Mix-up blamed on officials who did not know their Tyne from their Lyme

It must have been a bad day, a terrible phone line or a group of civil servants whose knowledge of regional geography was based on pre-Industrial Revolution Britain.

Whichever, the government office in charge of local councils was struggling yesterday to explain how grants totalling £2.8m have been paid by mistake to Newcastle-under-Lyme instead of Newcastle upon Tyne.

The improbable bungle, seldom made even by directory inquiries or GCSE candidates, mistook a quiet Midlands market town for one of the country's biggest cities, home of brown ale and Kevin Keegan's Premiership football team. It also handed the wrong local authority, a modest borough council whose greatest excitements come in the annual Britain in Bloom competition, funds worth more than a 10th of its whole net annual expenditure.

"This is a regrettable error and we have taken action to rectify it," said a statement from the communities and local government department, which is charged with helping local councils and therefore knowing where they are.

Initial blame is being placed on the complexities of a competitive scheme for extra cash, one of many introduced during Labour's decade in power, whose payments have been worked out in Whitehall, rather than locally.

Known as "Labgi money"- Local Authority Business Growth Incentive - the fund will have paid out £126m to some 270 councils by the time it is abolished at the end of next month. Grants have match-funded town hall success in attracting new businesses, which Newcastle-under-Lyme says partly explains its acceptance of the jackpot. "We took this money in good faith, because we've seen a lot of business generation," said a spokesman for the borough council. The payment, which should have been only £600,000, also came in several tranches.

The big Newcastle 185 miles north revealed that it had queried its "apparently low" level of payments under the scheme a year ago. John Shipley, the city's Liberal Democrat leader, said: "Our officers were surprised that we hadn't got more money. But now we find out that a gross error has been made. I'm pretty shocked. Those of us in local government are regularly accused of being inefficient by Whitehall. But at least we know our Newcastle upon Tyne from our Newcastle-under-Lyme."

Even the two places' differing policy over hyphens - a regular question in pub quizzes and Trivial Pursuit - failed to alert the London civil servants to their muddle. The city council is budgeting for spending cuts of £13.6m this year and on course to raise council tax in April by approaching 4%.

The communities department said yesterday that the correct money would now be sent to Tyneside, where youth service, care of the elderly and street warden budgets will probably be increased as a result.

Although the bulk of the windfall was put in Newcastle-under-Lyme council's reserves - more than quadrupling them - approaching £500,000 has been spent.

Council leader Simon Tagg said: "I'm flabbergasted that someone could have made this mistake. If we do have to pay it back, it should be over 20 years. We can't hand over £2m just like that." The department said that it was "taking steps to ensure this does not happen again and working closely with the councils involved" - now that it knows which is which.

The two Newcastles

Newcastle upon Tyne

· Is a city and the regional capital of the north-east

· Was founded by Emperor Hadrian in the 2nd century AD

· Has a population of 260,000

· Led the world in ship-building, armaments and the development of electric light

· Eats stotty cake and brews Newcastle Brown ale

· Spurns hyphens

Newcastle-under-Lyme

· Is a town near Stoke-on-Trent

· Is not mentioned in the Domesday Book but probably founded by 1100AD

· Population 74,000

· Is named after ancient forest of lime trees

· Has hyphens