Vital services in Oxford could grind to a halt unless drastic action is taken by Oxford City Council.

That was the warning today from financial experts who have revealed that the council's finances are in dire straits.

Earlier this year, the council pushed through a budget for 2001-2 which included cuts and fundraising measures of up to £3.8m.

But a number of cuts have not been made and a draft report circulated to political group leaders by accountants warns that the council is heading for trouble.

Corinna Redman, leader of the Liberal Democrat group, which runs the administration with the Greens, said measures were being put in place to tackle the shortfall.

The report, which was leaked to the Oxford Mail, reveals that by March next year, the council will be £806,000 overdrawn if no action is taken.

It adds: "For balances to be replenished to the prudent position of approximately £2m, then cuts/savings or transfer of capital resources to the value of approximately £3m are required in the current year."

Alex Hollingsworth, leader of the council's Labour group, said it was worrying that the council still needed to find £3m, after £3.8m worth of cuts were outlined in the budget.

He warned that vital services including waste disposal, housing, and street sweeping services could be halted if the council goes into the red.

He said: "It appears we are back to square one and it is an absolute shambles.

"To a great extent, it is the result of the current administration passing a budget which they knew did not add up.

"The Liberal Democrats and the Greens should be extremely concerned about this, and Labour will be putting forward an alternative budget which we believe contains more practical measures for getting funding.

"It is technically illegal for the council to go into the red, but if it happened, the council would no longer be able to issue any cheques. Staff would not get paid and services would stop.

"We want to avoid a situation where the district auditor has to be called in to issue instructions."

If the district auditor thought the situation was serious enough, he could refer the matter to the Government to take over the running of the council.

One option for the council is to dip into the capital account and transfer cash to the revenue account but this cannot be done repeatedly.

The report, by council's chief executive Marion Headicar, warned: "Any transfer of resources out of capital to revenue only addresses the budget problem in the immediate year."

It added that a longer-term solution would be cuts in council spending or significant increases in council tax.

The financial crisis is expected to be discussed by councillors at the strategy and resources committee on Tuesday.

Cllr Redman added: "We take financial management very seriously and looked at the current financial situation early in the year.

"There are some problems which have arisen, which are not of our making. We are bringing forward measures to address the situation and lengthy discussions will take place at the strategy and resources meeting."

Cllr Redman said she was not prepared to detail these measures until all councillors had seen the chief executive's report but added: "There is some discretionary expenditure and some that is essential."

She said the figures presented in the report were being constantly updated, and might not present a truly accurate picture of the financial situation.

Hackney: A worst case scenario

Oxford City Council's financial problems are nowhere near as serious as those of Hackney Borough Council.

But the London borough's position illustrates what can happen if a council's projected budget is not matched by annual revenue.

In November last year, Hackney Council in London agreed a three-year recovery programme to tackle the borough's financial problems, which happened mainly because of a problem with council tax collection.

The council had already agreed a target of £4m savings for the financial year 2000-2001, and savings of £16m in 2001/02.

Further savings of £9m are earmarked for the financial year 2001/02 - a further £10m in 2002/03 and £11m in 2003/04.

If no action had been taken, officers predicted that the budget deficit for the financial year 2001/02 would have been £78 million. Almost half of the projected deficit was due to problems with collecting council tax.

The budget was being set on the basis of collecting 96% of council tax but 65% was a more realistic estimate.

The council is now putting measures in place to recover unpaid tax and improve the service for the future.

During the height of the crisis in Hackney, services did actually grind to a halt and people's bins went unemptied for two weeks.

Ms Kat Myers, a spokesman for Hackney Council, said: "Last year, a section 114 legal instruction was implemented by the borough solicitor which froze financial transactions. This meant we were not able to give out any expenditure without consulting the district auditor.

"It was a very grave position for a council to find itself in but things now are improving. It will now take staff a year to deal with the backlog of council tax inquiries."