His plans threaten to put the Government at war with the legal profession, which sees a threat to its income, and create anomalies and apparent injustices among people denied aid through the changes, which critics describe as rationing.
He conceded that some would be excluded by the proposals but the intention was to help more people. Only half of the population is eligible for legal aid under the current means-tested provisions.
A Green Paper in the spring should define further the Lord Chancellor's plans, but he has not fixed a date for legislation. He has committed himself to changing funding for civil cases, but is still making up his mind about cash limits on aid for defendants in criminal cases.
He also wanted to break the lawyers' stranglehold on legal aid by encouraging the use of law centres, Citizens' Advice Bureaux and other advice agencies.
"Each legal aid area would have a budget for the provision of a full range of publicly-funded legal services within their area. They would contract on a block-funding basis with suppliers to provide advice, assistance and representation within their competence. "Such suppliers might be advice agencies, solicitors or combinations of both," he said. He recognised that the operation of block-contracting arrangements and allocation of money were crucial.
"I would see the process as involving a negotiation between the Legal Aid Board and potential suppliers," Lord Mackay said. "The objective would be to ensure a balance between access to legal services, quality of service provided and the value for money of the service." His department has not worked out the nature of the contracts, and whether they would oblige a contracted solicitor to handle all cases which came through his door.
Lord Mackay said the system mainly aided cases involving crime, family law and personal injury, and only a tiny proportion went to help people with "social welfare" cases, including housing, debt and employment.
Legal aid funded costly court-based solutions, contained no mechanism for a proper assessment of need and failed to recognise the valuable work done by advice agencies.
Lord Mackay revealed his plans in a speech to the Social Market Foundation, a centre-right think tank, which attracted his attention with a version of the regional cash limits in a discussion paper last summer.
"The legal aid scheme as it exists today is not living up to the demands being placed upon it. There must be change," he said. "If anything, the present system makes it possible to create and exploit demand in ways which may not always be in the best interests of the legal aid scheme or of the clients concerned."
The legal aid system should set priorities more effectively according to need, and introduce different ways of resolving problems without going to court.
He recognised that a cash limit for legal aid in criminal cases was more difficult to foresee, but thought a block-contracting scheme could work for duty solicitors and in magistrates' courts.
Paul Boateng, Labour's legal affairs spokesman, said the review of legal aid had been driven by the Treasury. "Arbitrary cuts and more quangos will not help working people."
Peter Goldsmith QC, the Bar Council chairman, welcomed the proposals but was concerned by the implications of a finite budget. "I am worried somebody might come at the wrong time of the year when the agency says that the money has already been spent on something else."
Charles Elly, president of the Law Society, representing solicitors, said cash-limiting would deprive those in need of help.
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