Colleges are counting the cost as thousands of students already enrolled on courses prepare to switch to more extensive New Deal training.
Some inner-city colleges are looking at cuts in excess of pound;300,000, while having to increase significantly the time spent teaching trainees.
Many expect the money they receive for training students to be cut by a third even though learners will be expected to spend nearly twice as much time in college once the New Deal goes nationwide next month.
Early evidence from the 12 pathfinder areas which began piloting New Deal in January suggests that the majority of young people opting for full-time training will be existing students rather than new enrolments.
Students taking courses while claiming Jobseekers' Allowance are currently prevented from attending college for more than 16 hours a week. Under the New Deal, 18 to 24-year-olds who have been unemployed for at least six months can continue to claim the same benefit but no longer need to be available for work. They attend college for 30 hours each week and spend much of the extra time acquiring key skills or receiving help finding a job once they complete their course.
Students covered by the 16-hour rule have their fees paid for by the Further Education Funding Council. Once they come under the New Deal, colleges claim money from the Employment Service using a formula which will leave most of them substantially worse off.
Ceri Williams, who prepared a bid for New Deal training at Tower Hamlets College, said the east London college was looking at a cut from pound;2,500 to pound;1,700 per year for a student on a basic skills course. "If we only get the amounts suggested under the Employment Service price bands then we are looking at a serious funding problem," she said.
Tower Hamlets, which is not a pathfinder area, estimates it has at least 200 18 to 24-year-olds studying under the 16-hour rule who will be eligible for the New Deal. Students will steadily convert to 30-hour programmes during the next six months once they attend a restart interview with an Employment Service adviser.
The funding row is threatening to cloud improving relations between colleges and the Employment Service which FE staff say is showing a more enlightened attitude towards students claiming benefits.
In theory colleges could end up better off by enrolling more students on FEFC-funded programmes and replace those switching to the New Deal. But that depends on sufficient students being available to recruit.
Linda Watson, New Deal co-ordinator at Barnsley College, said: "We are keen to be involved in helping regenerate the local community, but it's a great concern to us that we are losing FEFC funding and will have to recruit more students to meet our FEFC targets next year."
The new rules are a boost to young people frustrated by not being able to attend college for more than 16 hours. Neil Crick, who is working at a national vocational qualification in bricklaying at Lambeth College, said he should gain his NVQ far quicker and no longer waste time at home on other days.
As a pathfinder college, Lambeth has so far recruited 20 new students while 11 out of 800 existing students who are eligible for New Deal have converted to 30-hour programmes.
Graeme Hall, director of technology and business development, said: "Every college will be looking to increase their numbers as existing students convert to New Deal. We will all be chasing the same people."
Figures from the FEFC show 69,000 students aged 18 to 24 were claiming Jobseekers' Allowance in 1996-97. The problem is likely to become more serious for colleges in June when New Deal is extended to over 25s where three times as many students are in receipt of JSA.
Colleges also risk losing extra cash which the FEFC provides for students with learning difficulties, including those speaking English as a second language. Nadine Cartner, curriculum quality adviser at the Association of Colleges, said: "New Deal is undermining the Kennedy agenda which is all about recruiting more students from disadvantaged backgrounds."