"I am declining this tunnel because the environmental impacts are significant and beyond what is appropriate in two of New Zealand's most spectacular National Parks and a world heritage area,'' Dr Smith said.
The minister said there were three main reasons for declining the application.
Dr Smith said the first reason was that it would require depositing half a million tonnes of tunnel spoil that would permanently damage the natural landscape.
The second was the impact of the new roads and portals at each end and impacts on visitors at the entrance to the Routeburn track.
His third was that the engineering works and tunnel required were inconsistent with the Fiordland and Mt Aspiring National Park management plans.
Dr Smith said he walked the part of the Routeburn track to see where it would be most affected.
He also considered 1000 submissions.
The minister was responsible for a decision over granting access to Milford Dart Limited for the 11.3km, single-lane bus tunnel, because the development cut through conservation land, including Mt Aspiring National Park.
It was referred to the minister earlier this year by the Department of Conservation because of the huge scale of the project and the huge public interest in the outcome.
The plans stirred heated debate because the tunnel would have been built in prized conservation land which included one of the country's Great Walks, the Routeburn Track.
It would also have allowed buses to bypass Te Anau, which depended heavily on Milford Sound tourism for its economy. A petition created by the Stop the Tunnel lobby group collected 25,000 signatures.
The $170 million tunnel was designed to reduce the nine-hour return bus trip, and the company estimated the improved access to Milford Sound would draw 20,000 visitors a year to New Zealand.
Dr Smith, who is one of the greenest National MPs, has previously said that the decision whether to grant access to the national parks was a tough one.
"You don't get much more spectacular than the Routeburn and Milford Tracks, both of which I've done. It's a very difficult call in that I take the view that national parks are areas where nature rules and human needs come second.''
A separate proposal to cut a 41km monorail and road through Snowdon Forest was still being considered by the minister.
Green Party conservation spokeswoman Eugenie Sage said the decision was a victory for the thousands of New Zealanders who had demanded protection for national parks.
"The National Parks Act, the General Policy for National Parks and national park management plans, developed with community input, have clear rules on what is appropriate in our national parks.
"A private road tunnel would have been at odds with these provisions,'' said Ms Sage.
She hoped Dr Smith would make a similar decision about the monorail.
Forest & Bird advocacy manager Kevin Hackwell said the tunnel would have been a disaster for the surrounding environment and the local communities that depended on through traffic.
"We only hope now, the minister will make a similar decision when considering the proposal to build a monorail through Snowdon Forest in Fiordland,'' said Mr Hackwell.
- by Kate Shuttleworth of APNZ and Isaac Davison
