Wayne Swan had several moments where he watched all those budget revenue projections disappear into a black hole. Joe Hockey is about to experience just how that feels as commodity prices tumble, writes Ian Verrender.

Joe Hockey is facing his very own Wayne Swan moment.

It is the point in time when it suddenly dawns on a treasurer that all those revenue projections in that budget way back in May are disappearing into a deep and very dark hole.

In Swan's case, there were several. The big one was the implosion of Lehman Brothers in 2008 when credit markets seized, stock and commodity markets crashed and currency markets went haywire.

This time it's different. The world is flooded with cash, many asset markets are in bubble territory and currencies have been difficult to budge, creating their own unique set of problems.

But on the commodity front, prices are unravelling at a brisk pace, particularly for iron ore, the nation's biggest export earner. That spells bad news for our nominal income and the Federal Government's pledge to bring the budget back to surplus by 2017.

Even if the current iron ore downturn lasts only this year - and there is mounting evidence that it will be protracted - the reduced income will resonate through the estimates well into the future.

It is now a year since the Abbott Government won power. Until now, every economic glitch, every misstep, has been blamed on Labor's "debt and deficit disaster".

There comes a time, though, when that starts to wear thin, when a government has to take responsibility for its own actions. For the Abbott Government, that time is now.

As much as mining executives deny it and stockbroking spruikers ignore it, the slump in iron ore prices is remarkably different to previous years.

Since 2008, there have been numerous sudden and severe drops in the price, usually around this time of year and often caused by credit restrictions or one-off factors in China. They've been followed by sharp recoveries as Chinese steel mills scramble to rebuild iron ore inventories.

Not this time. This has been a long and steady slide, with an almost 40 per cent drop since the beginning of the year that now appears to be accelerating. The recoveries have been weak, brief and unsustained.

That points to a longer lasting downturn, one caused by a reversal in the supply demand equation. China's demand for steel is moderating just as a massive lift in supplies from Australia and South America are coming on stream.

With the price now threatening to breach $US80 a tonne, many smaller operations are under water and some larger ones now are operating on skinny margins.

What does that mean for the federal budget? Trying to quantify the exact damage is difficult. Treasury forecasts had iron gradually falling from an average $US97 a tonne in the first quarter to $92.10 in the final quarter.

With prices already about 15 per cent below the yearly average and with iron ore accounting for the largest share of the commodity index, that feeds directly into our terms of trade. Alarmingly, the terms of trade are declining much faster than Canberra anticipated, with reports Treasury is scrambling to recast its forecasts for the mid-year update.

The latest ABS data, the June quarter national accounts, showed a 7.9 per cent seasonally adjusted decline in the terms of trade from a year earlier, with a 4.1 per cent drop from March. It's only deteriorated since.

According to Stephen Anthony, a director of consultancy firm Macroeconomics, that could slice at least $5 billion directly from budget revenue.

Then there is the question of West Australia. The state that should boast the nation's most robust finances is an economic shambles. It has just lost its AAA credit rating and is staring down the barrel of a massive decline in revenue from iron ore royalties.

According to its most recent budget papers, WA has budgeted on an iron ore price of $US122.70 a tonne for this year, slowly dipping to $115 three years down the track.

Unfortunately, that is about to become Joe Hockey's problem. For under the GST arrangement struck when John Howard introduced the consumption tax, West Australia's share of the GST pool was to shrink when iron ore royalty revenues were up.

But the reverse applies when iron royalty revenue declines, meaning the Commonwealth will be forced to help fill the gaping and ever-expanding hole in West Australia's budget deficit with a larger slice of GST payments.

To a large extent, this crisis is being deliberately brought on by our two biggest miners, BHP and Rio Tinto.

As the two cheapest producers, both have embarked upon a war to drive out higher cost competitors, aggressively expanding production even as demand slumps.

Once the dust has settled, it is likely that the pair will have either permanently crippled or bought out their competitors.

It is no coincidence that Rio Tinto just launched legal action in New York against Israeli businessman Benny Steinmetz, claiming he and partner, Brazilian giant Vale, corruptly stole the rights to the huge Simandou iron ore deposit in Guinea in West Africa.

At current prices, Gindalbie, Arrium, Grange, Atlas and BC Iron are either losing money or at risk. Mount Gibson has a $US78 break-even price and Fortescue still has some margin at $US74.

Gina Rinehart's Roy Hill mine has a break-even price of $US58 a tonne, leaving her plenty of room for profit, while BHP at about $US53 and Rio Tinto at about $US44 will still be raking in mega-profits for quite some time.

So how should the Abbott Government respond to this looming revenue crisis? It could stop cutting revenue sources for a start.

It has celebrated its first year in office by removing the carbon tax - which would have provided $6.6 billion in revenue - and replacing it with a direct action policy that will cost $2.55 billion.

In addition, the deal it struck with Clive Palmer ensures many of the carbon tax compensation payments remain in place.

A fortnight ago it eliminated the mining tax, a deeply flawed tax designed by BHP, Rio Tinto and Glencore Xstrata, to ensure they paid virtually nothing. Now they'll pay absolutely nothing.

And one of the first actions Hockey took on his ascension to power was to hand the Reserve Bank $9 billion, a decision that provided a direct hit to the budget bottom line and one he would be ruing now.

According to Stephen Anthony, the Government should give up its bruising and futile war with the crossbenches, discard measures that target the disadvantaged and that have little or no budget impact and start thinking about real economic reform.

That means improving efficiency with better infrastructure, erasing barriers to competition, hitting up the Productivity Commission for a list of the 10 most obvious microeconomic reforms and ensuring the burden of economic repair falls on those who will benefit the most, rather than the most vulnerable.

Ian Verrender is the ABC's business editor. View his full profile here.