* Australian state eyes Rio, BHP iron ore fee to plug budget hole
* Proposal to ditch 25 cent/tonne levy for one-off payment
* Government to negotiate with miners
By James Regan and Jonathan Barrett
SYDNEY, May 29 (Reuters) - The cash-strapped Western Australian state government will ask Rio Tinto and BHP to pay an upfront multi-billion dollar fee in exchange for cancelling an ongoing levy on their iron ore production.
The revenue push by the mineral-rich state, which has run up more than A$30 billion ($23 billion) in debt following the end of a mining boom, sets the stage for talks with the miners, who are seen as unlikely to agree unless they win significant benefits.
Under the proposal, the two mining houses would pay as much as A$4 billion ($3 billion) in exchange for cancelling a A$0.25 a tonne ongoing levy on iron ore from their mines, some of which could be running for another 50 years.
State treasurer Ben Wyatt, whose centre-left Labor party won a state election in March, said the proposal was still in its early stages.
"It's an option that could only be close to crystalising if you had a range of things in play, one, obviously the engagement and agreement of the miners," Wyatt told reporters on Monday.
Rio Tinto has previously rejected the payout proposal, according to a company spokesman. A BHP spokesman declined to comment.
The mining companies are due to meet with the government this week, but a source close to one company said the proposal could set an unwelcome precedent.
"The last thing Rio and BHP want is to become the state's go-to ATM every time there's a financial crisis," said the source, who was not authorised to speak publicly on the topic.
The A$0.25 a tonne levy raised around A$150 million for Western Australia last year, based on the two company's combined output of about 600 million tonnes of iron ore.
The state earns far more from a 7.5 percent royalty based on the value of their sales, which contributes well over $2 billion a year to state coffers.
Pietro Guj, a professor at the University of Western Australia who previously oversaw the state's royalties system, said the miners would need to benefit in order sign up to the proposal.
"There would have to be a motivation from the miners' point of view unless they were feeling philanthropic," Guj said.
The current plan follows a suggestion by a rival party in the lead up to the March election that the levy be raised to as much $5 a tonne, a proposal that was condemned by the miners.
Only Rio Tinto and BHP pay the rental fee, which applies to mature projects, but other projects including those owned by Fortescue Metals Group and Gina Rinehart's Hancock Prospecting would be liable to pay it from 2023. ($1 = 1.3459 Australian dollars) (Reporting by James Regan and Jonathan Barrett in SYDNEY; Editing by Richard Pullin)