Clegg urges revamp of party funding system

Nick Clegg will propose a shake-up today of the way politics is funded, including a controversial extension of taxpayers' support for political parties. But the Liberal Democrats' long-standing backing for greater state funding could cause tension within the Coalition as Tory ministers fear a public backlash. "It would be the worst possible time to do this when we are making big spending cuts and after the MPs' expenses affair," one said.

Mr Clegg may have to plead with David Cameron to throw his weight behind more state funding. The Deputy Prime Minister is keen to show some concrete "gains" from the Coalition for his party – especially if the referendum on the voting system, due next May, results in a No vote.

The Liberal Democrats lost their taxpayers' grants to opposition parties when they joined the Coalition and had to lay off 20 party staff as a result.

Mr Clegg hopes that a new deal on party funding will be part of a "second wave" of constitutional reforms in the second parliamentary year of the Government, after Bills on electoral reform and fixed-term five-year parliaments in the current session. Turning the House of Lords into an elected chamber could also be part of phase two, although it could take years to implement.

Mr Clegg will say that changes to the funding system should include greater transparency and new rules on spending and donations, with parties relying on more small donations rather than on a few rich backers. One option would be for the state to match pound for pound the amounts raised by parties in small donations – of perhaps up to £10 – to encourage them to recruit new members and supporters.

He will be speaking at the launch of a new inquiry into the funding of politics by the independent Committee on Standards in Public Life, the anti-sleaze watchdog. Its report next spring will influence the Government's proposals.

Attempts to broker a cross-party deal on funding failed in 2007 after a row between Labour and the Tories over whether Labour's money from its trade union founders should be subject to a cap on individual donations. The talks were led by Sir Hayden Phillips, a former Whitehall mandarin.

Sir Christopher Kelly, chairman of the standards watchdog, said: "While significant difficulties remain, there is sufficient will to reform the system to give us some hope that it ought to be possible to find a solution which is both firmly based in principle and sufficiently acceptable to the main players to be sustainable."

In recent years Labour has become more dependent on union backing after big donations from individuals dried up in the wake of the "cash for honours" allegations against Tony Blair's government.

During the previous negotiations, a cap of £50,000 on donations was favoured by the Tories, while Labour and the Liberal Democrats preferred a lower ceiling. But the parties would then need more state funding to make up for the income lost from big donors.