George Osborne’s “project fear” forecasts about the economic risks of leaving the European Union have undermined public confidence in the Treasury and left it ill-equipped to influence Brexit, according to a damning new report from former Whitehall chief Lord Kerslake.

The Treasury is traditionally Whitehall’s most powerful department and its civil servants some of the brightest and best. But Kerslake finds that its reputation waned in the wake of the financial crisis – and when it published bleak forecasts of the impact of Brexit in the run-up to the referendum, “the public reaction … was unprecedentedly hostile”.

Osborne believed publishing gloomy official forecasts would convince the public there was too much at stake to risk voting Leave. But many appeared to believe the Treasury had simply been co-opted by the Remain camp.

So far, its projections appear to have been too pessimistic. “Whilst there is a debate still to be had as to whether the Treasury forecasts were completely wrong or just wrong in the timing, and how other factors such as the febrile political climate and criticisms of ‘experts’ played a part, there is no arguing that the standing and credibility of the Treasury was damaged by the widespread rejection of its warnings,” the report says.

Kerslake was head of the home civil service from 2012 to 2014, and permanent secretary of the Department for Communities and Local Government. He was commissioned by shadow chancellor John McDonnell to examine the Treasury’s role.

As Theresa May prepares to trigger article 50, the formal process for leaving the EU, and begin complex negotiations with the other 27 member states, his report warns that the Treasury’s role in the referendum campaign has left it “weakened in the crucial economic debates about free movement of goods and services and the free movement of people post Brexit”. Kerslake said May’s decision to announce in her Lancaster House speech last month that Britain would not try to stay in the single market, and would abandon key elements of the EU’s customs union, suggested the chancellor, Philip Hammond, had lost out. “His influence with her is not as strong as Osborne’s was with Cameron,” he said. Osborne told the House of Commons during the Brexit debates that the government had decided not to prioritise the economy in the forthcoming talks.

Kerslake carried out his review with a heavyweight panel including TUC general secretary Frances O’Grady and Oxford economist Simon Wren-Lewis, and also held a series of round-table meetings with businesses and experts. He suggests the Treasury may need extra resources to cope with the challenges of Brexit. “It is now clear the Treasury, and indeed the rest of the UK government, is unprepared and under-resourced for the tasks it faces in the immediate future and for some years to come,” he said.

Under Gordon Brown and Osborne – and to a lesser extent Alistair Darling – the Treasury’s influence extended right across the government, not just controlling the purse strings, but shaping policy in a range of other areas, from welfare reform to transport. Kerslake suggests it may have overreached itself, warning that its diminished reputation today, after the financial crisis, the “omnishambles” budget, U-turns over tax credit cuts and the Brexit forecasts, may be “potentially a consequence of departmental cultural hubris”. The report rejects the idea that the Treasury should be broken up, however – into a separate finance and economics ministry, as in Germany for example.

Instead, it calls for more strategic oversight of economic policy from the Cabinet Office; a stronger focus on accounting and finance skills, not just economics; and more open recruitment policies to encourage diversity. The chancellor’s council of economic advisers could also publish reports, to enable more public discussion of policy and allow alternative views to enter the debate.

The report was intended to be completed by last summer; but it was postponed because June’s referendum result unleashed what Kerslake called a “political maelstrom”, not least a leadership challenge in the Labour party.

He said some of the changes made by the May government, including adding industrial strategy to the role of the business department, had already begun to clip the Treasury’s wings.McDonnell said yesterday: “The Treasury is our most important economic policymaking institution, but one that has been criticised by some for its approach and attitudes. This review will help shape Labour’s economic policy, as well as being an first important step in setting a new direction for the Treasury in the 21st century.”