Chancellor George Osborne wielded the axe as he announced a massive £11 billion benefits squeeze and a hike in VAT to bring Britain's record deficit under control.
Delivering his first Budget to a packed House of Commons, Mr Osborne said he was acting "decisively" to prevent a potentially "catastrophic loss of confidence" in the UK economy.
He told MPs his "tough but fair" emergency package of tax increases and spending cuts would clear the structural deficit by the time of the next general election in 2015.
However his plans were condemned as "reckless" by acting Labour leader Harriet Harman, who warned they would jeopardise the recovery while hitting the most vulnerable the hardest.
Mr Osborne said that having inherited from Labour the largest budget deficit in Europe bar Ireland, the new Conservative-Liberal Democrat coalition had been forced to take drastic action.
"This Budget is needed to deal with our country's debts. This Budget is needed to give confidence to our economy. This is the unavoidable Budget," he said.
"Our policy is to raise from the ruins of an economy built on debt a new, balanced economy, where we save, invest and export."
The key elements of the Budget package include:
:: A £13 billion-a-year increase in the rate of VAT from 17.5% to 20% from January 4;
:: A three-year freeze on child benefit payments, while cutting tax credits to families on more than £40,000;
:: A cap on housing benefit payments and the introduction of a new medical assessment for disability living allowance claimants;
:: Future benefit increases to be linked to consumer prices rather than retail price inflation, saving £6 billion-a-year;
:: An extension of the public sector pay freeze to two years for staff earning £21,000 or more;
:: Accelerating the rise in the state pension age to 66;
:: A £2 billion-a-year levy on the banks;
:: The Civil List funding for the Royal Household to be frozen for one year at £7.9 million.
Mr Osborne said his welfare changes would save £11 billion-a-year by the end of the Parliament in 2015.
He made clear, however, that more pain would follow in the autumn spending review when Government departments whose budgets were not ring-fenced faced cuts in the order of 25%.
"I do not disguise from this House that the combined impact of the tax and benefit changes we make today are tough for people," he said.
"That is unavoidable given the scale of the debts our country faces and the catastrophe that would ensue if we failed to deal with them."
The Chancellor sought to soften the blow with an announcement that the link between state pensions and earnings would be restored from next year.
As had been widely trailed, he confirmed that personal allowances for basic rate taxpayers would be raised by £1,000, taking 880,000 of the lowest paid out of taxation altogether.
The child element of the child tax credit is also to rise by £150 over and above inflation next year, providing £2 billion in additional support for low income families.
But Ms Harman said that it was still the most vulnerable who would suffer most under the Government's plans.
"This is a Tory Budget that will throw people out of work, that will hold back economic growth and will harm vital public services," she said.
She reserved her harshest comments for the Conservatives' Liberal Democrat partners who, she said, had fought against measures such as the VAT increase which they were now supporting.
"How could they support everything they fought against, how could they let down everyone who voted for them, how could they let the Tories exploit them?" she demanded.
"The Liberal Democrat leaders have sacrificed everything they ever stood for to ride in ministerial cars and ride on the coat tails of the Tory Government."
The strains in the coalition were showing tonight, with Lib Dem MP Bob Russell warning that he could not see himself voting for the Budget.
"Less than 50 days ago, I was seeking re-election in Colchester opposed to a raise in the level of VAT," he said.
"So I am not at all happy. I need to discuss with colleagues how it is we have got into this situation."
In other measures, Mr Osborne said that ministers would be bringing forward plans to sell-off the air traffic control service, Nats, and the student loan book, as well as resolving the long-term future of the Tote.
He said he would go ahead with the Tories' promised overhaul of corporation tax - cutting the headline rate from 28p to 24p over the course of the Parliament - while raising the threshold for employers' national insurance contributions.
A controversial hike in capital gains tax on non-business assets for higher rate taxpayers will go ahead from midnight.
However the new 28p rate - 10p higher than previously - was less than some commentators had been predicting.
The Chancellor announced that there would be no new increases in duties on alcohol, tobacco or fuel for now.
However he indicated that there would be fresh measures in the autumn targeting alcohol products associated with binge drinking and underage drinking.
Mr Osborne said that the spending review - to be announced on October 20 - would cut departmental spending by a further £17 billion on top of the £44 billion planned under Labour.
The new Office for Budget Responsibility (OBR) is now forecasting that the deficit this year will be £149 billion compared to an estimate of £155 billion under the previous government's plans.
It will then fall back to £116 billion, £89 billion, £60 billion, £37 billion, and £20 billion in the years ahead.
The Chancellor acknowledged that economic growth would initially be slower than the OBR had been predicting, but said it would pick up towards the end of the Parliament.
Growth is now estimated at 1.2% this year and 2.3% next year - compared to its previous forecasts of 1.3% and 2.6%.
However, he said that from 2012 growth would pick up to 2.8%, then 2.9% and 2.7%, as against previous OBR forecasts of 2.8%, 2.8% and 2.6%.
© 2012 The Press Association Limited
