Smith vetoes switch to indirect tax: Labour leader holds secret strategy meetings amid party struggle over how to finance growth policy

JOHN SMITH killed off a power struggle over Labour's economic strategy last night when he vetoed powerful demands that the leadership switch from direct to indirect taxes to finance the high- growth policy the party wants for the next general election.

The Independent has been told by authoritative sources that highly-secret discussions and consultations have taken place between Mr Smith and Gordon Brown, the shadow Chancellor, trade union leaders, economists and others on options for the party's long-term economic strategy.

Those talks had been kept from the shadow cabinet and the national executive. One of the most acutely sensitive issues on the agenda was whether Labour should ditch its long-standing preference for direct tax increases - income tax and National Insurance charges - substituting higher indirect taxes like VAT, to finance investment for economic expansion and high employment.

But a spokesman for the Labour leader said that 'no hidden agenda' had been kept from colleagues, and there had been no meetings of any group outside the party's formal policy structure. 'There is no agenda item of shifting from direct to indirect taxation. It has not been on the agenda, and is not on the agenda.'

That meant that if Labour was to maintain a commitment to investment in growth and jobs, it would have to borrow - or repeat last year's election pledge to raise direct taxes.

It is commonly agreed that Mr Smith contributed to Labour's election defeat last April with his threat to raise an extra pounds 3.5bn from direct taxes. Mr Brown, his successor as shadow Chancellor, said in November that it would be a mistake to persist with that policy at a time of recession. He proposed a windfall tax on privatised utility profits.

But Mr Smith and Mr Brown are said to have been strongly urged, at a senior level, to go one step further; backing a Thatcher- style switch of emphasis to indirect taxation that could lead to a Labour commitment to lower income tax and higher taxes on spending.

It has been argued that the Conservatives managed to impose large-scale increases in value- added tax, and the overall tax burden, with political impunity since 1979, and Labour should learn from that. Last night's statement from the Labour leader's office effectively stopped that idea dead in its tracks.

That will dismay those who had been hoping for a bold break in thinking, and will underline shadow cabinet fears that Mr Smith and Mr Brown lack the imagination and determination to break the cycle of Conservative victories.

One senior party source said that he welcomed the suggestion that Mr Smith was 'doing something' about economic strategy. That barbed remark, a mix of relief and sarcasm, reflected feeling throughout the party that - like John Major and the Conservative Party - Mr Smith had allowed a vacuum to develop, with factional in-fighting filling the void.

Mr Brown, Tony Blair, the home affairs spokesman, and Robin Cook, the trade and industry spokesman, are perceived by colleagues to be leading the internal warfare. There is a strong suspicion that Mr Smith is playing them off against each other.

It was difficult to determine whether the leaks about the economic strategy talks - from a variety of sources - were part of that power struggle

But the leadership's flat denial of the leak would have been forced by the suggestion that formal party structures were being by-passed. Last year's party conference decided to set up a new joint policy committee, including equal numbers of national executive and shadow cabinet members, specifically to coordinate policy development under Mr Smith's chairmanship.

That committee was given the task of seeking 'to agree and sustain clear priorities - in the light of Britain's economic prospects - in terms of our policies for taxation and public spending.'

Meanwhile, one development was confirmed last night: Mr Smith and other Socialist International leaders are expected to set up an examination of the left's approach to the 'new economics' at a meeting in Athens next month.

Power 'abused', page 8

Andrew Marr, page 19