Business leaders urged the Government today to introduce a two-year pay freeze in the public sector and drop “unsustainable” pledges to maintain spending on health and overseas aid.

The British Chambers of Commerce said the Chancellor faced a “difficult” balancing act in next week's Budget, but warned that more drastic spending cuts will be needed to protect spending programmes.

In its Budget submission to George Osborne, the BCC said plans to increase employers' National Insurance contributions should be reversed and capital gains tax should not be raised.

An immediate two-year public sector pay freeze should also be announced, as well as reform to “rein in” the cost of public sector pensions, the BCC said.

The group's director-general, David Frost, said: “The right choices would put business growth at the very heart of Government policy, but short-term moves on tax or infrastructure spending could hurt business confidence and economic recovery.

“The Government must avoid punishing new taxes that negatively affect private sector growth. Short-term revenue gains would be outweighed by longer-term economic consequences, from reduced business investment to lower rates of job creation. If tax rises are unavoidable, they should be targeted at consumption taxes rather than payroll, income or profits.

“As politically unpalatable as it may be, the decision to ring-fence spending on health and overseas aid is unrealistic and unsustainable in the current circumstances. Ring-fencing health will mean deeper and more drastic cuts to important investment elsewhere, without the benefit of clear justification.”

Bob Crow, general secretary of the Rail, Maritime and Transport union, said: “This is an act of deliberate provocation by the bosses' organisation. While boardroom pay, bonuses and dividends have been allowed to let rip, the same people who have stuffed their pockets with cash are now telling public sector workers to pay for this crisis through a pay freeze.

“With inflation running at over 5%, a pay freeze means a massive pay cut in real terms dragging us into the same heavy measures that have been unleashed in Spain and Greece.

“We can expect the same response from British workers - a fightback to defend living standards and public services with co-ordinated industrial action across the public sector on the agenda.”