Proposals for a digital television top-up licence fee to fund the BBC have been rejected by the government, but the general licence fee will rise to �104.

It means colour television licence fees will go up by �3 from April, with increases of 1.5% above inflation in subsequent years.

Culture Secretary Chris Smith said the increase would amount to three pence a week over and above inflation.

Mr Smith said he had thrown out the proposals for a digital supplement because "it would be wrong to signal that there was something special and only for the few" about digital television.

But he stressed that the BBC was "the most important cultural institution in Britain" and it was crucial that the organisation remained strong.

He said he was prepared to offer the BBC more support, but said there would be increased scrutiny of the corporation, which needed to become "more cost effective and quality conscious".

He said the increase in licence fee funding would raise an average �200m a year between now and 2006, but in return it must raise �1bn through efficiency savings.

But he said the government was not allowing the BBC "the massive injection of cash it has sought, amounting to �700m a year by 2006".

Mr Smith also announced that free television licences for the over-75s would be introduced from November and there would be half-price licences for the blind from April.

Tough decisions ahead

BBC Director General Greg Dyke said Mr Smith's announcement was "a vote of confidence and an endorsement of the BBC's public service role in the digital age".

He said: "Our aim is to provide outstanding programmes and services that will help drive the take-up of digital and bring its benefits to every home in the UK.

He said there would be some "tough decisions" as the settlement fell short of the BBC's full bid, but added: "It gives us an opportunity to plan and develop strong public service broadcasting for the digital age.

"The challenge for us is to continue to do as much by self-help as we can. We need to make sure that we focus our spending on the things that really matter - wonderful programmes and services for our licence payers.

"Achieving almost �1.1bn over seven years through efficiency savings and other activities such as partnerships and joint ventures is a tough target."

His comments were echoed by the BBC's chairman Sir Christopher Bland.

He said the announcement was a "vote of confidence" in the corporation, but he did not rule out job cuts in the future.

Ministers divided

Mr Smith's statement in the Commons follows months of speculation about the digital licence fee proposals.

Proposals for the "digital supplement" to the licence fee were made to the government last summer by its advisory panel on BBC funding, chaired by the economist Gavyn Davies.

But the issue was said to have divided Prime Minister Tony Blair and Chancellor Gordon Brown, with Mr Blair favouring a general increase in the licence fee - the option adopted by Mr Smith.

The Davies panel - which made recommendations otherwise largely accepted by Mr Smith - recommended that the extra money needed by the BBC should come from people who watch digital TV.

It recommended a �2 a month digital supplement to the licence fee (adding �24 to the current fee of �101), which would gradually be phased out as the population as a whole switched to digital.