The depth of the financial crisis in the NHS is spelt out today in a report showing that £9 out of every £10 of the extra billions invested in the NHS this year went on increased pay and prices.

A quarter of NHS trusts are in debt and the overall projected deficit of £620m for the present financial year is the largest since Labour was elected, the King's Fund analysis says.

Of the £3.6bn cash increase for England in 2005-06, 50 per cent went on extra pay and 37 per cent on "other cost pressures".

That left just £475m for other developments such as cutting waiting times to meet government targets, the independent health policy think-tank says.

The report, which is based on new data from the Department of Health and covers the hospital service but not GPs, notes that the Department of Health assumes that efficiency savings worth 1.7 per cent of the budget, amounting to £769m, will be achieved this year, increasing the funds available for development.

Professor John Appleby, the chief economist at the King's Fund, said: "This new data shows just how tough the financial situation in the NHS has become. While this is worrying, it is not surprising, given that the NHS is facing tremendous cost pressures at present such as increased pay for staff and higher drugs bills.

"It is essential that the Government offers a flexible system of support to trusts with emerging financial problems, rather than just dealing with those with persistent financial deficits."

Last month Patricia Hewitt, the Secretary of State for Health, revealed that 50 NHS trusts were in serious financial difficulty, and turnaround teams of private accountants had been ordered into 18 trusts to help them to make cuts.

The King's Fund report says cost pressures will ease only slightly next year, with 2.5 per cent available for developments after pay and price increases have been met. But that could be squeezed if the cash increase for next year was less than this year at 9 per cent, or if hospital inflation ran higher than the projected 1.5 per cent.

It said higher pay was "not in itself a bad thing" if it helped to attract and retain staff. But with consultant and nurse pay rates already near the top of the international league table, "it raises questions about value for money".

The Department of Health rejected the analysis, claiming that half (48 per cent) of the extra expenditure went on extra staff, activity and drugs.

Ms Hewitt said: "The NHS is doing more work than ever in terms of procedures, and there has been year on year growth in the number of doctors and nurses. Around a quarter of the extra £20bn we have invested in the NHS has gone on paying staff much better. A similar amount has been spent on recruiting more staff. That is a very good thing. Extra money on pay is not wasted because pay reforms will lead to improved patient care."

Andrew Lansley, the shadow Health Secretary, said: "These figures once again demonstrate that only a fraction of the extra money available to the NHS is going towards growth in activities. In many parts of the country the way resources are allocated and used has meant cuts in services, in order to accommodate rising costs pressures and the cost of meeting government targets.

"It is essential that rising resources are accompanied by genuine reform."