There's No Third Way Round These Mighty Elephants

The work goes on... but it gets grindingly more difficult. After six long years, brave new policies rolled out to fanfares now feel like rolling boulders uphill. Even without the disastrous distraction of Iraq or Hutton, halfway through the second term would anyway be a testing time for delivery.

So the government struggles with how to finance universities with their booming student numbers: the fees issue will swell into a mighty climax at the party conference. This week, the proposed new top-up fees have been rebranded as an "individualised graduate tax", language more palatable to the MPs expected to rebel when it comes to the Commons.

Then, at the other end of the life-cycle, this week a report from the Association of British Insurers finds that the government's attempt to get millions of low income earners into a new stakeholder pension scheme is failing: in 82% of workplaces there have been no takers.

Meanwhile, school results are plateauing after good early improvement, and the gap between good and bad schools is widening. Star schemes such as Sure Start are highly praised - but still small in number and slow to spread.

Then consider the state of the railways: why is the Crossrail decision delayed to miss the Olympic timetable? Ponder on whether the cash-strapped chancellor can find £1.7bn more for child tax credits in November, or fail to hit his child poverty target. Turn to almost any policy and difficult stumbling blocks seem to obstruct the path at the moment. Why?

Two mighty elephants sit on the cabinet table, leaning heavily on most social policies - glaringly obvious yet politically unmentionable. Their names are Inequality and Under-taxation. Whatever social problem the government tackles, whatever public service it tries to improve, sooner rather than later one or other of these great tuskers makes its heavy presence felt. There just is no way round them, no triangulating them, no third way or "reform" to bypass their bulk.

Take the stakeholder pensions problem. It is true that large numbers of people - some 13 million - save nothing or too little for their old age and the burden of their retirement will fall hard on future generations. So stakeholders were designed for low- to-middle earners as simple, low-cost policies with just 1% service charges. But if it's such a good idea why have so few people bought them in the target group of people earning £10,000-£20,000?

Because most of the people who don't save can't save. A third of people can't afford to buy their own home - or even a part share - which ought to be anyone's first priority before worrying about pensions. The government's minimum income guarantee (MIG) of £102.10 a week is the sum below which no poor pensioner should now fall. So low earners would have to scrimp and save a lot to get themselves a stakeholder pension to pay above that. True, the government is unreliable: Tories may come in and cut the MIG - but the bottom sometimes falls out of stock market-based pensions too.

In its brochure for stakeholders, the government invented Parveen - a model kind of person who should be buying a stakeholder. Parveen was an unlikely young fitness trainer in her late 20s earning just £14,000, who was already buying a shared flat with a friend, yet she was rushing out to buy her stakeholder. However, no financial adviser (except the mis-selling government) would suggest it to someone on so low an income: she should keep her savings accessible for a rainy day. Luckily, few Parveens have been fooled. Most purchasers so far have higher incomes.

The point is that you can't get blood out of a stone. If Britain is under-pensioned, that's because it has a large, very low-paid population. Since half the people earn under £21,000, targeting them to pay the nation's pensions gap is plainly the wrong policy. Those who are poor or poorish in their working lives will still be poor in their old age, and it is right and fair that broader shoulders should carry the cost of their retirement as some small recompense. Research suggests those who can save usually do. The Inequality elephant that is the ever-widening earnings gap is to blame for our pensions deficit. Employers should be obliged to contribute to stakeholders, which might make joining a pension worthwhile. But it is fairer distribution of pay that would allow most people to save for their own old age.

This depth of social inequality bedevils student finance policy, too. In the broad sweep of fairness, the government is right to say that the soon-to-be half of school-leavers who go to university in order to become higher earners should pay back their own costs without taking it from the unlucky taxpayers whose children don't get the chance. But the huge wealth divide between rich and poor students makes this difficult to stomach.

Currently 40% of students pay no fees because their parents earn under £20,970 a year: they still clock up some £15,000 debt for living costs, paid back later on earnings over £10,000. Now that universities are to be free to charge £9,000 for a three-year course, poor students will get a £3,000 grant and £3,300 towards their fees, leaving their average debts at £17,700. In fact, it will be less, as the government insists high-fee universities create bursaries for poor students. Debt is scary but not unmanageable.

Universities need the funds: students arriving from competitors such as the US, where lecture notes are delivered to each student that evening, find facilities in our top universities medieval, in the worst sense.

The answer lies with the two elephants: the better-off should be taxed at European levels and universities should be well-funded. (Even so, university for this growing student population can never be free.) The Inequality elephant asks why parents at top universities who paid up to £20,000 a year to send their children to private schools to ensure a top place should not fork out similar sums once there to subsidise the fees of those who never had the same leg-up and might otherwise be deterred by the cost.

It won't happen, but university fees raise all the wicked issues about inherited inequality in Britain. That is why so many MPs will rebel, even though this is the wrong issue. Inequality is best challenged in the under-fives, where all extra money should be spent: those who pass A-levels have already triumphed over their backgrounds.

New Labour always pretended inequality didn't matter. Just pull up the poorest, open up universities and let everything else rip. Now they are finding in practical, not ideological, ways how many policies are tripped up by the dysfunctional shape of British society. Even as more money pours in, they see how much more still over many decades it has taken to make public services so much better in most of Europe. It's time to admit the presence of the two elephants and speak their names out loud - Inequality and Under-taxation.