George Osborne 'secretly plans to cut benefit budget by £2.5bn'

Leaked letter contradicts claims that no decision has been taken on what cuts will be made

George Osborne is secretly planning to take £2.5bn from the welfare bill by cutting the budget for long-term sickness benefits, it was claimed last night.

The Chancellor confirmed plans to impose deep cuts on the budget for employment and support allowance (ESA) – the successor to incapacity benefit – in a letter to Iain Duncan Smith, the Secretary of State for Work and Pensions, in June, according to a report in The Observer.

The suggestion that cuts to ESA – paid to those judged unable to work because of illness or disability – is "a particular priority" conflicts sharply with the Government's insistence that no decisions have yet been made on where the cuts should be made. Labour seized on the report to claim that the Coalition was planning "vicious cuts on the poorest" as ministers decided where to wield the axe on public spending this year.

Yvette Cooper, the Labour spokeswoman for work and pensions, said: "Tories and Liberal Democrats have clearly agreed to hit most heavily those they think will find it difficult to fight back."

Mr Osborne sparked a furious reaction last week when he revealed plans to cut an extra £4bn from the "out of control" benefits bill, on top of the £11bn target announced in his emergency Budget in June. He said: "People think it's a lifestyle choice just to stay on out-of-work benefits; that lifestyle choice is going to come to an end."

However, a leaked letter to Mr Duncan Smith three days before the Budget suggests the welfare crackdown has been a longer-term objective. "I am pleased that you, the Prime Minister, and I have agreed to press ahead with reforms to the ESA as part of the spending review that deliver net savings of at least £2.5bn by 2014/15," he said in the letter – copied to David Cameron and his deputy, Nick Clegg.

Mr Duncan Smith's camp insisted no decisions had been taken on where the Treasury axe would fall, and that he would not allow any cuts which affected anyone "too poorly to work".

Details of the latest difficulty faced by the Coalition in its attempts to reduce the deficit emerged as it was revealed that Mr Cameron is set to disown a pending report on child poverty.

Frank Field, the one-time Labour welfare minister asked by Mr Cameron to review child poverty, is understood to be on a collision course with the Treasury after proposing that mothers be given £25,000 to enable them to stay at home. Mr Field's interim report, due this week, has been shelved after his ideas – such as cutting holidays to stop disadvantaged children falling further behind – were considered too extreme and costly.

Downing Street is believed to have been aghast at Mr Field's plan to publish his ideas, which would focus on early intervention for the poorest children. But Mr Cameron wants to avoid history repeating itself. Tony Blair, the former prime minister who once asked Mr Field to "think the unthinkable" on welfare reform, subsequently claimed: "The problem was not so much that his thoughts were unthinkable as unfathomable."