'Happiness is ... " begins Professor Richard Layard. He pauses. I sit forward in my seat expectantly. Which definition will the government's happiness tsar pick? "A warm gun" (Lennon)?; "The greatest good" (Bentham)?; "The meaning and the purpose of life" (Aristotle)?; "The motive of every action of every man, even of those who hang themselves" (Pascal)?; "The greatest gift that I possess" (Dodd)?

This isn't a small matter. How he defines happiness is one of the most fascinating questions in British public life today, because Layard is quietly effecting a revolution in this miserable, materialistic, overworked country. A Labour peer since 2000, he has been able to influence first Blair's administration and then Brown's into making his happiness agenda government policy. His calls for cognitive behavioural therapy (CBT), for school lessons in emotional intelligence, and other allegedly happiness-causing reforms have been greeted warmly by education secretary Ed Balls, health secretary Alan Johnson, the health guideline-setting National Institute for Clinical Excellence and by local authorities up and down the country. Layard is founder director of the Centre for Economic Performance at the London School of Economics, and runs its Well-Being programme. He speaks cheerfully of how the word "well-being" now figures in job titles at government departments, how the new government policy includes commitments to well-being, how the Office for National Statistics is developing the measurement of well-being, how Ed Balls's Social and Emotional Aspects of Learning programme is devoted to making secondary school children focused on well-being. For Layard, you see, well-being is just another way of saying happiness.

But what is this thing called happiness? After a pause, he finishes his sentence thus: "Happiness is inversely related to income at higher levels of income because of the declining marginal utility of getting richer," says Layard. "Let me show you." He draws a graph: on the X axis is income per head, on the Y axis is average happiness. A curve ascends boldly and then tails off ignominiously. At the bottom of the curve, you will find countries such as Zimbabwe or Russia, where increases in national income per head will increase levels of happiness. "Think of economic growth in India - it has been associated with rises in average happiness." On the ignominious bit you will find a cluster of western countries, including our own, where such rises in income per head don't cheer us up one bit.

When do income rises stop making us happier? Around $20,000, according to Layard. Or, in sterling, £10,128.89. After that there is an inverse relationship between more money and happiness. Quite a lot of you might be thinking you should apply for massive salary cuts, but that's to misunderstand Layard: he's talking about average national incomes rather than individual pay rises.

"When I realised that pursuing national income per head wasn't necessarily a panacea, it was like a bolt of lightning. It made me question what economics is about. It made me ask, what is progress, if not rising GDP?" So, then, what is progress? "It's the reduction of misery and the increase in enjoyment of life. If rises in income aren't doing it, then you have to find out what does produce progress. That is where happiness comes in. Aristotle said that happiness was the only thing that man wanted for which he could give no reason. Anything else - income, sex or whatever - was always for something else, be it to buy things or for the future of the species. But happiness was, for Aristotle, a self-evident goal. And he's right: men and women want to be happy."

It is Layard's contention that, during the past 50 years, consumer society has become dominant and yet happiness has declined. We are richer, healthier, have better homes, cars, food and holidays than we did half a century ago. Unemployment and inflation are low, and yet so are levels of reported happiness. This is due, he says, to a series of things - the break-up of the family, fractured communities, a loss of trust. "The same thing has happened in America, but it hasn't happened in the same way on the continent. I think this shows we are suffering from the extreme individualism that we have reported from America. We are unhappier as a result."

Layard talks in simple ways about these problems. "People would be happier if there were nice people when they went outside. But there is little confidence that there are nice people out there. Here and in the US levels of trust have fallen from 60% to 30% in the past 50 years. We are consumed with status, with envy." This makes the world a much more discombobulating one than economists traditionally thought: individual preferences are not constant, but shift in rhythm to cultural trends and peer pressure. It's a world in which one's accumulated possessions depreciate in value. Like Jacob Marley's chains, they drag us down rather than make us happy.

Layard had a problem, though. Happiness was not regarded as measurable. "I showed in 1980 that surveys showed happiness wasn't increasing, even though income per head was. I stopped thinking about the issue then, because I couldn't see how social policy could change that depressing fact; I had nothing to contribute because happiness was not yet objectively measurable."

