NSW's water minister says the "only way is up" for Warragamba Dam as questions are raised about who will fund the $1.6 billion project.
As the Perrottet government forges ahead with plans to raise the dam wall by 14 metres, 2GB radio reported the federal government would not contribute to the funding.
The claims have since been dismissed by Canberra, which said Prime Minister Anthony Albanese would make a decision on the project after receiving the final business case.
NSW believes a business case will find the entire project, including biodiversity offsets, will cost $1.6 billion, Water Minister Kevin Anderson said.
"It's a big job. It's a hell of a job," he told 2GB.
"That's the reason why this has been made critical state infrastructure: to ensure the federal government gets the clear message this is critical for protecting lives, protecting properties."
NSW last week laid the groundwork to fast track aspects of environmental and planning laws involved in raising the wall.
Two days later, though, Mr Albanese told western Sydney business leaders the economic case was yet to be made.
If the talks were to fall over, decisions over whether NSW could go it alone would have to be put to the state's expenditure review committee.
Mr Anderson said funding issues were a matter for Mr Albanese and Premier Dominic Perrottet.
"This is something that has to be done. Infrastructure NSW has clearly stated that this needs to be done," he said.
"The modelling says the only way is up."
One reason for raising the wall is that water currently can't be released during periods of high rainfall to mitigate overflows.
Even if the settings were different, outflows would not be ideal and during La Nina seasons where catchments are highly saturated, they could lead to more flooding in the Hawkesbury Nepean and western Sydney, the government says.
Reducing the dam's capacity also heightens the risk of putting Sydney into a permanent drought.
The controversial project has long been on the government's agenda, despite warnings it was not a cure-all solution and would inundate significant cultural and environmental sites upstream.
Up to 1000 hectares of world heritage area and 3700 hectares of surrounding national park would be under water for up to two weeks, which environmentalists argue could destroy a globally-significant ecosystem and some rare species.
Insurance Australia Group withdrew its support for the wall raising in 2020 due to probable loss of cultural sites.
