Local authorities in England have been warned by the government to keep council tax rises below 5% next year.
Local authorities say they are struggling to meet service demands
Local government minister Phil Woolas told MPs that he will not hesitate to cap "excessive" hikes by councils.
But council leaders say many authorities would struggle to make ends meet without extra funding.
The settlement comes weeks before Sir Michael Lyons delivers his long-awaited report to ministers on how councils should be funded in the future.
Mr Woolas told Parliament on Tuesday that government support for local councils in England will rise by 4.9% to £3.1 billion next year.
But he warned councils that any tax rises for the year 2007-08 must be kept below 5%.
In his speech, Mr Woolas also said that total revenue grants to English local authorities for the same period will reach £65.7 billion.
The Local Government Association (LGA) has warned that a large number of authorities will get just 2.7% - well below the rising costs of many council services.
Leaders say an ageing population and tighter regulation of waste disposal is putting extra pressure on councils and those receiving the minimum grant increase would face "very real difficulties" in balancing the books.
If government grants do not increase further, the only solutions for some authorities would be to cut services or implement an above-inflation council tax increase, the association has warned.
LGA chairman Lord Bruce-Lockhart said: "It is the council tax payer that has funded the 'unprecedented increase in spending', as government grant has not kept pace with the demands on local government, including rising demand and the costs from new legislation."
He added: "Government must be honest and decide if it is serious about meeting the demographic, social, environmental and economic costs of the future."
But Mr Woolas said no government had ever put such sustained investment into local services and that there had been an increase in real terms of 39% in grants since 1997.
"We've provided a strong and stable funding basis for local services, and we expect local government to respond positively with an average council tax increase in England in 2007-08 of less than 5%," he said.
"We have used our reserve capping powers in previous years to deal with excessive increases and won't hesitate to do so again if that proves necessary."
Mr Woolas said minimum grant increases have been set at 2.7% for shire councils, fire and rescue authorities and authorities with education and social services responsibilities, and at 3.6% for police authorities.
Conservative local government spokesman Eric Pickles said council tax had "rocketed" since Labour came to power in 1997, rising by 84% to £1,268 for a band D property this year.
He said a 5% increase this year would mean an extra £63 for a typical pensioner couple or family.
He had calculated that the average bill could hit £1,500 if similar rises occurred until the end of Labour's third term of office.
He expressed concerns that capping powers would not apply to Londoners - who could end up paying for the 2012 Olympic Games over 30 years.
And Liberal Democrat local government spokesman Tom Brake said many councils would be faced with putting up council tax or cutting services because of "burdensome red tape issued from Whitehall".