It' s clear that the spending party is over. But when will the clear-up begin? So far, ideas for cuts have largely been limited to getting rid of silly spills, such as ID cards. Gordon Brown, like a bear with a bad hangover, rages that any “cuts” will hit nurses and teachers at the front line.

But it is the other half of the public sector - the back room - that has become a dead weight on all of us. The back room is where the really heavy stuff was consumed at the party - in the dark. Someone needs to go in there armed with more than just an aspirin.

Filling the hole in the public finances will mean transforming some public services, not just tinkering at the edges. If you were to start with the most costly part of government, it would be the welfare state. In 2007, at the height of the boom, social security benefits made up almost a third of all government expenditure and 11 per cent of GDP. Almost half the nation - 30 million people - were receiving some kind of benefit. The complexity of the system makes it a nightmare to administer and creates perverse incentives - to move up from unemployment benefit to incapacity benefit, for example, or up the housing ladder.

Last year I discovered that the sadist boyfriend who tortured Baby P had been attracted into his mother's life by Haringey's decision to upgrade her to a four-bedroom home, big enough to house him and the lodger who also tortured the boy. The welfare party did nothing to help Baby P.

Times Archive, 1942: Freedom from want

Sir William Beveridge has put the nation deeply in his debt, for a masterly exposition of the means wherby poverty can be speedily abolished

• The Beveridge Report

• Leading article: can we afford it?

Our welfare system has become a canyon of dependency. Whole groups of people find it too risky to climb out of it by taking a job, or even doing training, because of the potential loss of entitlements. Real life is not a one-way street: people can recover, shake off depression, kick the drug habit. Yet the system encourages them to exaggerate their needs and to imprison themselves in the welfare system.

William Beveridge, the founder of the modern welfare state, was aware of this. In 1948, six years after his great attack on the five giants of want, disease, ignorance, squalor and idleness, he wrote another report that expressed his fear that his reforms might encourage people to focus too passively on their needs. He wondered if there was enough “room, opportunity and encouragement for voluntary action in seeking new ways of social advance... services of a kind which often money cannot buy”. This argument fell on deaf ears at the time, in the face of the manifest good done by the NHS and social security. Now, some brave organisations are facing up to it.

One is Participle, run by Hilary Cottam. She spent many years trying to help the disadvantaged by starting out from where they are, rather than categorising them by “need”. She thinks in terms of what people can still do, not what they can't. She has lured “sick” people on to trampolines, by promising not to remove their entitlements, and watched them come off benefits by themselves as they became fit. She has got people to design their own schools. She has paid them for helping others, another heresy. She has freed countless people - and saved the State money - by upending conventional wisdom.

I recently visited one of her projects, Southwark Circle, which helps the over-50s. Any way you slice the official figures, it is clear that the elderly are a huge cost to the public purse. In the field of personal care, most councils have stopped home visits to old people who are deemed to have “low to moderate” needs. But little money is saved, because they deteriorate faster and are shunted off to homes earlier than they should have been. Looked at through the lens of the State, the ageing problem seems intractable. But the pioneers of Southwark Circle take a different view. They think that you can help people to help themselves in ways which could be self-financing.

Interviewing groups of pensioners, Ms Cottam and her team found that few describe themselves in the same terms as the welfare state. They dislike being talked down to about their “needs” - most also feel that they have something to give. Southwark Circle helps them to help each other, and to pay each other small amounts of money for doing so. I met Dee, who was helping her previously unknown neighbour, Belinda, to fix her washing machine, and Fe, who was teaching Bill Spanish and how to save money on his utility bills. The State does not know Fe, because she is not “in need”. But she loves helping Bill, who is lonely and 80, and is transformed by the friendship. If Fe buys in help from others locals - such as help with her computer - the money will be used to expand the service.

This simple project demonstrates three things. First, that the one-way relationship with the State is no substitute for wider social networks that keep people functioning and healthy. Strong networks can help people to overcome the small setbacks that otherwise escalate and require expensive state intervention.

Second, relationships are best fostered by linking neighbours who want something, rather than bussing people to day-care centres where they have nothing in common - like going to prenatal classes where all you share is your due date.

Third, the potential pool of funds for care of the elderly is bigger than it looks. The over-60s own most of the nation's wealth. By developing services that richer people will pay for - such as lift-sharing, or introductions to local handymen - Southwark Circle could subsidise services for the poor. The principle of cross-subsidy is a hugely powerful tool, but is still taboo for many charities and policymakers.

It will not be easy to change the dependency culture, or the systems that have brought it about. But Hilary Cottam's work shows that there is hope. There are many things to be done - not least simplifying the benefits system. But the changes do not all have to be punitive. They could transform the lives of some people who didn't, it turns out, have much fun at the spending party. That must be worth thinking about.

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