Chancellor seeks VAT protection for 'nearly poor': Downing Street says Cabinet now very close to settlement in battle over public spending

KENNETH CLARKE, the Chancellor, is urgently examining ways of ensuring that 'nearly poor' people, particularly pensioners with savings, are not penalised by the imposition of VAT on fuel from next April.

As Downing Street made a snap announcement last night that the Cabinet battle over meeting the coming year's public spending totals is all but over, the question of compensating those just above income support levels was said by a source close to the Chancellor to be a 'big issue that he takes very seriously'.

What could have been a prolonged Cabinet row over keeping spending within the agreed pounds 253.6bn ceiling ended yesterday after the Prime Minister and Mr Clarke met key spending ministers, leaving final details to be settled in Thursday's routine meeting.

The exercise was bloody, none the less, and the upshot a series of deep cuts in real terms for some departments. Budgets for roads, which were completely protected last year, rail and the Housing Corporation have been slashed, a move certain to cause anguish to a building industry showing only sluggish signs of recovery and which will do little to create construction jobs.

Some ministers feared yesterday that the London CrossRail link might never get off the ground, while the Channel tunnel link could face serious postponement.

Discretionary spending by the Ministry of Agriculture is also reported to have been hit.

And despite the broad agreement reached yesterday, just who will be covered by the final VAT on fuel compensation package, and how, is still unresolved - partly because of uncertainty over whether Mr Clarke will stick to Norman Lamont's scheme to introduce it in two stages. Final details of the compensation scheme will be revealed in the Budget on 30 November and are likely to take until the last moment to finalise.

The Treasury has insisted help should be confined to the five million people on income support, which would cost pounds 700m if the likely pounds 2 a week cost of the tax at 17.5 per cent is to be met.

But the thrift of the 250,000 pensioners with incomes within pounds 5 of income support levels stands to be penalised without compensation, Cabinet colleagues and backbenchers have been pointing out.

Peter Lilley, Secretary of State for Social Security, has been pressing for help to be given to many more - up two million people on housing benefit or council tax benefit. He has pledged budget savings by tightening eligibility for invalidity benefit, but that requires legislation and even then the results will take several years to filter through.

Malcolm Rifkind, Secretary of State for Defence, appears to have secured a compromise he can sell to concerned backbenchers, with the 1996-97 cut scaled down to about pounds 500m instead of pounds 1bn. He will be expected, however, to find savings in administrative costs.

John Patten's education budget, said by Mr Clarke to be a priority at the party conference in Blackpool, has been protected. Virginia Bottomley's health budget is also set to increase in real terms in line with manifesto pledges.

Agreeing spending priorities does not mean, however, that Mr Clarke has reached decisions about whether tax changes are needed to help pay for them and, if so, what those changes should be.