States that fail to permit coal seam gas mining would be penalised under a fresh proposal from the Grants Commission to change the method of distributing goods and services tax revenue.

The adjustment would hurt Victoria, New South Wales, Western Australia, Tasmania and the Northern Territory, each of whom has complete or partial bans on coal seam gas exploration or development or has a moratorium on fracking.

The proposal, in a position paper prepared for the commission's review of the principles behind the GST distribution, is to treat royalties from coal seam gas in the same way as taxes on gambling. It would apply from 2020.

States that choose not to allow poker machines and collect poker machine revenue are regarded as having voluntarily forgone income and not compensated for earning less than the states that do.