The smug and the mugged: What happens to the coalition now?

The toughest austerity package in decades, and the Tories escape untouched. But the Lib Dems are sore

David Cameron could be forgiven if he can't quite believe his luck. Twelve months after failing to win an outright majority against an exhausted Labour government, his dream of deep spending cuts is realised, the Tory brand decontaminated, and he has pulled off the rare feat of leading a governing party into council elections in which it increased its hold on town halls.

Despite public talk of "no gloating", there remains a swagger about the top Tories that everything is going just fine. Liberal Democrats, by contrast, feel as if they have been had. Having got into bed with the devil, they are now damned for trying to make it work. So desperate were they to prove that coalitions could function, they took responsibility for everything. At the ballot box, that translated to taking all of the blame – blame which many Lib Dems lay squarely at the door of the Prime Minister, and notably his Chancellor, George Osborne, who signed off the cuts and has since escaped public scorn.

They are particularly angry at the No to AV campaign targeting Nick Clegg for broken pre-election promises. "It beggars belief that they had a leaflet attacking Nick Clegg for breaking his word on increasing VAT, when we only did that to sign up to their economic strategy," said a furious ally. The Lib Dems have been damned for doing the only thing open to them – entering a coalition with their sworn enemies, and have paid a heavy price in polling booths.

As the full horror of the electoral wipeout emerged on Friday, Clegg hit the phones, contacting more than 50 party figures around the country, many of whom had lost their seats. The charm offensive – which some note has been too rare an occurrence since the coalition was formed – seemed to pay off. All but a handful of defeated councillors came out to defend both Clegg and the coalition.

Clegg has admitted to friends that the "bro-mance" with Cameron went too far: the rose garden ... tales of late-night texting. "He knows that there has got to be a new phase," confesses one adviser. Foreign Office minister Jeremy Browne adds: "We need to make a clearer explanation of our liberalism and what we are in government in order to achieve."

There has been much talk about concessions being made to the Lib Dems to "shore up" their position, after losing more than 700 seats on Thursday night. The Tory right, though, won't stand for it. Geoffrey Cox, another Tory MP, said the Lib Dems were in a "difficult transition from being a party of protest to a party of government.... It all depends whether they have the political maturity to live up to their responsibilities."

For the coalition fall guys, this will not do. Senior Lib Dem peer Lord Oakeshott said: "We have taken far too many bullets for coalition policy while the Tories have dodged them." Lib Dems plan a co-ordinated effort to claim credit for more of what the Government is already doing. After the electoral rout, "battle-hardened" Lib Dems are preparing to "flex their muscles", according to strategists.

Senior Lib Dems have already drawn up a list of key policy areas where they are uneasy and will demand change. They are determined to remind the Conservatives that their leader failed to win last year's general election, and needs their support to get legislation through. So plans for elected police commissioners – described as "ridiculous" by Lib Dem ministers – will be targeted, climate change policy and Lords reform accelerated, and there will be no let-up in the criticism of the City. Vince Cable tells The Independent on Sunday today he wants the coalition to go further on banking reform and taxing the wealthy. "I will fight the Lib Dem corner," the Business Secretary says.

Top of the agenda, though, are Andrew Lansley's health reforms. The Lib Dems have already set out non-negotiable amendments. From tomorrow, two trusted aides from No 10 – health adviser Sean Worth and press officer Abbie Sampson – will be seconded to the Department of Health to rescue Lansley and his reforms. But as one Tory admitted: "It is impossible to square the circle and please both the Lib Dems and Lansley." A Lib Dem source close to Nick Clegg went further, suggesting the scale of the changes they will demand might mean that Lansley "cannot stomach it" and quits.

If he did, it could present the perfect opportunity to bring back David Laws, who quit the Cabinet over an expenses scandal a year ago. The idea is being discussed at the highest level of government and the outcome of the sleaze inquiry into Mr Laws's case is expected in the next fortnight.

However, say cabinet sources, this is likely to be the extent of the consolation prize offered to "help Nick" after a period of discomfort for the Deputy Prime Minister. "David will hug Nick and Danny [Alexander] close, but after the behaviour of Huhne and Cable, they are not going to get much leeway."

Relations between Huhne and Osborne in particular are at a new low. The Lib Dem Energy Secretary confronted the Chancellor in Cabinet last week over the aggressive turn the No campaign took. Huhne, it is understood, was also not informed in advance that Mr Osborne was to introduce a £10bn tax on North Sea oil and gas companies in the Budget.

