The CBI has warned that rising public sector costs could prevent the government from improving frontline services.

Unless a tight grip is kept on spending, rising costs could take up to £7.5 billion of government funds this year, the CBI warned on Monday.

Publishing its submission to the Treasury ahead of the pre-Budget report, the CBI emphasised the need to press on with public service reform.

It highlighted "relatively generous" wage growth and disappointing productivity performance which if left unchecked would have a serious impact on the delivery of improved public services.

The submission said the unit cost of public service provision increased by 7.6 per cent over the past year, costing £7.5 billion for the current financial year.

Over the year to the second quarter of 2003, the public sector saw wages grow by 5.1 per cent compared with three per cent in the private sector.

And public sector output per job fell by 0.5 per cent while in the private sector there was a rise of 1.8 per cent in services and by four per cent in manufacturing.

"Improvements in public sector productivity are failing to match the increase in investment," said CBI chief Digby Jones. "The government must urgently improve the efficiency of public spending or face the painful choice between scaling back investment or increasing taxes further.

"The private sector is busting a gut to be both productive and competitive. Surely tax payers - businesses and individuals - are entitled to see the public sector do the same."

Jones warned the chancellor Gordon Brown not to "ignore an efficiency problem that threatens to undermine the government's investment programme".

He called for the public sector to examine the potential for external benchmarking, introduce greater competition between public service providers, increase flexible working and make better use of capital.

The submission avoids calling for major cuts in business tax, but warns against further rises.

However, it praises aspects of the chancellor's pro-enterprise agenda and calls for a package of modest tax changes to boost innovation and help small firms.

"The chancellor has done a good job promoting enterprise. It is so disappointing that the benefits have been outweighed by a serious increase in overall business taxation," said Jones.

"But I'd still rather be doing business in the UK than anywhere else in Europe and I am pleased to see Mr Brown championing European reform."