The application was referred to Dr Smith earlier this year by the Department of Conservation because of the huge scale of the project and huge public interest in the outcome.
He said there were three main reasons for declining the application.
The first was the need to dispose of 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 the effects on visitors at the entrance to the Routeburn Track.
The third was that the engineering works and tunnel were inconsistent with the national park management plans.
He was also concerned about the economic viability and safety of the tunnel proposal.
"These issues are interrelated in that making a long narrow tunnel safe requires huge investment in ventilation and emergency systems. I am not satisfied that the tunnel can be safely built for a price that makes it economically viable.
"The risk for the Government under these circumstances is that corners are cut or the project is left half-completed with a clean-up liability for the public."
Dr Smith also rejected an alternative plan, submitted only last week, that would have made the tunnel about 2km longer and moved the eastern entrance about 3km south east.
"This is a significantly different proposal on which I have not received any technical advice, and of which neither the public nor the hearing commissioner has had the opportunity to consider.
"I have determined that I have insufficient information to make a decision on this alternative."
Dr Smith said he walked part of the Routeburn track to see where it would be most affected and considered 1000 submissions.
He acknowledged that his decision would be a disappointment to the applicants and their supporters and said he did not in any way criticise them for their entrepreneurial spirit or ambition to ease access for the hundreds of thousands of people who visit Milford Sound.
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.
