If introduced successfully into nearly 500 further education and sixth-form colleges in England, the funding system could influence universities and even school budgets.
For years the poor relation of British education, further education colleges have now been given top priority by the Government, and directed to expand student numbers at breathtaking speed: 25 per cent over the next three years.
Money for further education has been boosted by 6 per cent in real terms by switching pounds 2.5bn from local authority budgets, at a time when school spending is being squeezed and the expansion of universities is being reined back.
What happens in the further education sector after it is cut loose from local authorities in April next year will clearly have wider influence.
At present schools, colleges and universities are funded broadly on the basis of the numbers of students they enrol. The council wants to offer colleges a financial incentive for keeping students on courses and teaching them well enough to secure qualifications.
As a 'payment by results' system would tempt colleges to exclude weaker students and to lower assessment standards, the funding council is working on ways of combining the two approaches in a way that is not impossibly complicated.
Vouchers - which students could cash in for courses of their choice - are also under discussion as a logical extension of the existing training credits. However, the full vouchers option appears less likely to be adopted at this stage.
College principals yesterday discussed a range of options at a conference in Birmingham called by the funding council, which intends to consult widely before reaching a decision next summer.
Next April, the diverse group of institutions - ranging from academic sixth-form colleges to agricultural colleges and ones offering mainly part-time vocational courses for local employers - leave the control of more than 100 local education authorities, which funded them in different ways. They will come under funding councils in England and Wales, and the Scottish Office. Funding has been kept as simple and stable as possible in the first year to avoid confusion.
Despite a difficult public expenditure round, John Patten, Secretary of State for Education, has secured an open-ended commitment from the Treasury to fund each full-time student recruited by colleges, even if they exceed targets. The sum involved, pounds 750, is only a third or a quarter of the average cost of teaching a course, but is intended to encourage colleges to recruit extra students above target.
William Stubbs, chief executive of the funding council, said that the same rules would be extended to part-time students in subsequent years and that, in future, laboratory or workshop-based courses could attract higher rates than classroom-based courses.
A total of pounds 68m has been allocated by the funding council for health and safety works in the coming year. Roger McClure, finance director for the funding council, said that legislation had been tightening. 'We have now got to the position where a college could be ordered to close down buildings if health and safety authorities thought there was a problem.
'If these problems are not addressed quickly there could be problems over accommodation for existing students, let alone new ones,' he said.
In a determined effort to maintain and improve the quality of further education as it expands, the funding council is setting up its own independent inspectorate of more than 70, headed by Terry Melia, who instituted the HMI inspection system for the polytechnics. Unlike the new schools inspectorate, Ofsted, all the inspectors will be experts, drawing on outsiders from industry where necessary.
Mr Melia believes that publishing the HMI inspection criteria proved it was possible to raise teaching quality in the polytechnics. 'It had a fundamental impact in the polytechnics because teachers were able to see what they were being measured against.' He is doing the same for further education colleges.