By Marcin Grajewski

BRUSSELS, Sept 6 (Reuters) - Farm aid should be reduced toabout one third of the European Union's budget and spendingcould be shifted towards research and innovation, the EU'sbudget chief said on Monday.

Budget Commissioner Janusz Lewandowski said talks that areabout to start on the EU budget, now worth about 130 billioneuros ($167.5 bln) annually, could be the most difficult in thebloc's history following the global economic crisis.

Agriculture subsidies account for more than 40 percent ofthe EU's budget. A fierce battle is expected over their futureas the Union tries to overhaul its budget, and an annual rebatecherished by Britain could be under threat.

The EU executive, the European Commission, will publishproposals on the future of the farm subsidies next month.

"A hot budget season will start from October. These may bethe most difficult negotiations in (the EU's) history," Lewandowski, a liberal economist and Poland's formerprivatisation minister, told Reuters in an interview.

"We are living in special times, when national budgets aresubject to painful cuts which creates a lot of frustration."

The talks will coincide with efforts to cut budget deficitsacross the EU to below a cap of 3 percent of economic outputafter governments boosted spending to fight the crisis.

The overhaul could cut the EU's Common Agricultural Policy(CAP), which critics say unfairly protects European farmersagainst foreign competition and wastes funds that could be usedmore productively elsewhere.

"Farm spending should constitute about a third of EUspending and not its main part," Lewandowski said.

"To defend the credibility of the budget, we must supportthe trend of falling farm spending. But it is defended by astrong lobby and will remain an important part of the Europeanbudget."

The negotiations, which start in earnest early next yearafter the Commission makes proposals on the overall reform of EUexpenditure, will determine the shape of the EU's long-termbudget for seven years from 2014.

France, a major farm aid beneficiary, is expected to leadefforts to defend agricultural subsidies. Net payers to thebudget, such as Austria and Germany, are likely to call forausterity while poorer, eastern European countries seek aid.

MORE SPENDING ON RESEARCH AND DEVELOPMENT

Lewandowski said funds for research, development andinnovation should increase -- a view likely to please some ofthe richer EU countries such as Sweden and the Netherlands.

Lewandowski said spending should be put aside to help the EUenhance its global role, but did not say how much.

He promised to defend EU aid funds to its poor regionsagainst expected demands for cuts by richer countries.

Lewandowski dismissed reports that the Commission had backeda new pan-EU levy to help fund its budget, such as a financialtransaction tax or a levy on airfares, although the issue couldbe considered in the overhaul of the budget revenue system.

Efforts to simplify the way the budget is collected couldinvolve ending all rebates, such as the British one now worthsome 5 billion euros annually.

Britain secured the rebate in 1984 as compensation forreceiving little benefit from farm aid, but the size of the EU'sfarm aid has since fallen substantially.

Lewandowski said he would fight for restraint onadministrative spending. A planned increase in such spendingnext year, despite cuts in most of the 27 member states, hasprompted severe criticism in some countries.

He called for a moratorium on the creation of new EUinstitutions and bodies.

"The Union must not try to solve its problems by creatingnew institutions all the time. The credibility of the Europeanproject is at stake. We have come to the wall here. And we needa solid audit of existing institutions," he said. (Editing by Charles Dick)