Britain begins painful government spending review

A video grab image shows Britain's Chancellor of the Exchequer, George Osborne, speaking in the House of Commons, in central London June 8, 2010.

LONDON (Reuters) - Britain's coalition government will take a close look at social security, tax credits and pensions in a 2011-2015 spending review that will form the backbone of its efforts to slash a record budget deficit.

Conservative finance minister George Osborne and his Liberal Democrat deputy Danny Alexander announced the review blueprint to parliament on Tuesday, two weeks before an emergency budget will set out the overall scale of the planned consolidation.

The review, due to be published later this year, will break down exactly which departments will suffer most as the new coalition government, formed after the May 6 election, tackles a deficit running close to 11 percent of national output.

Health and overseas aid budgets have been spared the axe.

"Given that Britain has got the largest budget deficit of any advanced economy, we've got to get on and deal with it," Osborne told parliament. "The threat to the British economy is if we do not deal with this deficit."

Ratings agency Fitch said on Tuesday that Britain faced a "formidable" fiscal challenge and would require a faster pace of austerity than planned by Labour, which lost power in May. The comments sent sterling lower against the euro and the dollar.

Independent forecasts for economic growth and borrowing from the newly-created Office for Budget Responsibility will be published on June 14, giving a clearer indication of the magnitude of the task that lies ahead for the new government.

The spending review will use a "star chamber" of key ministers to examine departmental spending and the coalition will also consult the public, trade unions and the private sector.

"The process is beginning and ministers are very clear that they are going to have to find savings," Prime Minister David Cameron's spokesman told reporters.

PAINFUL CUTS

Wary of contagion spreading from the euro zone debt crisis and the threat of higher borrowing costs, the coalition wants to take tough action to maintain investor confidence.

Executing such a painful deficit plan is likely to involve heavy job losses in the public sector and seems bound to trigger union unrest at a time when Britain's economy is emerging from its worst recession since the World War Two.

Trades unions said the cuts could trigger protests.

"It would not be possible to make cuts on the kind of scale that have been contemplated without them having very significant damaging consequences, without them hurting some of the most vulnerable, and potentially doing damage that would last decades perhaps even generations," Brendan Barber, General Secretary of the TUC, the union umbrella body, told BBC radio.

The debate over where to cut -- the coalition wants much of the deficit reduction to be carried out through slashing spending rather than tax hikes -- could also create tension and reveal cracks in the fledgling governing partnership.

Speaking to cabinet earlier, Osborne cited independent forecasts -- based on previous Labour plans -- of cuts of 15-20 percent in non-protected areas of spending. The coalition wants to protect fewer areas while cutting the deficit faster than Labour.

Many analysts say they doubt whether many Britons are aware of the pain that awaits. Cameron warned on Monday that the deficit reduction would change the British way of life.

Labour says too severe a fiscal tightening could put Britain's frail economic recovery at risk, arguing that the Conservatives are using the need for deficit reduction as a cover to implement their ideological desire to shrink the state.

"All parts of government and society, and all parts of this parliament, if they want to take up the opportunity will have a chance to make their voice heard," Osborne said.

"After years of waste and debt and irresponsibility, we have got to get Britain to live within its means. It's time to rethink how government spends our money," he told parliament.

(Additional reporting by Avril Ormsby and Keith Weir)

(Editing by John Stonestreet and Susan Fenton)