* 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's Conservatives would slash government spending on welfare by 10 billion pounds ($16 billion) a year if re-elected, finance minister George Osborne said on Monday, though he offered few ideas on how to bring the economy out of recession.
The 2015 election is likely to be decided on the health of the economy, the pace of deficit reduction and the areas of spending and taxation on which each party would focus to balance stretched public finances.
The Conservatives, who had bet that growth would reduce the deficit and help them win the next election, are struggling with a recession and a series of blunders which have put them about 10 points behind the opposition Labour Party in opinion polls.
Chancellor of the Exchequer (finance minister) Osborne and Prime Minister David Cameron are trying to use their party's annual conference in Birmingham to project an image of economic prudence and have promised more spending cuts across the board.
They hope voters will welcome a further 10 billion pounds of cuts in welfare spending - an area often portrayed in the media as rife with scroungers and waste.
"How can we justify giving flats to young people who have never worked?" Osborne told party supporters before a large Union 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's Liberal Democrat junior coalition partners. Osborne dismissed their calls for a "mansion tax" on expensive homes or a further tax on the wealthy.
"This party of home ownership will have no truck with it," he told the conference. "The great bulk of savings must come from cutting government spending - not increasing taxes."
The Lib Dem business secretary, Vince Cable, said: "As far as we're concerned we haven't had a formal negotiation about this. Clearly, if they are reluctant to move on things we consider fair taxation, it's going to be difficult for us to move on things that matter for them."
Cable, on a visit to Nigeria, said the issue would be "a dividing line we will be perfectly happy to campaign on in the next general election".
Osborne, a close Cameron ally who was booed by crowds at a Paralympics medal ceremony last month, said Western democracies would lose ground relative to wealthy emerging economies unless they reformed welfare, education and tax.
In the 35-minute speech, Osborne said the Conservatives must appeal to those who aspired to improve their situation, adding it was a delusion to believe public finances could be put back on 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 endanger Britain's recovery by putting its low borrowing costs at risk.
But many Conservative lawmakers are worried that Osborne cannot revive growth. In one of the biggest set-piece speeches of the political calendar, the 41-year-old offered few new ideas on how to nurture Britain's stagnating economy back to health.
Osborne's March budget forecast he would have to cut borrowing by 49 billion pounds in the two years following the 2015 election, after weak growth put paid to his plan to eliminate the record deficit before the election.
Osborne has staked his reputation on preserving Britain's AAA sovereign credit rating. A 375 billion pound central bank-funded bond-buying drive has reduced the cost of government borrowing to record lows.
But the underlying budget deficit has risen by a fifth so far this year compared to the same period last year and public sector debt rose to more than 1 trillion pounds at the end of August - 66 per cent of gross domestic product.
Investors say Osborne, who announces revised economic and borrowing forecasts on Dec. 5, will be forced to either cut spending more deeply or extend austerity well after the next election to honour his pledge to tame the deficit.
Osborne has refused to say how far behind schedule his deficit reduction plan is but he rebuffed critics who say he should pump up demand with government spending.
"Our critics would gamble everything: our credibility, our financial stability, our low interest rates, the cost of our debt they would risk everything on the dubious idea that a few billion more of spending would dramatically improve the fortunes of the trillion-and-a-half pound British economy," he said.
Osborne said he would allow companies to offer shares in the business to new employees in return for giving up certain dismissal and redundancy rights. He also said shale gas could get generous tax breaks.
Shaving more off the welfare budget would allow cuts in other government departments to be held at a similar pace as is being enforced in current spending plans which run until the end of 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 for the election battle.
The Lib Dems' Cable said Osborne's plans were "an entirely hypothetical discussion" about a budget that would ultimately be the responsibility of whoever won the next election.
"I've made it very clear we're not making commitments on spending levels into the next parliament," he said.
($1 = 0.6176 British pounds)
(Additional reporting by Tim Cocks in Lagos; Editing by Mark Heinrich, Giles Elgood, Paul Taylor and Kevin Liffey)
Keywords: BRITAIN POLITICS/AUSTERITY