Mr Blair and Gordon Brown, the Chancellor, are determined to use part of the estimated pounds 10bn "war chest" at the Chancellor's disposal to cut taxes for lower and middle income groups. But some cabinet ministers fear Labour is being sucked into a dangerous "Dutch auction" with the Tories, who have signalled their intention to make lower taxes a central plank in their election manifesto.
The rebel ministers want to see the lion's share of the Government's buoyant revenues spent on boosting public services. They are said to include John Prescott, the Deputy Prime Minister; David Blunkett, the Secretary of State for Education and Employment; Frank Dobson, the Secretary of State for Health; Margaret Beckett, Leader of the Commons; and Clare Short, Secretary of State for International Development.
"We need the money for health, education, public transport and tackling crime," one cabinet source said yesterday. "If we cut taxes, we reduce our funding base. If the economy turns down in a future parliament, we might have to put taxes up and that would be very damaging."
City analysts believe Mr Brown could have an extra pounds 10bn at his disposal by next spring, because tax revenues are growing faster than expected and falling unemployment reduces the bill for state benefits.
Another senior minister said the battle between "tax-cutters and big spenders" would be the crucial debate inside the Cabinet over the next year. Pro-spending ministers will argue that the pressures on public services will require a further boost after pounds 40m is injected into health and education over the next three years.
Mr Brown is said by cabinet colleagues to be determined to go down as a tax-cutting chancellor. He wants to build on the 1p cut in the basic rate to 22p announced in his March Budget. It will take effect in April, at a cost of pounds 2.2bn a year.
Yesterday, Mr Blair showed his support for Mr Brown's approach, telling a Sunday newspaper: "We want to achieve for ordinary families as lower a tax burden as possible. No one likes paying tax." He promised to "get the public finances sorted out, get the investment we need in the public services, then get the tax cuts".
The Prime Minister also hinted at help for people paying the 40p top rate of tax, which starts to bite on earnings of more than pounds 28,000. "I want to do something for middle-income families and we'll try to do that," he said. He also promised a "moral crusade" for Britain's new generation, expressing his concern about the rise in teenage pregnancies.
Mr Blair's allies played down the cabinet rift last night, predicting that Britain's strong economic position would allow the Government to cut taxes while improving public services. "We will be able to do both; we won't take risks on either front," one aide said.
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