The former defence secretary also urged a wholesale rethink of earnings and savings taxation, including a Capital Gains Tax holiday, to breathe life into the ailing economy, according to The Times.
His intervention, which comes less than a fortnight before George Osborne's Budget, echoes concerns raised by many of the party's backbenchers over the way funding has been ring-fenced for three Whitehall departments while others, like the Ministry of Defence, have been hit hard.
Dr Fox said: "I believe that in leaving money in people's pockets, economic activity will follow. People will buy houses, invest for their future or just go shopping.
"Whichever is the case, it's creating a society that it sustainable for the future in the way that our current - welfare dependent and debt-ridden - economy is not.
"We should gradually move towards the reduction - or even abolition - of the taxes where the state not only taxes the same money on multiple occasions but discourages the very behaviour that would lead to a more responsible society."
It comes after a weekend of dire poll ratings for the party and increasing pressure on David Cameron's leadership.
Conservative MP Sarah Wollaston warned the prime minister he was "running out of time" to tackle problems with his "posh" top team.
In a series of tweets she wrote: "Inner circle still look far too posh, male & white & Cameron is running out of time to fix it.
"I consider myself a Cameron loyalist; he is the best person for the job but should listen to critical friends.
"I am a Cameron loyalist but he needs to change his inner circle which just seems to be telling him what he wants to hear."
Home secretary Theresa May fuelled speculation that she harbours future leadership ambitions after giving a detailed speech that roved across a number of government briefs and included plenty of proposals to appeal to the right of the party.
Baroness Warsi said the Prime Minister commands the support of "large parts" of his party and insisted she, and May, had "full confidence" in his leadership.
"He is doing a very difficult job in very difficult circumstances and he commands the support of large parts of his party," the Foreign Office Minister told Sky News.
Tory backbencher Eleanor Laing acknowledged that some MPs were unhappy with the leadership, but said it was essential the party pulled together.
"There are some people who are clearly positioning for what might happen after the next general election and there are some people who are openly talking about challenges to the leadership," she told the BBC Radio 4 Today programme.
"They should all be quiet. They should all get their heads down and work together as one Conservative Party for the good of the country."
"It means that all future pressures then come on things like the Army, the police, local government, skills and universities. So you get a very unbalanced approach to public spending," he told the BBC Radio 4 Today programme.
"I went along with the overall ring-fencing approach in this parliament - as part of the Coalition we have had to work as a team.
But I think as a long-term approach to government spending it isn't very sensible."
However, he poured cold water on Dr Fox's call for a VAT cut to kick-start growth.
"That is one of the many desirable things that we would love to do if we had more money," he said. "We have to do what we can afford."
Instead he reiterated his call for investment in housing and infrastructure projects to stimulate the economy.
"The priority has now to be to get the economy going," he said.
"Once the economy does get going, you generate more tax revenue, there are less people dependent on public spending and the budget then tends to improve itself.
"I think that's the direction we are going in. My colleagues in government certainly understand that."
Cable suggested that Dr Fox's comments may reflect the kind of "jihad" against public spending by the Tory right wing which he warned about at the Liberal Democrat spring conference over the weekend.
The Business Secretary told the BBC News channel: "I would simply say that there are certain forms of public expenditure - apprenticeships is a good example, science is another and university training is another - where Government expenditure actually improves the economy. It doesn't drain the economy at all, it actually necessary for our future growth and our future success.
"The other point I would make about Liam Fox's intervention is it would involve committing us to spending policies well into the next parliament. The next parliament has yet to be elected and determine its own priorities."
Cable said his call for a move towards policies to drive growth in the economy had the support of other ministers in the Government.
"The point I've made is that we are making difficult choices in Government. There's no easy solution, there's no risk-free solution," he said.
"We talk all the time about a balance of risks. The point I was emphasising is that the balance of risk is shifting in the direction of policies which drive growth and drive recovery. I think many of my colleagues in Government have no problem with that, it's just a question of how we implement it in practice.
"I think the opposite case to Dr Fox's needs to be made - and I and my Lib Dem colleagues make it - that we need all the time to be looking at the right balance between taxation and public spending cuts.
"Certainly what my colleagues would argue is that, particularly as we go into the next parliament, we can't just rely on cutting public spending, though no doubt there is a role for efficiencies.
"We have to think about a bigger contribution in taxation from people who can afford to pay, and that's why we continue to press the case for a mansion tax and other taxes of that kind."