The Tories believe it is all a storm in a teacup. A No 10 source stressed: "The priority over the next two or three weeks is to steady the ship. The Lib Dems might have a fit of pique but will settle down into realising where their best interests are." The dynamic between Cameron and Clegg is key to the success of the coalition. A year ago, it seemed the pair agreed on everything. Now the two camps cannot even agree on how to mark their first anniversary in coalition.

Danny Alexander, the Lib Dem Chief Secretary to the Treasury, and Tory policy chief Oliver Letwin, who are both conciliatory voices in the Cabinet, are planning a "mid-term" coalition agreement with new policies that would herald a "fresh start" to the Lib-Con arrangement.

Alexander told the IoS: "We have talked about doing an agreement for the second phase of the Government which is something which is being worked on." Dubbed Coalition 2.0, both parties see it as a chance to pull the agenda in their direction. Some Lib Dems, including Mr Cable, warn that there is too much "unfinished business" in the existing agreement to justify a new one.

A study by University College London suggest 75 per cent of Lib Dem manifesto pledges made it into the original coalition programme, compared with 60 per cent of the Conservatives'. Lib Dems fear a new agreement would be overwhelmingly Tory in its nature.

Senior Lib Dems privately admit to being "astonished by the power and unity" of the right-wing establishment, which "galvanised" big money donors and their supporters in the media to defeat the alternative vote. Some have begun to doubt if the much-heralded progressive majority in Britain can ever be united, or that it even exists.

At least some in the Labour Party believe it does, and will seek to reach out to Lib Dems at their lowest ebb. On Wednesday, Andy Burnham, the shadow Education spokesman, will table amendments to Michael Gove's free schools plans based on a motion passed by last year's Lib Dem conference calling for the reinstatement of local admissions forums. Burnham said: "Lib Dems have to decide whether they want to put their names to right-wing reforms of public services and the creation of a free-for-all in our schools system."

Labour leader Ed Miliband will attempt to make further overtures to Lib Dems, including Cable and Huhne, to hold out the prospect of the allusive "progressive alliance" in the event that the coalition falls apart. There seems little prospect of that happening soon. But while the Tories float around government confident in their birthright to rule, the Lib Dems know deep down this is a fight to the death.

Tories

George Osborne

The Chancellor is targeted by top Lib Dems as a blocking force in the coalition, and they want him to be reined in by Cameron. Success of No campaign and of Tories in local elections is attributed to his ability tactically to outsmart opponents.

David Cameron

The Prime Minister wants it to be "business as usual" and to "help Nick" with a Lib Dem concession or two. But he's also under pressure from the right of his party after a year of U-turns and a major watering down of NHS reforms.

Oliver Letwin

Tory policy chief has formed a strong alliance with Alexander, acting as conciliator for the Tory side of the coalition. Wants a new coalition document to be a "fresh start" – Lib Dems suspect it will be Tory-heavy.

Andrew Lansley

Unpopular Health Secretary who could pay the price for NHS reform Bill controversy. A one-time rival to Cameron at Conservative Central Office, the PM would love an excuse to sideline him. Unlikely to go quietly.

David Davis

Beaten to the Tory leadership by Cameron, the influential right-wing backbencher warned the PM not to hand out "baubles" to the Lib Dems. Is likely to step up the pressure for a bluer coalition if he sees any more concessions to Clegg.

Lib Dems

Nick Clegg

The Deputy Prime Minister needs all the love he can get after poll drubbing and will be "hugged close" by Cameron. But Clegg, who will not resign, now wants to fight for more independence as he is wary of other cabinet Tories.

Vince Cable

Already a leading cabinet rebel, the Business Secretary today makes clear he will "fight the Lib Dem corner" to prevent a complete takeover by the Tories. Enjoys a healthy working relationship with George Osborne, but has clashed with David Cameron.

Tim Farron

The Lib Dem president and potential leadership challenger to Nick Clegg is flexing his muscles, warning there are "lessons to be learnt" from the party's poll rout. Could demand a vote of no confidence in the coalition.

Chris Huhne

Identified by Tories as the new Lib Dem troublemaker after confronting Osborne at Cabinet over the No campaign. The Energy Secretary is always positioning himself as a potential leader, but has little support in the party.

Danny Alexander

The Chief Secretary to the Treasury is a key conciliator and has fought to keep coalition harmony alive, giving him Cameron's ear. But some Lib Dems feel he has sold out completely to the PM and the Chancellor.