With one bound he is free. Just when you thought Labour would finally have to choose between cutting income taxes with Kenneth Clarke and increasing education spending with Paddy Ashdown, Tony Blair has pulled from the hat a windfall tax on the utilities. A one-off lump sum of at least pounds 2bn to spend on attacking unemployment and all paid for by those nasty water and electricity companies. Politically brilliant - but surely there's no such thing as a free lunch? Even if Labour manages to ensure that the tax isn't just passed on as higher prices, the policy could still prove costly. It risks damaging the pro-market, pro-profit image new Labour has tried so hard to cultivate.

City analysts estimate that the water industry alone could cope with a one-off tax bill of up to pounds 5bn, stick to the same pricing plans and still keep dividends to shareholders rising at 6 per cent a year until the year 2000. Dividends just wouldn't rise as fast as they would without the tax.

From Labour's point of view, water provides the clearest target, but the party also wishes to attack the profits of the electricity companies. Telecommunications, once also a Labour bete noire, is for some reason excluded.

The essential case is that all of these industries were undervalued at privatisation. Since then weak regulation has allowed the utility companies to make excessive profits.

But the Labour plan faces two important difficulties. Under fear of takeover, companies have been jacking up dividends in an effort to sustain shareholder loyalty. They could well offload the cash so fast that there will be none left by the time the election arrives. As a result any tax squeeze by a Labour Chancellor could hit staffing, future investment programmes and service quality rather than shareholders. Also, if the regulator is not vigilant, the squeeze could be passed on to customers in higher prices.

The second danger is the spectre of Labour wilfully penalising profits and business success. Citing previous windfall taxes on banks and oil companies as precedents does not help. If the party is to show that this policy embodies more than the politics of envy, it must argue convincingly that the utilities are a special case, that these are local monopolies with safe, overblown profits privatised at below their market price.

But even if Labour jumps this hurdle it could still jeopardise its future relationship with the City. Many would view the tax as a breach of contract, as Labour unilaterally changing the terms of an agreement long after the ink has dried on the deal. Certainly this is an insuperable objection against the Government stealing Labour's clothes on this issue.

Labour at least can claim consistency. Gordon Brown has long called for a one-off levy on the utilities. But that may not be enough for the City. Mr Brown knows full well that he must be trusted in the markets, on everything from the conduct of monetary policy to the search for joint public-private sector projects. His windfall profits tax risks disturbing the considerable progress he has made on this front.

Fortunately for Labour, the utility fat cats could save the party's fiscal reputation. Animosity towards the pay rises of the utility bosses has reached such heights that everyone, even industrialists and financiers, senses that they deserve their knuckles rapping. No matter how suspect the economics of windfall taxation, the politics are strongly in Labour's favour.