The federal government's drive for federation reform has been met with opposition claims the far-reaching initiative will be used to make further budget cuts and blackmail the states into supporting a GST increase.
Prime Minister Tony Abbott outlined the terms of reference for his long-awaited federation white paper at Saturday's Federal Liberal Council meeting in Melbourne.
"Now is the time to make each level of government sovereign in its own sphere," he announced.
The Commonwealth would continue to take a leadership role on issues of genuine national and strategic importance, Mr Abbott said.
But there should be less federal intervention in areas where states have primary responsibility such as health and education.
The white paper was promised during the 2013 election campaign as a way to end waste, duplication and buck-passing between Canberra and the states.
Since then, however, tension between the two tiers of government has bubbled over across the political divide after plans were revealed in the May budget for the states to receive $80 billion less in funding to spend on hospitals and schools.
Speaking at Saturday's meeting, Queensland Liberal Premier Campbell Newman said he was open to reforming traditional federation arrangements but argued for a greater federal revenue commitment.
However, South Australia's Labor Premier Jay Weatherill was scathing of the proposal, telling ABC TV it would lead to the "Americanisation" of the health system.
Labor's Shadow Treasurer Chris Bowen said he feared the white paper would be a blueprint for further budget cuts on top of the government's $80 billion "curtain raiser".
"We are concerned that Tony Abbott will use this... (to) blackmail state governments into accepting an increase in the GST," he said in a statement.
Senior officials from the prime minister's department will work on the paper in consultation with the states and territories and representatives of local government.
It is due to be released at the end of 2015.
Mr Abbott also made a pitch on Saturday to the Senate's new cross-bench which will decide the fate of the government's agenda from July 7.
The Palmer United Party block of senators will share the balance of power.
"I say to the new senators, we won't hector you and we won't lecture you," Mr Abbott said, adding that he respected the election of the micro party senators and asked them to respect his mandate.
The federal government faces an uphill battle to get controversial elements of its budget, such as welfare changes and a GP co-payment, passed by the upper house.
Treasurer Joe Hockey told the party faithful to "stay the course" in the face of budget criticism.
"When the critics grow fierce and when the words appear intimidating, strengthen your resolve," he said.
The federal council narrowly passed a motion urging the government to refrain from introducing the GST on overseas online shopping purchases under the current $1000 threshold.
It's at odds with the NSW government's stance and the work state treasurers have been doing for the past couple of years in trying to reach an agreement.
Meanwhile, the Greens have accused outgoing Liberal president Alan Stockdale of letting "the cat out of the bag" on how the party will continue to seek corporate funding to get around restrictions on political donations.
Mr Stockdale flagged that the party should consider introducing corporate membership.
New president Richard Alston said he hadn't given the idea much thought but was open to sensible suggestions.