitudinal specification in this study allows us to separate short- and long-run costs of disability using a hybrid panel data regression approach. Results: Our results show that people with a disability need to increase their adult-equivalent disposable income by 50% (in the short-run) to achieve the same standard of living as those without a disability. This figure varies considerably according to the severity of the disability, ranging from 19% for people without work-related limitations to 102% for people with severe limitations. Further, the average cost of disability in the long-run is higher and it is 63% of the adult-equivalent disposable income. Conclusions: Firstly, our results show that with the same level of income, the living standard is lower in households with people with a disability compared to households without members with a disability. This indicates a strong relationship between poverty and disability. However, current poverty measures do not take into account disability, therefore, they fail to consider substantial differences in poverty rates between people with and without a disability. Secondly, the estimated costs reflected in this study do consider foregone income due to disability. Therefore, policymakers should seriously consider adopting disability-adjusted poverty and inequality measurements. Thirdly, increasing the income (e.g. through government payments) or providing subsidised services for people with a disability may increase their financial satisfaction, leading to an improved living standard. The results of this study can serve as a baseline for the evaluation of the National Disability Insurance Scheme (NDIS).