Radical reform of local government funding is essential if Labour is not to throw away its support in schools, council leaders warned this week.

The new Local Government Association called for a wholesale rethink of councils’ tax-raising powers to end long-standing inequalities in education funding, and counselled against “tinkering at the edges”.

Councils have long complained about central government’s “unfair” funding system which results in substantial variations in education budgets from one county to the next.

But equalising the budgets could also penalise some rich authorities, and the LGA, which represents district, county, metropolitan and unitary authorities, says the Government must relax its spending restrictions to ease the pain. It called for an extra Pounds 500 million to fund this year’s teachers’ pay settlement.

School standards minister Stephen Byers has already indicated that his colleagues are looking at the council-capping regime which proved so controversial during the Conservatives’ years in power. But council leaders, waiting for the outcome of appeals against the Labour Government’s first attempt at council tax-capping, are concerned that any review will not address the fundamental problem.

This, they believe, is the system of standard spending assessments (SSAs) which determines council spending.

The issue threatens to give ministers an early taste of friendly fire - many of the council leaders involved in disputes are Labour, and the new wave of Labour MPs includes council politicians on both sides of the argument over funding.

Tensions are likely to be heightened given the predicted across-the-board squeeze in spending levels next year - a consequence of Chancellor Gordon Brown’s promise to stick to Conservative spending plans.

Dave Wilcox, Labour chairman of Derbyshire’s education committee and vice-chairman of the LGA, said Derbyshire had broadly the same funding allocation as Hertfordshire eight years ago. Now Derbyshire was Pounds 60m behind.

He said: “Some authorities have to pay an inner or outer London allowance and that has to be reflected. However, there are counties in the South-east which receive an area cost adjustment, but do not pay London allowances; there’s inequality in that.

“If there is a fixed overall budget and there is redistribution then it means robbing Peter to pay Paul - but that does not mean you ought not to address the problem.”

Graham Lane, Labour chairman of the LGA’s education committee, called for a release of cash from the sale of property and business rate receipts to stabilise council funding in advance of a wholesale review. And he described moves to fund the teachers’ pay settlement from Whitehall as vital to prevent a new wave of cuts and a further increase in class sizes.

He said: “Whatever bit they grab between their teeth there will be winners and losers. What ministers have to do is sit down and say ‘What are we going to do about the whole system of local government finance?’ We have a complete financial system which has been built on over time. What we have to do is rebuild it from scratch.”

And he called for a lifting of the capping regime to allow low-spending councils to raise tax levels. “Low spending authorities may have to decide to put up council tax levels.”