The recommendations penned by the Policy Transition Group is fully acceptable for the federal government and while its gears up to honour and implement the tax deal it forged with Australia's major miners, it also warned state and territory governments to follow suit and face the consequences.

Federal Treasurer Wayne Swan said on Wednesday that financial penalties await state and territory governments if they elected to impose runaway royalty taxes as Prime Minister Julia Gillard conceded that all royalty taxes would be credited on mineral resource rent tax accounts by mining firms.

The taskforce headed by former BHP Billiton chair Don Argus supported claims by BHP, Rio Tinto and Xstrata that all royalties must be refunded under the MRRT but Australian premiers insisted on their rights to set royalty rates and pledged to counter any federal intervention through the Council of Australian Governments (COAG).

State and territory governments deviating from federal position would have to deal with Swan, who declared yesterday that "we can't give a green light to the states to increase royalties endlessly."

The commonwealth is considering the possibility of docking GST payments to governments who would remain adamant in lifting their royalties as Resources Minister Martin Ferguson aired his appeal that royalty hikes could erode investors' confidence and "we all have to live with the committee's report because it provides the best possible outcome."

Still, the governments of Queensland and Western Australia appear ready for a showdown as they insist on their sovereignty and argued that GST revenues could not be withheld by federal authorities without their full consent.

Queensland Premier Anna Bligh called on the federal government to thresh out the issue with major mining firms while WA Premier Colin Barnett simply advised Ms Gillard to ditch the mining tax, with the Victorian government declaring that it is not bent on "filling up the federal Labor government's budget black hole."

The Coalition, however, scored the latest government tactics on the mining issue as opposition resources spokesman Ian MacFarlane argued that Ms Gillard totally bungled the problem and is now reduced to dishing out "veiled threats of blackmail to prevent states from increasing royalties."