While recent welfare reforms have focused on people who are out of work, the government continues to neglect a far more damaging defect of our welfare state - that hard-working families on middle incomes are being taxed into state dependency.

If you earn slightly above the average income of £25,000, you pay taxes of just over £10,000. You get back cash benefits and public services (such as health and education) worth slightly more than that - an extra £141, according to official statistics. Instead of taking it away with one hand and giving it back with another, why doesn’t the government let us keep our income and make our own arrangements with our own money?

Most of us earn enough not only to pay for all the benefits we receive, including the National Health Service, schools and universities, but also to cover the cost of providing for less fortunate members of society. But by being taxed at source we are put in a weak position.

The vast majority of people gladly pay into a common fund to ensure that everyone receives good healthcare and education. But our determination to guarantee access for everyone has been confused with a desire for absolute political control. The result has been to suppress the most effective method of maintaining high standards: competition.

If the only way of providing guarantees for the least fortunate inevitably involved lowering standards for the others, there might still be a majority in favour. But there is nothing inevitable about it. Indeed, in education it is children from poor backgrounds who are being failed by state monopoly. The majority of hard-working taxpayers need to be granted independence from state control for the sake of their least fortunate neighbours, not in spite of them.

We are often told that the UK is one of the most unequal countries, but the Office for National Statistics (ONS) has shown that a huge redistribution of income is already taking place. In 2006-7, before taxes and benefits, the ratio of the total income of the richest 20% of people to that of the poorest 20% was 15:1. After taxes and benefits it had narrowed to 4:1.

One of the more remarkable consequences of this massive equalisation is the extent to which people on middle incomes and above have to pay for the benefits they receive from the government. How much money flows back and forth from the same family?

We can get some idea of this churning from ONS figures. It divides the population up into tenths according to income and works out the average taxes paid and benefits received. It also puts a price on the “free” health and education services provided by the state.

Let’s look at the tenth of the population whose average private income in 2006-7 was £25,104. Each household received from the government average cash benefits of £4,363, but paid direct taxes (income tax, National Insurance and council tax) of £5,620. Each household also paid indirect taxes (such as Vat and duties on alcohol, petrol and tobacco) of £4,742 on average and received state services (such as the NHS and education) valued at £6,140. In total, each household paid average taxes of £10,362 and received state benefits in cash or kind of £10,503. The average final income, after taking into account churning, was £25,245.

If there was little difference of outcome financially, there was certainly an effect socially. Our earned independence is being undermined. If you go out to work and earn enough to keep yourself - and to pay for health, education and welfare for less fortunate people - you should not be prevented from choosing health and education services that meet your own needs best, especially when there is no cost to anyone else. More than that, free choice of school and hospital is the key to raising standards for everyone, whether they are humble or mighty.

Our great mistake over the past 60 years has been to confuse social solidarity with public sector monopoly. Defenders of state monopoly argue that if the middle classes are allowed to opt out of the state system they will leave behind a second-class service for the poor. The real truth turns out to be the opposite. Solidarity and choice can go together. In Switzerland, for example, everyone pays their own health insurance premiums. Nearly a third of the population receive a subsidy from better-off taxpayers, but hospitals don’t know whether individual patients have been subsidised or have paid their own way. As a result, rich and poor alike enjoy a degree of consumer choice that has given the Swiss one of the best healthcare systems in the world.

With a recession already under way, if the public sector is to keep serving all sections of society it will need every bit of extra productivity it can find. But without competition nothing will change and, as usual, it will be the poorest in society who feel the loss.

David Green is the director of Civitas and author of Individualists Who Cooperate, published this week

Times Recommends

• We have kit and leadership. Let’s go
• Behind the scenes at the biggest deal
• Conferences — what a waste of money