Mayor Walter E. Washington proposed yesterday a sharp reduction in the amount of money to be set aside for city employee pay increases as a way of balancing his 1979 budget.

The $17 million reduction would mean that there would only be enough money in the budget, as proposed by the mayor, to support a 3 per cent cost of living pay increase for some 35,000 regular city employees in the fiscal year beginning next October. Initially the mayor had set aside enough money to give city employees a 5.5 per cent pay raise.

If the mayor's recommendation is accepted by the City Council, it would mean the city would have to get additional money from Congress to support any pay increase greater than 3 oer cent.

The $17 million reduction was necessary because the Home Rule Charter prohibits City Council from approving a budget greater than the ceiling set by Congress.

The 1979 budget proposed by the mayor assumes a $317-million federal payment. The current ceiling for the federal payment-the U.S. government's reimbursement to the city for the loss of revenues from tax exempt federal property-is $300 million.

The mayor based his $1.3-billion operating budget on the $317-million federal payment because the White House has indicated to city budget officials that it would propose an increase in the federal payment to that amount.

Legislation pending in Congress would raise the payment ceiling. However, key congressional leaders said last month they would oppose an increase to $317 million-more than the city has ever received before-because they do not believe the city government is operating as efficiently as possible.

In a letter to the City Council yesterday, the mayor said that he believes legislation raising the ceiling to $317 million would be approved by Congress before he sends the budgets to the White House in mid- January. The White House receives the D.C. budget from the district government and forwards it to Congress.

Deputy budget director Gladys Mack said the city has no specific indication that the legislation will be approved by that time. "But the point is, there is sufficient time to have it passed by then." She said.

Mack could not say yesterday what the mayor would propose doing if the $317 million is not approved. "Our position is that the city absolutely needs $317 million to maintain the levels of services and programs," she said.

If Congress approves raising the federal payment ceiling to $317 million or more after the budget is sent to the White House, the city could still get the addtional money through a supplemental budget request.

Even so, the budget would contains only enough money - $37.5 million - to support a 5.5 oer cent pay increase. If the csalaries of city workers, prevently keyed to those of federal employers increase by more than 5.per cent, the city would have to look again for additional money.

That is what has happened this year. The 1978 budget, still pending before Congress, contains only enough money for a 5 per cent increase. Congress has approved a 7 per cent increase for federal and city workers.

As a result, the city lacks the money necessary to pay mandatory pay increases, and it is still uncertain where the money will come from.

The mayor's decission to extract the $17 million from pay increase funds rather than proposing program or service reductions appeared to be aimed at abtaining a maximum amount of political leverage in the event of a confrontation with Congress over additional appropriations to the city.

That approach was immediately criticized by Council member Marion Bary (D at karge). Chairman of the Council's Finance and Revenue committee and a likely candidate for mayor in 1978.

The mayor should have taken the $17 million from the $76 million in new spending he has proposed for 1979, rather than take it from salary increases." Barry said. "It's unrealistic to think that our employees are not going to get a oay raise that other federal employees will get. The mayor's just playing games."

the Council which has been deliberating on the 1979 budget since September, will begin final actions on it early next week