Confidential Labour documents leaked to The Independent reveal that a battle over tax will break out at a meeting of the party's National Policy Forum in Durham next weekend. It will fuel the debate over whether the Government should woo the party's traditional supporters instead of middle- class voters.
A party-wide consultation exercise has provoked demands for a more redistributive tax policy. Although Mr Blair will want to squash the demands, he faces a dilemma because of his desire to convince party members that they have real influence over government policy.
The documents reveal that activists are proposing a big rise in national insurance contributions for the better off - which would be widely seen as a backdoor tax hike.
They have tabled an amendment to a Labour policy statement on welfare, saying the ceiling on national insurance contributions, currently pounds 26,000 a year, should rise to pounds 32,344, raising almost pounds 1bn a year.
According to the Institute for Fiscal Studies, this would push up the tax bills of 2.2 million people, mainly higher rate taxpayers, by up to pounds 7.50 a week on top of increases already announced by the Government.
The move would end an anomaly in the national insurance system under which the low paid are hit harder than the rich. "Charging workers on lower incomes a marginal tax rate half as much again as those on higher incomes cannot be defended," says the amendment.
Gordon Brown, the Chancellor, who announced an above-inflation rise in the national insurance ceiling in his March Budget, may have some sympathy with the grassroots demands. But he will be reluctant to have his hands tied ahead of future Budgets.
Mr Blair, who promised further tax cuts earlier this month, will be more cautious. Blairites believe that plans by the late John Smith, then shadow Chancellor, to abolish the ceiling played a big part in Labour's 1992 election defeat.
One minister who has seen the documents said last night: "This is a critical issue; it goes right to the heart of the debate between Old and New Labour."
Many constituency parties demanded a more progressive tax system. The Islington South and Hampstead and Highgate parties said tax levels in Britain were the lowest in the EU. They demanded "a more ambitious and redistributive welfare policy".
The Tatton constituency party questioned Mr Brown's decision to cut the basic rate of income tax by 1p from next April. Tunbridge Wells said: "Our philosophy must be of the rich helping the poor. Some of this has got to come down to income tax rates and we should not be frightened of admitting we might have to raise taxes."
Activists also demanded an all-out attack on poverty. Another amendment criticises Mr Brown's working families tax credit, warning that tens of thousands of families will still face marginal rates of more then 70 per cent when it takes effect in October. Reducing these incentives to work should "take priority over further tax cuts for higher earners," it says.
Several local parties criticised the "workfare" approach, under which jobless people face benefit cuts if they refuse work, and reductions in state help for the disabled.
Another grassroots demand is for an increase in the basic state pension by raising it each year in line with earnings rather than prices. This will be a crucial issue when the welfare statement is finalised at Labour's annual conference in October, where Mr Blair could face an embarrassing defeat.Reuse content