Expect something dramatic in Brown's first Budget

Income taxes, allowances and all, must be out of bounds. Any changes would have a theme of long-termism, doing the difficult thing now for eventual economic gain

Our new Chancellor seems to like springing surprises. Following his great coup in granting the Bank of England its independence this week, it is a fair bet that there are more on the way.

We await news on the membership of the Bank's new Monetary Policy Committee, and the US-style Council of Economic Advisers, and there will no doubt be some unexpected appointments.

The Chancellor also has between two and four important international meetings before the Budget, depending on whether it is held in mid-June or the start of July: the annual meeting of OECD ministers, an EU finance ministers' meeting, the EU Inter-Governmental conference, and the G7's world economic summit. Plenty of scope for fresh initiatives on an admiring world stage, perhaps on the international development front.

But the big question is what kind of Budget we are going to get. The smoke signals indicate that this is not yet a done deal, with continuing discussions between the Chancellor's and Prime Minister's offices about what measures would be consistent with the spirit as well as the letter of Labour's manifesto.

It is clear, though, that Mr Brown would like to go ahead with something more radical than the limited package of windfall tax, jobs programme and cut in VAT on fuel. The something would involve raising the tax burden more than already planned - for increases inherited from Kenneth Clarke are still due to come into effect, notably through the phasing out of profit-related pay.

It is easy to see the Government's dilemma. Although Labour was extremely careful during the election campaign not to rule out all forms of tax rise - its promise applied only to basic rates of income tax - the broader message was that middling voters had nothing to fear financially from a Labour government.

The first Budget cannot turn around and snatch more from their pay-packets without a serious loss of political credibility - as Gavyn Davies argued in his column in The Independent this week. Surely two months is too soon to allow disillusion to set in?

On the other hand, Labour has also made great promises on long-term improvements to the economy, which will involve fundamental tax reform. At the same time, almost anybody you can think of is urging the Chancellor to tighten fiscal policy for one reason or another.

The industry lobbies, and those economists prone to gloom about the outlook for growth as exports slow down, are desperate for any relief from the strong pound. They hope that if taxes go up more than planned, interest rates will not need to rise as much as feared.

Other experts argue that this kind of fiscal fine-tuning has never worked in the past and would be a bad old habit to fall back into. But Government revenues still need to be higher to close the structural hole in the public finances.

Borrowing is falling sharply, but is much higher than it should be at this stage. They argue there is also a case for finding a bit more revenue as insurance against the bits of sticking plaster Mr Clarke applied to the government finances falling off. After all, Treasury officials freely describe the plans set out last November as "demanding" - mandarin for having a snowball's chance in hell of being met.

With these two varieties of professional support and an ambitious programme for the long-term shake-up of the British economy, it is no wonder Mr Brown is tempted to opt for a radical Budget. He hinted as much in his announcement earlier this week. While stressing that nothing in Labour's manifesto required extra spending and taxes, he said we would have to wait and see whether he decided the fiscal stance needed tightening.

The vaunted inspection of the government books and planned fundamental review of expenditure, along with the switch to commercial-style accounts in the public sector due by the end of the century, could all provide rationales for more dramatic action. Announcements on these are due imminently.

How could this dilemma be resolved? Income taxes, allowances and all, must be out of bounds. Any changes would have a theme of long-termism, doing the difficult thing now for eventual economic gain. The most likely bets are:

r An announcement about phasing out tax relief on mortgage interest. Bad news for home owners, even though its value has dwindled over the years, but it could be just about presented as not being a change in income tax. Economists would unanimously acclaim this move for removing a distortion that makes UK house prices more expensive. It could also prevent a damaging housing boom gaining ground. And it would save more than pounds 2.5bn a year.

r Welfare-to-work measures, on which the Treasury is already dusting off its research. The central problem for many people claiming benefits is that the loss of benefit far exceeds the amount they can hope to earn if they get a job. The withdrawal of benefit needs to be tapered more gently for the low-paid.

Unfortunately, this costs money in the short-term - just as the schemes to get the young unemployed into work will absorb receipts from the windfall tax. It is only later that there are savings to the Exchequer. But with Mr Brown's team eager to take the long view, additional welfare-to-work measures would be no surprise.

r The necessary funds could be raised via higher "green" taxes or a higher corporate tax burden. Mr Brown is known to favour a fundamental overhaul of corporate taxation. This could not be achieved in the next few weeks. But in the meantime, the Government could decide to limit tax relief on companies' interest payments, a potentially big source of revenues as it costs pounds 7bn a year in total.

This would add up to a Budget genuinely far more radical than any recent package, it would favour the have-nots over the haves, and it would not blatantly breach the spirit of Labour's manifesto. If the Chancellor can stage the drama, chances are he will.