Then, in the late 1990s, something happened that revolutionised Layard's career. Happiness became a new science. Or at least Layard, despite wails of derision from sceptics, says it did. Psychological researchers found a close correlation between reported happiness and activity in the cerebral cortex. As a result, Layard insisted, lots of the scepticism about reported happiness was misplaced."I have been so struck with the sophistication of the science in this area," he says. "It's really impressive." It gave Layard hope that he could both define happiness objectively, measure it accurately and then set about creating more of it.

What is happiness, Layard asked in his 2003 lecture series Happiness: Has Social Science a Clue? His answer was simple: "By happiness I mean feeling good - enjoying life and feeling it is wonderful. And by unhappiness I mean feeling bad and wishing things were different." To his satisfaction, he had cut through a philosophical Gordian knot. Yes, many philosophers didn't think the matter was so simple. And true, Nietzsche did write derisively in Twilight of the Idols: "Mankind does not strive for happiness; only the Englishman does that."

No matter. Layard was reclaiming an Englishman's birthright - the intellectual heritage of utilitarianism handed down by Jeremy Bentham, the 19th-century philosopher who argued that what was really important in ethics was "the greatest happiness of the greatest number". But Bentham was not advocating that each person should acquire more and more happiness in the way Imelda Marcos bought shoes. Just before he died Bentham wrote to the daughter of a friend: "Create all the happiness you are able to create; remove all the misery you are able to remove ... And for every grain of enjoyment you sow in the bosom of another, you shall find a harvest in your own bosom."

Stirring stuff. Only one problem, identified by John Stuart Mill: "Ask yourself whether you are happy and you cease to be so." Everyone from Socrates to the Dalai Lama argued that happiness was a recalcitrant little bugger: you couldn't create it, particularly not in someone else's bosom. And so to set happiness as the overarching goal of social policy might seem to be a terrible error.

Layard discounts Mill, Socrates and everybody else's views on this. He thinks happiness is something one can create by working on one's dispositions towards well-being - or getting someone else to show you how. Layard has no doubt there are some of us who are predisposed, perhaps genetically, to being happy. Many of the rest of us, though, need help.

Last year, Layard visited Bhutan, the Himalayan kingdom where government pursues the goal of gross national happiness (GNH). "Bhutan seems much happier than countries that have a materialist rather than moral ethos. Relationships are rather equal, there's very little status anxiety." He was impressed by the four pillars of Bhutan's GNH: the promotion of equitable and sustainable socioeconomic development; preservation and promotion of cultural values; conservation of the natural environment; and establishment of good governance. "What really struck me is that as a matter of policy, there is very little extreme poverty. Bhutan realises that a redistribution of wealth that favours the poor most is better for producing happiness."

Layard's mission now is to make Britain a bit more like Bhutan. It is a mission that has revivified him intellectually and politically late in a distinguished career. He is 74, and has been married since 1991 to Molly Meacher, a social worker who specialised in mental health and now sits as a crossbencher. In his bestselling 2005 book, Happiness: Lessons from a New Science, he cited his wife as a key influence on his thinking.

In 2005, such was his access to government, that he presented a paper called Mental Health: Britain's Biggest Social Problem? to the No 10 Strategy Unit. There he argued that the scourge of unemployment had been replaced by that of depression. He pointed out that more mentally ill people were drawing incapacity benefits than there were unemployed people on Jobseeker's Allowance. Depression was thus bad for both GDP and GNH. One in six people suffered from depression or chronic anxiety, but only a quarter of sufferers were receiving treatment - mostly drugs. Layard recommended that CBT was as effective as drugs and was preferred by most patients.

In his subsequent The Depression Report he recommended scaling up CBT for people suffering from depression and anxiety through training an additional 10,000 clinical psychologists and psychological therapists. The report seemed to promise a great leap forward in British happiness: a national service of 250 local treatment centres, with 40 new services opening each year till 2013, would offer courses of therapy costing £750. Each course would pay for itself in money saved on incapacity benefits and lost tax receipts. Everybody - including the Treasury - would be happy.

But CBT, and Layard's support of it, has been derided. Typical was the GP, Mike Fitzpatrick who, writing in the British Journal of General Practice, charged that Layard was committing a fallacy similar to that of his LSE predecessor William Beveridge, whose 1942 report predicted that improvements in health resulting from better health services would rapidly result in a reduced demand for health and welfare services and hence in a declining burden on the exchequer. It did not. "The notion that a few weeks of CBT will transform miserable people languishing in idleness and dependency into happy shiny productive workers is embarrassing in its absurdity," added Fitzpatrick.