The Turnbull government believes it has finally solved the problem of the carve-up of goods and services tax revenue.

It has rejected a key recommendation from the Productivity Commission that would have sent billions of extra GST dollars flowing to New South Wales and Western Australia while leaving every other state worse off. Instead, it has proposed its own model, to be phased in over eight years.

The government says the current GST distribution system, which attempts to lift the fiscal capacity of every state to the same level as the strongest state, is no longer working. It proposes moving to a new benchmark where the fiscal capacity of every state is at least the equal of NSW or Victoria (whichever is highest).

It has also proposed introducing a “floor” of 70 cents per person, per dollar of GST, to ensure no state receives less than 70% of their own GST revenue, from 2022-23. The “floor” will rise to 75 cents per person, per dollar of GST, from 2024-25.

To assist with the transition to the new system, the government says it will provide short-term funding over three years from 2019-20 to 2021-22 to ensure no state receives less than 70 cents per person per dollar of GST.

This funding will be untied, meaning recipient state governments will be able to spend it as they see fit to deliver services in their state. Western Australia and the Northern Territory will be the only governments to receive that extra untied funding in 2019-20 and 2020-21, with WA getting $1.4bn and the NT getting $69m.

However, to ensure no state falls below 70 cents per person after 2021-22, the government says it will regularly inject extra untied funds into the GST pool to ensure all states receive a fair share.

It will start by injecting $600m into the GST pool in 2021-22, the first year of transition to the new equalisation standard, with contributions in subsequent years being equivalent to indexing the cash injection at the same rate of growth as GST collections in those years.

A second cash injection, of $250m, would come in 2024-25, when the system would be halfway through its transition to a new equalisation standard, and the government would have introduced a 75-cent floor.

Further commonwealth payments into the GST pool would then be indexed to grow in line with GST collections on a permanent basis.

The government’s plan increases the size of the untied portion of GST distribution by $7.2bn from 2021-22 to 2028-29, with the vast majority of the untied funds going to Western Australia.

By 2028-29, the commonwealth will be contributing more than $1bn a year in untied funds to the GST distribution.

“The Turnbull government will fix problems in the system used to share the revenue from the GST leaving all states and territories better off,” the treasurer, Scott Morrison, said in a statement. “This will be the first time real changes have been made to fix problems in how the GST is shared since the GST was introduced almost 20 years ago.

“This problem has been kicked down the road for too long and it is time we now got on and fixed it.”

The government says it will adopt every other recommendation from the Productivity Commission’s final review of the GST system.

The commission’s review was released on Thursday.

Morrison initiated the review of the GST in April last year following repeated complaints from Western Australia’s government that the system was treating WA unfairly.

The former Liberal government in WA campaigned heavily on the fall in the state’s GST share. It blamed the poor state of its budget on the “unfair” federal GST carve-up in the lead-up to last year’s WA election, which it lost.

The Productivity Commission has acknowledged the GST’s redistributive model is based on an “undeliverable ideal”, and that it should stop trying to lift the fiscal capacity of all states to the same level as the strongest state.

It says the system should only be used to lift the fiscal capacity of all states to the average of all states, “with the remaining GST distributed on a per capita basis”.

Under its proposed model – a portion of which leaked on Wednesday – a four-year transition to its new model would leave NSW $12.6bn better off by 2026-27 and WA $10.6bn better off.

Queensland would be $11.7bn worse off. Victoria (-$5bn), South Australia (-$3.9bn), Tasmania (-$1.2bn), the Australian Capital Territory (-$978m) and the Northern Territory (-$539m) would all lose out.