George Osborne has announced that he will slash almost £4bn a year from the government's welfare bill by raising benefits for Britain's poorest families by just 1% a year until 2015.

Declaring himself to be on the side of those "who want to work hard and get on" he also risked a backlash from middle England by raising the higher rate tax threshold by 1%, pushing thousands more into paying higher taxes.

The chancellor was forced to admit there was "much more to do" to balance the books against a backdrop of grim economic data revealing higher borrowing and lower growth expectations and a deficit that was "still far too high for comfort".

Osborne told MPs in his autumn statement to the House of Commons he would extend his austerity plans for another year, until 2017-18, deep into the next parliament. Osborne said measures to tackle the country's debts needed to be done in "a way that is fair".

He told a packed Commons: "In everything we do, we will show today we are on the side of those who want to work hard and get on."

He said this would ensure that "those with the most contribute the most – and they will". He then went on to resurrect his scenario of the ordinary worker who sees their neighbour "still asleep, living a life on benefits", to announce measures to cut almost £4bn a year from the welfare bill by uprating benefits for Britain's poorest by just 1% a year until 2015.

"As well as a tax system where the richest pay their fair share, we have to have a welfare system that is fair to the working people who pay for it," said Osborne.

Measures targeting high earners included cutting the amount they can put into their pension pot tax-free from £50,000 to £40,000, from 2014, raising £1bn. The threshold for paying the higher rate of income tax will increase by just 1% a year – lower than the rate of inflation – raising £1bn. He also announced a raft of measures to clamp down on tax avoidance and evasion.

To the delight of the motoring lobby and despair of environmental campaigners, he cancelled a planned 3p rise in fuel duty for January.

Business groups were also cheered by news that they can offset up to £250,000 of investment in new machinery and equipment against their tax bill. Despite public outrage about the rock-bottom tax bills of large international companies, the corporation tax rate will be cut by 1p, to 21% in 2014.

To raucous laughter from the Labour benches, the chancellor insisted the British economy was "on track", despite conceding that the Office for Budget Responsibility was now predicting a contraction of 0.1% in 2012, down from the growth of 0.8% it forecast alongside the chancellor's budget in March.

"It's taking time but the British economy is healing," he told MPs. The independent forecasting body also slashed its forecast for GDP growth next year to 1.2%, down from 2%.

Despite the weaker-than-expected economic outlook, the chancellor reaffirmed his determination to press ahead with the coalition's deficit-cutting strategy, insisting that "turning back now would be a disaster".

Osborne conceded that the OBR had judged he now looked likely to miss his promise that the national debt would be falling by 2015-16. Instead, the OBR believes debt as a share of GDP will now peak at 79.9% in 2015-16, instead of 76.3%, a year earlier, as it predicted in March.

However, the OBR's assessment does show the government meeting Osborne's other target, the so-called "fiscal mandate", of balancing the budget over the next five years. The deficit is expected to fall as a share of GDP over the coming five years, from 6.1% this year, to 1.6% in 2017-18. It was previously expected to be just 1.1% by 2016-17.

"The deficit is still far too high for comfort; we cannot relax our efforts … the road is hard, but we cannot relax our efforts," he told the Commons.

In a nod to critics from the left and right who are respectively calling for deficit reduction to be slowed down or accelerated, Osborne said "we are no going faster or slower" and made clear he intended to stick to his plans.

While insisting "we need more from the better off" to close the deficit, the chancellor stood firm on his decision to cut the top rate of income tax from 50p to 45p next April, despite the derision which met his budget announcement last March as Labour accused him of delivering "a millionaires' budget".

"Punitive tax rates do nothing to raise money and simply discourage enterprise and investment into Britain," he said. "Other countries on our doorstep are trying that approach and are paying the price. We're not making that mistake."