Rejected: Queen's plea for more cash

The Queen and the Government are locked in a secret dispute over royal demands for increased public funding to meet the growing expense of the monarchy.

Palace aides have told ministers they need extra money to offset the cost of maintaining the Royal Estate of palaces and pay for increased fuel, food and staffing costs. But the Government is refusing to increase the £15m it pays for the upkeep of the Queen's occupied palaces and is fending off demands for a large rise in the £7.9m Civil List which pays for the monarch's public functions. Ministers argue that, in the present economic climate, Whitehall budgets are already overstretched. Royal aides counter that Parliament has a constitutional duty to ensure the Queen is financially secure.

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An investigation into the royal accounts by The Independent, with the accountants Baker Tilly, has revealed that – by 2011 – the Queen will not be able to balance her books as the escalating cost of maintaining the Royal Household will be more than double the £7.9m allocated by Parliament. This year's palace accounts already show Civil List expenditure will reach £14.4m – £6.5m more than the Government has agreed to pay the Queen each year.

The dispute can only be settled if either the Government agrees to give the Queen more money or the Royal Family scales back its public spending. All that the Treasury will say on the subject is that an announcement on the Civil List will be made "in due course".

Palace aides, who are now pessimistic about a state bailout, claim the royal finances have been ravaged by inflation. Without more funds, Buckingham Palace insists, the Queen will no longer be able to pay for the upkeep of her palaces, which her aides claim require £32m of refurbishment and maintenance in the next 10 years.

A Palace source said: "We have spent a lot of time convincing the Department for Culture Media and Sport of the merits of our case but I am not convinced they are listening very carefully to our arguments. It is a major disappointment." The Palace believes that competing interest from the Olympics budget has helped to close ministers' minds to releasing more cash.

There is strong public and parliamentary pressure to rein in the growing cost of the Royal Family, which stood at £40m overall last year and includes maintaining the Royal Household, the upkeep of the palaces and the Royal Family's travel bill. That is £12m more than in 2002, when the Palace first published detailed accounts of its finances. Some MPs suspect that members of the Royal Family, principally the Prince of Wales and the Duke of York, have been profligate with taxpayers' money and want the royal accounts publicly audited in the same way as government departments.

Paul Flynn MP, a Labour member of Parliament's Public Administration Committee, called for a "root-and- branch investigation" of all property and land owned by the Royal Family.

Included in the list of palace demands is a more generous tax treatment, specifically a call for a VAT exemption on the payment of services rendered to the Queen. "Government departments get VAT exemptions on services, why shouldn't we?," said an aide.

Negotiations are about to enter a critical phase as the Government prepares to review the Civil List. The Civil List was last increased to £7.9m in 1990 under a private agreement with John Major's government in what was recognised, at the time, as a very generous settlement.

Under the Blair government it was reviewed again in 2000, but ministers balked at giving more taxpayers' cash to the Royal Family even though it was clear inflation had considerably reduced the real value of the Civil List. It is due for renewal before 2010.

According to palace accounts, the Queen had built up a reserve of £35m in 2000. But as palace officials made further "draw-downs" to meet the increasing cost of living and the impact of inflation, the reserve was reduced to £26m last year. It is estimated to fall below £20m this year and will be wiped out completely before 2011.

While palace maintenance represents the biggest call on public expenditure, the Queen is also responsible for a growing salary and pensions bill that has increased to £9.1m, up £2m in four years. Her finances have also been hit by rising fuel costs and the crash in the stock market, where some of the Civil List reserve has been invested.

The harsh economic realities were recently brought home to the Queen when she was forced to sell land at the Royal Garden Hotel, Kensington, to raise £2.5m to pay for emergency repairs and refurbishments, including a staff accommodation block in the Royal Mews area of Buckingham Palace.

Mark Harwood, head of UK risk and corporate governance with Baker Tilly, concluded: "Future funding will need to be at a higher level and will probably need to increase year on year, rather than the policy under John Major of fixing a higher List, allowing surpluses in earlier years to be invested to cover deficits in later years."

Explainer: The Queen's income

The queen's wealth can be divided into the income she receives from the Government and earnings from her estates and investments. The public cost is partly funded by the Civil List, while further taxpayers' money is spent on the upkeep of the occupied palaces and the Royal Family's travel on state business. Prince Philip receives a grant of £359,000 for his state role as consort to the Queen.

The Queen continues to generate income through the privately owned 46,000-acre estates of the Duchy of Lancaster. This year it rose from more than £11.7m to £12.6m. This helps pay for her private estates and some expenses for the junior royals.