Colin Barnett blows $2bn hole in Wayne Swan's budget target

West Australian government's decision to increase royalty rates for a certain type of iron ore will not stop the Commonwealth delivering a budget surplus in 2012/13, a federal minister says.

In handing down its 2011/12 budget today, the WA government said it would lift the royalty rate for iron ore fines in the three financial years to 2014/15, bringing in an extra $1.9 billion in state revenue.

It would bring the fines rate into line with the rate for lump iron ore and was also a way to recoup falling GST revenue to the state.

But federal resources minister Martin Ferguson says the Colin Barnett government may have shot itself in the foot in "a short-term grab for cash" and should have waited for the Commonwealth Grants Commissions (CGC) GST carve-up.

"The WA government may have cut their own nose off to spite themselves," Mr Ferguson told reporters in Perth.

"The decision sends a message to the Commonwealth Grants Commission that the revenue-raising capacity of WA is far higher.

"It will not have any impact in terms of returning the budget to surplus."

Mr Ferguson said the federal government would honour its commitments to credit state iron ore and coal royalties to the miners, saying "a deal is a deal".

"We will credit the royalties but we are not happy about it because it cuts the amount we can spend on infrastructure.

Australia has blown a $2 billion hole in the Gillard government's predicted return to a budget surplus and threatened to wreck its mining-tax peace deal with the big resources companies after announcing it would raise iron ore royalties.

The Barnett government's move presents Wayne Swan with a major headache after he promised the miners, including BHP Billiton and Rio Tinto, he would reimburse them for all state royalties when the planned $7.4bn mineral resources rent tax starts next year. The federal Treasurer must now choose between picking a bitter fight with Western Australia by imposing heavy financial penalties on the resource-rich state or by backing down on his agreement with the mining companies to foot the bill for state royalty increases.

Mr Swan last night admitted the move would hit his budget, delivered only last week, and warned that Western Australia faced the prospect of receiving even lower GST grants through the Commonwealth Grants Commission and lower federal infrastructure funding as a result of the royalty hike.

The federal government does not intend to intervene in the CGC process to save Mr Barnett from the effects of his own decision to play politics with the mining boom."

A review of the formula for distributing GST receipts among the states is being conducted by a panel led by former NSW premier Nick Greiner, but will not present a report to the government until September next year. It will therefore not affect the redistribution of GST revenue in 2011-12 and 2012-13.

A spokeswoman for BHP said the company was seeking talks with the West Australian government over the royalty move.

The state's Chamber of Minerals and Energy called on the federal government to honour its commitment to fully refund all current and future state royalties.

The Association of Mining and Exploration Companies said it was disappointed that industry bodies and companies were not consulted over the royalty hike. AMEC chief executive Simon Bennison said the move would add to the uncertainty being created by the MRRT.