The Government is spending more on welfare than on education or law and order, but the vast sums are doing little to relieve poverty, according to a think-tank.

A study entitled Reforming Welfare says that Gordon Brown, the Chancellor, has constructed an expensive welfare and benefits system that is “not fit for purpose” and requires a radical overhaul.

The study is by the right-of-centre think-tank Reform, which promotes the liberalisation of public services and extended choice. It claims that Labour has created a benefits nation, with two in five households — including many of the richest — claiming handouts.

Rather than encouraging people to work, the benefits often end up punishing those who want to better themselves.Britain must start a national debate on the failings of its welfare system, according to the think-tank.

The welfare state cost £79 billion last year, more than is spent on the entire education system, twice as much as on law and order and almost as much as on the NHS. It totals nearly £3,000 a household a year.There are 51 different benefits, with 39 per cent of households claiming one or more. Although the Chancellor often boasts about his record on unemployment, there are 5.4 million people of working age who are out of work and living on benefits. Many of those are registered disabled; Britain has more long-term sick than any European country besides Poland.

The benefits system has become so generous that being “on welfare” is no longer a mark of even relative poverty. Households with incomes of up to £66,350 — which puts them in the richest fifth — can be entitled to welfare.

The Chancellor has repeatedly said that he wants to build a benefit system that is a “hand up” rather than a “handout”, encouraging people to move from welfare to work. The 143-page study says that he has comprehensively failed in this aim, with 80 per cent of benefits — £64 billion — paid without any strings attached.

Instead, Britain now has the deepest poverty trap in the Western world, with thousands of people stuck in low-paid and part-time work because any extra money that they earn by finding a better job or working longer hours would have to be handed over to the Treasury.

Just under 800,000 working parents lose more than 70p in every extra pound they earn, and nearly 400,000 lose more than 90p in the pound. About 34,000 people lose more than £1 for every £1 they earn.

The study says: “The combined effect of different means-tested benefits has been to create a system which actively dissuades millions from bettering their position. Incentives to work have weakened, not strengthened, since 1997.”

Mr Brown has said that he wants to ensure that “work pays” but the report says: “In short, for many, work barely pays. It makes them ever poorer.” The result was that poverty had barely declined, and that the deepest forms had increased. Nicholas Boys Smith, the report’s author and a former Conservative parliamentary candidate, said: “It may prevent the very worst hardship, but only at the cost of holding millions of people either in unemployment or in very low-paid work.”

Frank Field, the Labour MP, former Welfare Minister and former director of the Child Poverty Action Group, said: “It’s a good piece of work and it should be the beginning of the debate. We’ve had these ten incredibly favourable years for welfare reform, and the results are modest. Just doing more of the same is not going to work.”

George Osborne, Shadow Chancellor, said: “This detailed report is part of a growing consensus, on the Left and the Right, that Gordon Brown’s welfare reforms have undermined work incentives and increased the number in severe poverty. Gordon Brown’s greatest boast may become his greatest failure.”

A Treasury spokesman said: “Since 1997 the Government has lifted 700,000 children out of poverty, and employment is at record levels. Reforms of the tax and benefits system mean that families with children are on average £1,500 per year better off in real terms since 1997, and those in the poorest fifth are £3,400 per year better off.”

• More than ten million families face paying a 40 per cent inheritance tax bill when their relatives die, according to research by Scottish Widows (Rosemary Bennett writes).

  The threshold is £285,000 and 41 per cent of households would now have assets worth more than this, compared with 34 per cent last year.

  Rising property prices are behind the sharp increase, the report said. House prices have risen by about 6.3 per cent this year.

  The Conservatives and some Labour MPs argue that the thresholds need to rise sharply to take property prices into account. They say that many middle-income families are now liable for a tax that was designed to target the wealthy.

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