As the government's white paper on social care finally limps out this week, remember the last election. A hard-hitting Tory poster showed a gravestone with the words: "Now Gordon wants £20,000 when you die. Don't vote for Labour's new death tax." What did they mean? Philip Hammond, deceptively resembling a respectable undertaker, was shadow chief secretary to the Treasury when he explained this scary ad. "Labour are secretly planning another tax – a death tax – to pay for their unfunded, ill-thought-out plan for social care. When you die, a Labour government would take £20,000 from what you leave to your children and family. For those with modest savings, Labour's plans would leave them with nothing."

In that most mendacious Tory campaign it was, of course, a lie. Andy Burnham, then health secretary, proposed a national care service if Labour won the election. It required £20,000 paid on retirement by anyone with savings or property above a threshold: or they could delay payment until after their death. This guaranteed nobody would ever lose everything, however high their care costs. It was brave, dangerous and, as it turned out, foolhardy in the face of a shamelessly Tory campaign.

Labour should have been forewarned: Burnham and Andrew Lansley began to discuss an all-party policy on paying for care, but Lansley was ordered out of negotiations abruptly when George Osborne went on the "death tax" attack instead of resolving this failure by successive governments.

Now they face the consequences. They commissioned a report from the distinguished economist Andrew Dilnot;, but embarrassingly, he emerged with a plan virtually identical to Labour's, only this time the "death tax" would be £35,000. His figures are undeniable on costs, while he saw undertaxed property as the obvious source.

Despite the Tories' previous bad faith, the thought that he may soon be back in power to deal with this had Burnham re-entering talks with Lansley, their roles now reversed: if both parties presented the case for Dilnot, both would have political cover. But yet again Osborne sabotaged any deal, ordering Lansley to break off. Instead, this week's peremptory white paper emerges without Labour knowing the contents, let alone agreeing.

It will apparently support "the principle" of Dilnot but, as Burnham says, that's meaningless without the money to pay for it. Osborne has kicked it into the next spending review and will then try to take money for care out of the NHS, while still claiming the NHS budget is protected. Osborne always wanted the care scheme to be voluntary, not a tax, but the sums only work with compulsory risk-pooling.

Here is the Tory dilemma: Dilnot is contrary to everything they believe. The David Cameron, George Osborne and Oliver Letwin dogma is to shrink the state – but this increases it. People should pay for more things privately – but this puts more burden back on the state. Whitehall should devolve to let councils spend their shrunken budgets; this imposes on councils a universal standard so people know what care their up-front money buys.

Big state, here we come, costing the Treasury £1.7bn and rising. But Tory heartlands have for years been outraged at the system. As the Mail puts it, the "middle class continue to be unfairly penalised", with those who have "worked and saved" being charged, but not the improvident. Two Tory principles clash, protecting middle-class interests v shrinking the state. Dilnot's plan is social democratic, with a progressive tax to extend a universal welfare state this government is bent on dismantling.

Other inconvenient facts abound. Dilnot only concerns who pays – the division between state and individual. The Treasury's £1.7bn only covers the status quo, with no extra for galloping care costs. This is all dead-weight cost to protect inheritances, but not adding a jot to improve the appalling standards of care. Is saving the homes of people who go into residential care the best way to spend money at a time like this? Probably not. But the indignation by the 24,000 families a year who lose their property has reached such a pitch that all parties agree it's unfair: in the end-of-life lottery, a random half the population need care costing over £20,000, while care for one in 10 costs over £100,000.

This is where Britain reveals its essentially social democratic cast of mind. An ICM poll shows 89% of voters think the state should pay for all the care of the frail, just like the NHS. The Dilnot insurance deal is a hypothecated tax, capped and borne by broadest shoulders, sharing financial risk fairly, promising universal quality. Leave everyone to pay for themselves and many will be cleaned out; but share the risk collectively and no one faces ruin. Here is Labour's chance to remind people what a welfare state means for the better-off too, when the concept of universal social security is under daily assault.

In fact this will cost more: the sum will be closer to £50,000 for individuals, with the Treasury spending more too, as Dilnot admits, to raise extra cash for better care. But savings would come from the 120,000 expensive bed days wasted every two months by old people trapped in hospital for lack of home care. In the last year, 4.5% was cut from already pitiful care budgets; only those with "substantial" needs now get any help.

I spoke to Diane, a home care worker too nervous to let me use her name or her employer, in a hard-pressed north-west town. Her time allocated for care visits is constantly cut, now to under 30 minutes, and sometimes to less than 15 minutes. She was told to care for a totally blind man in under half an hour. One old man refuses to get out of bed, often soils his sheets and needs everything washed. Less than half an hour is far too little to get him dressed, to microwave a frozen meal and feed it to him, tidy up, do the washing, take the rubbish out and talk to him. "Of course it takes longer. Often they've no one else to talk to all day." A council worker now outsourced to three agencies in three years, her paid time monitored on an electronic register, is constantly cut back and now unpaid for travel between clients.

Everywhere you ask, gross neglect is now endemic. If old people go unfed in open hospital wards, worse happens in the dangerous privacy of the home or the secretive world of residential care. Good care has to be paid for: pay independently and it will cost more for less. Pay collectively and everyone can have good enough care, with no one losing all their savings. As the government prevaricates, watch Labour seize the issue.

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