* Conservatives seek to project image of economic prudence
* But deficit reduction plan far behind due to recession
* Conservatives lag opposition Labour party in opinion polls
* Proposes shale gas tax breaks and employee share plan
(Adds comments from Lib Dem business secretary)
By Matt Falloon and Guy Faulconbridge
BIRMINGHAM, England, Oct 8 (Reuters) - Britain'sConservatives would slash government spending on welfare by 10billion pounds ($16 billion) a year if re-elected, financeminister George Osborne said on Monday, though he offered fewideas on how to bring the economy out of recession.
The 2015 election is likely to be decided on the health ofthe economy, the pace of deficit reduction and the areas ofspending and taxation on which each party would focus to balancestretched public finances.
The Conservatives, who had bet that growth would reduce thedeficit and help them win the next election, are struggling witha recession and a series of blunders which have put them about10 points behind the opposition Labour Party in opinion polls.
Chancellor of the Exchequer (finance minister) Osborne andPrime Minister David Cameron are trying to use their party'sannual conference in Birmingham to project an image of economicprudence and have promised more spending cuts across the board.
They hope voters will welcome a further 10 billion pounds ofcuts in welfare spending - an area often portrayed in the mediaas rife with scroungers and waste.
"How can we justify giving flats to young people who havenever worked?" Osborne told party supporters before a largeUnion Jack-design backdrop at a party conference whose slogan is"Britain can deliver".
"We will have to find greater savings in the welfare bill,"he said.
But his plans may cause tension with the government'sLiberal Democrat junior coalition partners. Osborne dismissedtheir calls for a "mansion tax" on expensive homes or a furthertax on the wealthy.
"This party of home ownership will have no truck with it,"he told the conference. "The great bulk of savings must comefrom cutting government spending - not increasing taxes."
The Lib Dem business secretary, Vince Cable, said: "As faras we're concerned we haven't had a formal negotiation aboutthis. Clearly, if they are reluctant to move on things weconsider fair taxation, it's going to be difficult for us tomove on things that matter for them."
Cable, on a visit to Nigeria, said the issue would be "adividing line we will be perfectly happy to campaign on in thenext general election".
Osborne, a close Cameron ally who was booed by crowds at aParalympics medal ceremony last month, said Western democracieswould lose ground relative to wealthy emerging economies unlessthey reformed welfare, education and tax.
In the 35-minute speech, Osborne said the Conservatives mustappeal to those who aspired to improve their situation, addingit was a delusion to believe public finances could be put backon track by raiding the "wallets of the rich".
Britain's welfare budget is estimated at 207 billion pounds($335.2 billion) in 2012/13 - almost a third of total spending.
Labour, which wants to see more taxes on banks and the rich,says Osborne has cut spending too quickly and choked demand.The government says softening its austerity plan would endangerBritain's recovery by putting its low borrowing costs at risk.
But many Conservative lawmakers are worried that Osbornecannot revive growth. In one of the biggest set-piece speechesof the political calendar, the 41-year-old offered few new ideason how to nurture Britain's stagnating economy back to health.
Osborne's March budget forecast he would have to cutborrowing by 49 billion pounds in the two years following the2015 election, after weak growth put paid to his plan toeliminate the record deficit before the election.
Osborne has staked his reputation on preserving Britain'sAAA sovereign credit rating. A 375 billion pound centralbank-funded bond-buying drive has reduced the cost of governmentborrowing to record lows.
But the underlying budget deficit has risen by a fifth sofar this year compared to the same period last year and publicsector debt rose to more than 1 trillion pounds at the end ofAugust - 66 per cent of gross domestic product.
Investors say Osborne, who announces revised economic andborrowing forecasts on Dec. 5, will be forced to either cutspending more deeply or extend austerity well after the nextelection to honour his pledge to tame the deficit.
Osborne has refused to say how far behind schedule hisdeficit reduction plan is but he rebuffed critics who say heshould pump up demand with government spending.
"Our critics would gamble everything: our credibility, ourfinancial stability, our low interest rates, the cost of ourdebt they would risk everything on the dubious idea that a fewbillion more of spending would dramatically improve the fortunesof the trillion-and-a-half pound British economy," he said.
Osborne said he would allow companies to offer shares in thebusiness to new employees in return for giving up certaindismissal and redundancy rights. He also said shale gas couldget generous tax breaks.
Shaving more off the welfare budget would allow cuts inother government departments to be held at a similar pace as isbeing enforced in current spending plans which run until the endof the 2014/15 fiscal year, according to Treasury calculations.
The government's next spending review, expected before 2015,will cover much of the 2015-2020 parliament and set the tone forthe election battle.
The Lib Dems' Cable said Osborne's plans were "an entirelyhypothetical discussion" about a budget that would ultimately bethe responsibility of whoever won the next election.
"I've made it very clear we're not making commitments onspending levels into the next parliament," he said.
($1 = 0.6176 British pounds)
(Additional reporting by Tim Cocks in Lagos; Editing by MarkHeinrich, Giles Elgood, Paul Taylor and Kevin Liffey)
Keywords: BRITAIN POLITICS/AUSTERITY