Mr Nardella on Tuesday told Melton local newspaper Star Weekly that he would not pay the money back or apologise because it would imply that he had acted illegally or rorted the system.

The veteran Labor MP also revealed that he would not contest Melton – held by Labor by 11.2 per cent – at the 2018 poll, citing the recent controversy around his claim contributing to his decision.

"I think it's probably time that Melton had somebody new," he said. "But the difficult time that I've had has influenced that decision.

"Every term you think about these things, but these circumstances [brought] this up as a catalyst."

The heavy metal enthusiast entered parliament in 1992. The seat is held by the Socialist Left faction, with former mayor Justin Mammarella already the frontrunner for the spot.

Last week Fairfax Media revealed that Speaker Telmo Languiller had claimed nearly $40,000 to live in Queenscliff while maintaining a residence in Footscray, rather than his Tarneit seat.

Soon after it was revealed Mr Nardella had claimed $113,000 to live at Ocean Grove in a similar arrangement.

The revelations have sparked a fresh crisis for the Andrews government, with Premier Daniel Andrews on Tuesday demanding Mr Nardella repay taxpayers.

Mr Languiller is repaying the money and has quit as Speaker.

While Mr Nardella has stood down from his post, he is resisting public and internal Labor party pressure to pay the money back.

The Premier spoke to Mr Nardella over the weekend and made it clear the money should be repaid.

"It is my view that he should repay the money; he should do exactly the same thing as Telmo Languiller has done," Mr Andrews said Tuesday.

Opposition Leader Matthew Guy said Premier Andrews needed to match his talk of responsibility with action.

"If Don Nardella refuses to pay this money back then Daniel Andrews needs to kick him out of the Labor Party, otherwise he will be accepting a tainted vote," he said

Government MPs are livid with yet another distraction for Labor. Privately Labor figures are urging Mr Nardella to repay the money, with others looking at all options to recoup taxpayers money.

Parliament's internal audit committee, chaired by the Bruce Atkinson, a Liberal and President of the upper house, and involving PricewaterhouseCoopers, met on Tuesday morning to formalise a two-week investigation into the pair.

An overhaul of entitlements has also been approved by cabinet, including restricting access to the second residence allowance to genuine country MPs and requiring greater documentation to prove claims.

The Premier conceded the current rules were "opaque".

The veteran Melton politician has been a vocal critic of MPs behaving badly in the past, including rogue Frankston MP Geoff Shaw.

Mr Nardella sat on the powerful privileges committee that oversaw an inquiry into allegations of rorting by Mr Shaw.