In a bleak Autumn Statement, the Chancellor said that weakening economic growth meant the era austerity would be extended for another year to 2018, well into the next parliament.
He sought to sweeten the pill, scrapping a planned 3p-a-litre rise in fuel duty which had been due to come in January.
However, he was also forced to admit that the independent Office for Budget Responsibility now believed he would miss his target for debt to start falling as a proportion of GDP from 2015/16 - the year of the next general election.
Labour seized on the forecast, claiming it revealed the "true scale of this Government's economic failure".
Shadow chancellor Ed Balls claimed the UK was "falling behind in the global race" as a result of Mr Osborne's management of the economy.
Mr Osborne told MPs: "It's taking time, but the British economy is healing."
He acknowledged that previous growth predictions were wrong, but he pledged to continue efforts to drive down the deficit.
Quoting the latest Office for Budget Responsibility growth forecast, Mr Osborne said the economy was now expected to shrink by 0.1% this year compared with a previous prediction of 0.8% growth.
Setting out spending plans for 2015-16 and a framework into 2017-18, he said deficit reduction measures would be achieved fairly with further savings from bureaucracy, from benefit bills and the better-off.
He hailed a reduction in borrowing, saying it was forecast to fall from £108 billion this year to £99 billion next year, £88 billion the year after, then £73 billion in 2015-16 and £49 billion and £31 billion in the two years after that.
He admitted he was going to miss his target that debt should start falling as a proportion of GDP by 2015/16 - the year of the next General Election. Instead he said it would take another year.
He said the OBR's central forecast is that net debt will be 74.7% this year, then 76.8% next year, 79% in 2014-15 and 79.9% in 2015-16. It will then fall to 79.2% in 2016-17 and 77.3% in 2017-18.
He told MPs: "Yes, the deficit is still far too high for comfort. We cannot relax our efforts to make our economy safe.
"But Britain is heading in the right direction. The road is hard but we're making progress."
He again ruled out a mansion tax but confirmed plans to cut tax allowances for big pension pots.
He said that from 2014-15, the lifetime allowance would be cut from £1.5 million to £1.25 million and the annual allowance from £50,000 to £40,000, saving £1 billion a year by 2016-17.
He told MPs: "I know these tax measures will not be welcomed by all; ways to reduce the deficit never are. But we must show we're all in this together. When you're looking for savings, I think it's fair to look at the tax relief we give to the top 2%."
The Chancellor said most working age benefit increases would be pegged at 1% for the next three years - a real terms cut.
The higher rate income tax threshold would also be increased by just 1% in 2014-15 and 2015-16, so the income at which people start paying the 40% rate will go up from £41,450 to £41,865 and then to £42,285.
Mr Osborne told MPs: "I want to be completely clear with people. This is an increase; in fact, it is the first cash increase in the higher rate threshold in this Parliament.
"But it is not an increase in line with inflation, and so it raises one billion pounds of revenue by 2015-16."
He also announced another cut in corporation tax rate by a further 1% to 21%, compared with 40% in the US, 33% in France and 29% in Germany.
He said: "This is the lowest rate of any major western economy. It is an advert for our country that says: come here; invest here; create jobs here; Britain is open for business."
He confirmed that the planned increase in fuel duty would be suspended, saying: "It means that under this Government we'll have had no increase in petrol taxes for nearly two and a half years."
And he announced more help for working people with an increase in the amount they can earn before paying any income tax from next April - currently due to be £9,205 - by a further £235.