Up to 5,000 jobless will have to take the test to quality for allowances as part of a trial to address welfare-fuelled substance abuse.
Benefit recipients who do not pass will have their handouts put on a cashless debit card which they can only use to buy essentials such as food and housing.
Those who fail more than once will be referred to medical professionals for assessment and treatment.
"We're going to trial this with just 5,000 people and if it doesn't work we'll stop it and if it does work and it's helping people well we'll keep doing it, we'd be silly not to," said Treasurer Scott Morrison.
Australia's unemployment rate currently stands at 5.9 percent, with 753,000 people out of work.
The government hopes the plan, along with docking welfare payments for people who skip job interviews or fail to attend meetings, could save taxpayers more than Aus$600 million (US$440 million) over the next four years.
Sewage data would be used to pinpoint three sites for the trial based on the National Wastewater Drug Monitoring Program which has identified "astonishingly high" rates of methamphetamine use across Australia.
Social Services Minister Christian Porter said it was about helping people have the best chance possible of getting a job.
"The 5,000-person drug testing trial is squarely aimed at identifying and assisting people and driving behavioural change," he said.
"What we think we can achieve through this is to ensure people at that absolutely critical point in their life when they're searching for a job, engage in behaviours that assist them in that process and don't destroy that process."
Some welfare lobby groups have argued the approach was wrong.
"This is further demonising of people on social security, people on the lowest incomes in the country," Australian Council of Social Service chief executive Cassandra Goldie told the Australian Broadcasting Corporation.
"Another harsh welfare crackdown, compliance, it's already really tough."
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