Gordon Brown has told ministers there will be no more money for students in the new funding package being agreed in Whitehall.
Despite the review of student finance announced at the recent Labour Party conference, The Independent on Sunday has learnt that the Treasury will not increase the amount of cash for higher education. Whitehall sources have made it clear that the financial demands of the war on terrorism and the money already pledged in the three-year spending plans will take priority in the coming months. As a result, any changes to the system are likely to be merely structural. One source said: "It is not necessarily about cash. It could be about the reorganisation of the system."
It is expected that the current system of up-front tuition fees and loans will be scrapped in favour of a pay-back scheme once students have left university. Already struggling, higher education was hoping the public purse would make good any shortfall. That now seems unlikely.
"In the short term we will stick to our three-year spending plans, and we can afford to do that because they are built on the most cautious economic assumptions," said the source. "On top of that, we are going to meet our international obligations. But clearly there is a need for discipline in relation to additional expenditure."
One option is to raise taxes. But the Treasury insists that there will be no "war tax". Sources admitted though that "over the medium and long terms there is probably a debate to be had about public services, the investment in them and how we pay for them".
Both the Chancellor and the Prime Minister have made it clear in recent weeks that they have put investment in services ahead of tax cuts. A Labour Party source said: "I just don't see how the Government can maintain the pretence any more that it can stick to the spending plans without tackling the issue of personal taxation. The question is going to be maintaining investment or raising taxes."
The Chancellor will deliver his annual pre-Budget report next month, and is expected to signal a range of measures designed to avoid the 11 September terror attacks plunging Britain into recession.
Mr Brown is considering a number of tax increases, through VAT and other indirect measures, but at this stage is fighting shy of breaking Labour's election pledge not to increase income tax.
He is already facing a tough round of spending bids by senior colleagues, including Alan Milburn, Secretary of State for Health, and Estelle Morris, Secretary of State for Education, who are under orders to limit pay rises for more than one million public sector workers.
Mr Brown has called a conference this week to look at the long-term future of health service funding. An interim report to the Treasury has come down firmly in favour of increasing spending on the NHS from taxation, rejecting an expansion of private insurance.
The left-leaning think tank the Institute for Public Policy Research has warned the Chancellor that he cannot afford to increase spending on the NHS without raising taxes if he is to meet his other commitments to tackle poverty among children, pensioners and low-paid adults.Reuse content