But colleges argue that the 78-page guidance circular represents a U-turn by the LSC on its pledge to slash bureaucracy.
The LSC is proposing to agree three-year contracts with colleges and private training providers.
Once a college is signed up to a contract it will receive a 2 per cent rise in its budget. If in 20045 it is still on target it will get a further 2.5 per cent. But above-target colleges judged as "excellent" will earn rises of 3.5 per cent in 20045 and in 20056.
They will also need to open their doors to a wider range of students. Their leadership and management must be outstanding or good, and no curriculum area graded less than satisfactory. About 10 per cent of colleges are expected to reach this category. Colleges where there are "serious concerns" will only get rises in line with inflation. This group is also expected to be around 10 per cent of the sector.
The proposals have been put out for consultation by the LSC in response to the Green Paper Success for All. In this, the Government wants "something for something" in return for its pound;1.2 billion investment in further education and training over the next three years.
The funding difference between the best and the worst will be 7 per cent.
The LSC will work with failing colleges to help them improve, and institutions might need to be reorganised or merged.
A private training provider which does not meet its targets will lose its contract. Any top college which slips in its performance will revert to the standard funding rate. "The aim is simply to define what they are expected to do with the money we are giving them," said Rob Wye, the LSC's Success for All programme manager. The LSC intends to set "floor targets" which colleges and providers must meet to get their funding. But these are already proving controversial.
John Brennan, director of FE development at the Association of Colleges, said: "There is a danger that someone will say, I won't allow any student to enrol in case they fail and I miss my target."
Mr Wye denied, however, that colleges would be less innovative. "We want everyone to succeed. Colleges should be making the right judgments about individuals."
Floor targets colleges must reach by 20056 include a 45 per cent minimum success rate for qualifications needing more than 24 weeks' study.
Mr Wye said the targets were modest. The qualification aim is based on the number they set out to achieve, and the number they do achieve. Colleges will also need to show how they will reward staff who help learners to succeed.
The AoC is concerned about increased bureaucracy. Dr Brennan said: "We are concerned about the complexities of the regime. Success for All was a step towards direction and control. This new circular reinforces that."