Plan for graduate tax dropped in second U-turn over grants

Graduates could be forced to pay market rates of interest on their student loans under proposals drawn up after a Whitehall dispute over the future of university funding.

The Government was accused of presiding over a "mess" last night after it dropped plans to reintroduce maintenance grants of £3,800 a year for all students weeks after floating the proposals at the Labour Party conference in September. Treasury and Downing Street had become worried by the £3bn annual cost.

Ministers are also getting cold feet on a proposal for students to pay a graduate tax on top of the basic rate of income tax for up to 25 years after they leave university, which they fear could be dubbed "a stealth tax on the middle classes".

A Whitehall source said: " We have gone back to square one. It is a very complicated issue."

The options had been under consideration in a review of student finance, which was due to be completed before the end of the year but will be delayed until 2002. Tony Blair announced the review during the party conference in response to fears that loans and fees dissuaded those from low-income families going to university. The review, by the Department for Education, Downing Street and the Treasury, is looking seriously at charging market rates for student loansto fund the Government's drive to attract students from hard-pressed households to university.

Interest is currently only charged on student loans to cover inflation. Loans of up to £4,700 are available in London and up to £3,815 elsewhere.

The handling of the review came under fire last night from Barry Sheerman, the Labour chairman of the Commons Education Select Committee. "They are in a bit of a mess over this," Mr Sheerman said. "They have realised that they have got a lot of Middle England voters excited and raised expectations about change. First of all the Prime Minister gets involved and raises expectations. The Department for Education and Skills runs around like a headless chicken trying to come up with some new system. This is not the way to make policy ... We're getting the worst of all possible worlds, uncertainty, high expectations, which I think will all end in tears."

Ministers dismissed the criticism, saying the Government had delayed making decisions because it wanted to make sure an affordable and fair system was introduced.