Hard road ahead as Osborne embarks on mission to reshape state

By William James LONDON (Reuters) - Britain's finance minister George Osborne is under pressure to spell out how he will slash government spending after getting the green light from voters to finish off what is expected to be, for many, a painful redefinition of the role of the state. After five years of austerity under a coalition government, newly-reappointed Osborne now says he needs to find another 25 billion pounds of spending cuts in the next two years, and more beyond that, to complete what is set to be the most radical shrinking of the state in Britain since World War Two. Many of the most politically palatable cuts have already been made, meaning that reductions to benefits will hit Britons' pockets directly, and already-downsized government departments will need to rethink the public services they offer. "It really is a sea change in the way the government views itself," said Ian Jackson, an economist at Staffordshire University. "The government is saying to households 'you must take on responsibility yourself'... that will mean that a whole range of government activities will be profoundly different." Osborne's aim is to turn a 5 percent budget deficit into a surplus by 2018/19. He has committed to do that without raising income, employment and consumption taxes, and says the first step is to carve 12 billion pounds from welfare spending and cut government department funding by 13 billion. The cost could rise even further to accommodate billions of pounds of tax cuts and healthcare spending that Prime Minister David Cameron's Conservative Party promised in the run up to a surprise outright win in the May 7 election - their first for 23 years - without saying how they will be paid for. Despite intense scrutiny from media and political rivals, Osborne, seen as a potential successor to Cameron, has not disclosed how the cuts will be realised, which analysts say could be for political or practical reasons. "Either they knew exactly what they were going to do and they just weren't going to tell people, or they haven't actually worked it out yet," said Carl Emmerson, deputy director of independent think-tank the Institute for Fiscal Studies (IFS). On July 8, Osborne will set out a new budget which may give some clues on how he will start cutting the welfare bill and set out the terms for a spending review he will carry out later this year on a department-by-department basis. SECOND TIME LUCKY? Back in 2010, he had promised to eliminate the deficit by this year. A debt crisis and deep recession in the euro zone helped blow those plans off course, though political rivals say his austerity push also slowed the economic rebound. The cuts made Osborne unpopular among some voters and initially provoked expressions of concern from the International Monetary Fund. Last year, that concern turned to praise as Britain became the fastest-growing major advanced economy, making up ground lost during the financial crisis. But the momentum has slowed and it is now projected to grow 2.5 percent this year, after 3 percent in 2014. In this environment, finishing the job won't be easy. In the past five years day-to-day public spending fell to 18 percent of GDP from 21.6 percent, and the record-high peacetime deficit was reduced from 10 percent of GDP to 5 percent. To generate a surplus by 2018/19 without raising taxes, such spending will need to fall below 15 percent of GDP, according to official data. "If you take the consolidation as a whole, this parliament and the last, then it's unprecedented since at least the Second World War," said Emmerson. "We've generally only cut for two years in a row, not eight or nine." NARROW The government has ring-fenced health, education and state pensions, has previously protected the foreign aid budget and is under pressure from the United States not to reduce the spending on defence. This leaves a narrow area of public spending in line for cuts, such as local government funding, policing and benefits to those of working age such as child, housing, disability and unemployment allowances. "Obviously they've already picked the lowest-hanging fruit, and large areas of spending are out-of-bounds. So continuing at the same pace means that the cuts get harder and harder," said Adam Corlett, economic analyst at the Resolution Foundation. The IFS estimates that a 12 billion pound welfare reduction would take spending on unprotected social security payments as a percentage of GDP back 25 years. The Conservatives say the welfare reforms will create a fairer system, supporting only those who need it and pushing others back into work. Campaigners say further reductions will disproportionately hit those in poverty and the disabled. For those government departments in the firing line, the prospect of further cuts to their budgets is likely to mean big changes in the services they provide the public, and lobbying to protect their budgets has already begun. "Cuts have consequences and quite simply, we can do no more," Steve White, the chairman of the Police Federation of England and Wales, told members of his staff association on Tuesday. He said 17,000 officers and 17,000 civilian staff had been cut since 2010. "If the government is not careful, it will be too late, and the public and those in power won't realise what they have got in the police service until it's gone," he said. The Local Government Association, which represents local authorities across the country, on Sunday made a similar plea, writing to the Observer newspaper to highlight that council funding had been cut by 40 percent over the last five years. "Efficiencies cannot be remade or buildings resold," said LGA Chairman David Sparks. "Vital services, such as collecting bins, filling potholes and caring for the elderly, would struggle to continue at current levels." Philip Shaw at Investec said investors thought Osborne's plan was possible to fulfil, but also that the financial market pressure that forced harsh cuts in 2010 had eased. "Markets do think it's credible, but nor would they be too upset if he misses it slightly." Osborne's political future, however is at stake. "Having nailed his colours to the mast very publicly in the election, not achieving a surplus, effectively a year or so before the next election, would be a political embarrassment," Shaw said. (Editing by Andrew Osborn and Philippa Fletcher)