George Osborne drove his axe deep into the heart of the British state today, with a range of sweeping cuts to welfare, higher education, social housing, policing and local government that he claims will draw the country back from the brink of bankruptcy.

Outlining his long-awaited comprehensive spending review, which will cut £81bn from government spending, Osborne vowed to restore "sanity to our public finances and stability to our economy". Perhaps the most striking of the new cuts announced was a package of £7bn in extra welfare cuts on top of the £11bn already made in the last budget. This will include the withdrawal of £50 a week from the million people claiming incapacity benefit for more than a year.

Osborne told MPs: "Today is the day when Britain steps back from the brink, when we confront the bills from a decade of debt. It is a hard road, but it leads to a better future." His gamble rests on the assumption that the private sector and exports will fill the gap caused by the loss of nearly 500,000 public sector jobs that will result from the cuts, mostly through natural wastage.

In a rapid-fire speech to the Commons, Osborne slashed £350m from the legal aid budget, reduced the police budget by 20% over four years, and hacked two-thirds off the £9bn communities department budget, including more than halving the support for social housing over four years. The pension age will rise to 66 from 2018.

Rail fares will be allowed to increase by 3% above RPI inflation from 2012, higher education spending will be cut by 40% – £2.9bn – by 2014/15, and flood defences by 15%. Further education will be cut by £1.1bn by 2014/15 and the "poorly targeted" education maintenance allowance for 16- to 19-year-olds is abolished.

In the isolated splashes of good news in the speech, Osborne claimed to be sparing health, schools and international development from the brunt of the cuts, and said he would set aside £2bn for the work and pensions secretary Iain Duncan Smith's plans to unify tax and credits.

He also announced extra spending on adult apprenticeships, raised spending on schools from £35bn to £39bn, confirmed £1bn of funding for a new green investment bank, and said the science budget would be frozen at £4.6bn.

Attempting to wrongfoot Labour politically, he claimed that the extra £7bn savings on tax credits and a range of other welfare benefits had enabled him to limit the overall reductions in the budgets of Whitehall spending departments to 19% over the next four years – less than the 20% pencilled in by the Labour chancellor, Alistair Darling, to cope with the UK's record peacetime deficit.

Labour said the Osborne comparisons were bogus, however, and took no account of the fact that Labour also planned to make cuts in welfare that would have the effect of reducing the average size of departmental cuts it would have imposed to well below 20%. The Tories were cutting £20bn more over the parliament than Labour had planned, shadow Treasury sources said.

Alan Johnson, the shadow chancellor, rounded on Conservative MPs for cheering Osborne's statement as the chancellor sat down. "We have seen people cheering the deepest cuts to public spending in living memory," he said. "For some people opposite this is their ideological objective. For many of them, not all of them, this is what they came into politics for."

Labour also said the extra cash for the £2.5bn pupil premium was a con as it was coming from within the schools budget, a point disputed by the education secretary, Michael Gove. A confidential internal projection by officials predicted 40,000 teachers could end up losing their jobs.

Nick Clegg, the deputy prime minister, held a teleconference with hundreds of Lib Dem parliamentary candidates and faced tough questions on why he had reneged on the Lib Dem pledge not to raise university tuition fees. He told the callers that he felt wretched about signing the pledge and then reneging on it.

Amid signs that public anxiety over the severity of the spending review has affected both consumer and business confidence, Osborne said the pain would help Britain to a better future of lower interest payments on the national debt. The chancellor also announced that he was prepared to borrow an extra £2bn a year to limit the cut in investment on infrastructure, following concerns raised by business that the slashing of the capital budget would affect the economy's long-term growth potential.

Many City economists were, however, sceptical of the central economic claim made by the chancellor – that the paring back of state spending by more than £80bn over the next four years could be more than offset by a thriving private sector. The impact of the squeeze on spending will be to reduce growth by 0.5 percentage points in each of the next four years at a time when the economy is still struggling to recover from its deepest and longest postwar recession.

Osborne said 490,000 jobs would go in the public sector during the rest of the parliament, but said redundancies were "unavoidable when the country has run out of money". He also signalled that public sector workers would have to increase substantially their contributions to pensions, the issue that has drawn people onto the streets of Dublin and Paris.

Carl Emmerson, acting director of the Institute for Fiscal Studies, said it remained to be seen whether the government could achieve its ambitious objectives. He said: "A key lesson from the last Labour government and the last Conservative government is that the public finances often do not behave as expected."

Official figures out today showed net borrowing in the current financial year to be little changed on the £156bn amassed last year, but Osborne is relying on stronger growth to help him reduce the deficit.

Andrew Smith, chief economist at KPMG, said the government's economic assumptions were "heroic", warning growth would be hit by consumers repaying debt, businesses delaying investment, and a tougher climate for exporters.

Cuts at a glance

What we got yesterday

£46bn cut from departments, including 27% from local government, 29% from the environment and 23% from the Home Office

£7bn from welfare, including £2.5bn in child benefit changes


£11bn from welfare announced in the budget in June

£6bn announced in May when the coalition took power

£10bn saved in lower debt interest payments

£1bn of other savings

Making a total of

£81bn total cuts


Patrick Wintour and Larry Elliott

The GuardianTramp

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