TAKING his seat beneath the portrait of Sir Robert Walpole in the cabinet room, Tony Blair knew the discussion he was about to chair could prove critical to Labour’s chances of re-election.

On the table in front of him lay statistical reports from the Downing Street strategy unit, Treasury officials and the head of the civil service. They revealed troubling news: Labour’s reform of public services was not delivering as planned.

It was early last month and Blair was caught up in the row over allegations by Clare Short, his former cabinet colleague, that British spies had bugged the United Nations. The findings in the officials’ reports, however, had the potential to inflict far greater damage on new Labour.

The confidential research prepared for senior ministers and aides showed that, although his government had pumped billions of extra taxpayers’ money into the public sector, large amounts had apparently been wasted.

Since Labour was elected in 1997, total public spending has risen almost 50% to £459 billion. But the research found the taxpayer, hit by a series of stealth taxes, had not received value for money. Much of the cash had been swallowed up by an inefficient bureaucracy and inflation-busting pay rises for civil servants.

The revelations, contained in cabinet committee minutes leaked to The Sunday Times, may have lasting consequences for Blair and Labour come the general election, which is expected next year.

Three weeks earlier, the cabinet had held a “political strategy session” when ministers discussed findings from Labour’s chief pollster, Philip Gould. Gould had warned that people’s experience of improving public services was critical to electoral success. However, internal polling showed that most people did not believe Labour’s claims that things were getting better: 60% thought there had been no improvement in public services.

For the cabinet committee meeting on Thursday, March 4, Blair had brought together some of his most senior colleagues. Among them were John Prescott, the deputy prime minister, Gordon Brown, the chancellor, and David Blunkett, the home secretary. What they were told appeared to confirm the public perception.

The reports before them showed public sector productivity — the key measure of efficiency — has “fallen steadily” since 1997. According to official data never previously released, efficiency has dropped 10% over the past seven years. In health and education, the key election battlegrounds, it has slumped by between 15% and 20%. In the past, the government has only ever admitted to a 3% fall in productivity since the 1997 election.

In basic terms, this means the extra money being spent on the public sector is not being adequately reflected in better services. Economists found that the massive “inputs” into the public sector were not being matched by enhanced “outputs” in the form of better schools, hospitals and police forces.

Experts calculate the slump in productivity means Labour is wasting £20 billion a year — equivalent to almost 6p on the basic rate of income tax.

After years of trying to play down allegations that its extra cash for public services is being wasted, the government’s research amounts to a startling admission. The solution, outlined in the minutes of the meeting, is classic new Labour: ministers discussed how to change the way in which the statistics — prepared by the Office for National Statistics (ONS) — are presented in order to flatter the government’s performance.

“A change to the definition of productivity in the public sector was vital, particularly in measuring health outcomes,” the minutes recorded.

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