 Aborigine communities have comparatively low life expectancies |
Campaigners for the so-called Stolen Generations had asked for a reparation fund of almost A$1bn ($870m; £443m) as part of a promised official apology.
But indigenous affairs minister Jenny Macklin says money will instead be put into health and education schemes.
Many Aboriginal children were handed to white families from 1915 to 1969.
They were brought up by white people in an attempt by the government to assimilate the white and Aboriginal populations.
 |  Even though they've changed the saddle blankets we're still dealing with the same horse  Sam Watson Aborigine activist |
The country's new Prime Minister, Kevin Rudd, has promised to apologise formally to the victims of the assimilation policy.
And campaigners felt that the Stolen Generations should have received damages as part of the apology.
"People get paid crimes compensation for victims of crime," Lyn Austin, head of Stolen Generations in the state of Victoria, told local radio.
"You are looking at the gross violation and the act of genocide and all the inhumane things that have happened to our people."
Protests promised
But Ms Macklin instead pledged to invest in initiatives which she said would improve life expectancy for today's Aborigines.
"What we will be doing is putting the funding in to health and education services, and providing additional support for services needed for counselling, to enable people to find their relatives," she said.
"We think the best way to give force to the apology is to provide funding to close the gap in life expectancy between indigenous and non-indigenous Australians.
"So we won't be creating a compensation fund."
Aboriginal campaigners have promised to protest against the decision.
Brisbane-based activist Sam Watson said the new Labor government was following the same policies as their predecessors.
"Even though they've changed the saddle blankets we're still dealing with the same horse," he told Australian broadcaster ABC.
