Blind panic, bitter rivalry, rows and resolution: the inside story of Gordon and Tony's historic gamble

In the days leading up to the most dramatic and important Budget since Labour came to power, Tony Blair and Gordon Brown had a row. The Chancellor wanted this pivotal political event to be a Budget that focused exclusively on the NHS, at least as far as the public services were concerned. With furious Cabinet ministers breathing down his neck, Mr Blair demanded that Mr Brown should range a little more widely. What about education? What about crime?

The row was resolved, as many of the Blair/Brown disputes are, by some linguistic contortions. Mr Brown did deliver a Budget for the NHS , but he made passing references to education and crime. The words plastered over the cracks for the time being.

The internal dispute was more significant for what Mr Blair and Mr Brown were not rowing about. They have been discussing this Budget for months now. On Monday and Tuesday of last week they were rarely out of each other's sight: on the sofa in the Blairs' Downing Street flat, in the Prime Minister's office. But they were finalising the small details, the fine print. The two of them had agreed long ago that taxes had to rise. On this they were leaping forward together, although they had arrived at this historic moment through very different routes.

Mr Brown, a politician with the rare skill of seeing at least 10 pieces ahead on the chess board, has been preparing for last week's Budget for a decade. As shadow Chancellor he and his small entourage would head off to millionaire businessman and MP Geoffrey Robinson's flat near Hyde Park and talk late into the night of long-term goals and how to get there. Privately they were saying from the mid-1990s that their ultimate objective was to resurrect the politics of "tax and spend" in new ways.

Even then during the years of extreme caution, of reckless prudence, there were public signs of what was to come. Mr Brown sought a "popular tax" in the run-up to the 1997 election. His close adviser, Ed Balls, came up with a tax on the privatised windfall utilities. Mr Brown and his entourage also wanted to introduce a new top rate of income tax for high earners. Tony Blair vetoed the idea in one of their early skirmishes.

In his early years as leader Mr Blair had greater faith in a combination of reforms, additional spending from economic growth and an expanded role for the private sector. He even gave interviews in which he preached the cases for lower taxes and public spending. According to some Treasury insiders Mr Brown's stealth taxes in the first term were disguised partly to get them through Downing Street rather than Middle England. In 1998 one of them observed: "If Tony knew what we were really doing with taxes he would have tried to stop us."

During these early years both Mr Blair and Mr Brown underestimated the scale of the crisis in the public services in general and the NHS in particular. Mr Brown was sceptical about investing large sums into the NHS. Mr Blair was proclaiming a "revolution in the NHS" in 1999 on the basis of the introduction of NHS Direct.

Mr Blair was jolted out of his complacency by the flu crisis in January 2000. During that month Lord Winston, the Labour peer and consultant-cum-media celebrity, gave an interview to the New Statesman in which he described the dire state of some hospitals, comparing them badly with those in eastern Europe. The newspapers became hysterical. Two days later Mr Blair told Sir David Frost that the Government would increase spending on the NHS to the EU average ­ an astonishing commitment made out of blind panic and a genuine sense that urgent action was required. This weekend some of those close to Mr Blair have cited the interview as a key moment, trying to ensure that Mr Blair gets some of the credit for the Budget strategy. "Tony set the ball rolling with that Frost interview. Gordon was furious at the time," says one government insider.

A livid Mr Brown felt that comparisons with the EU average were irrelevant. For him the only pertinent funding question should be: what resources did the NHS need in Britain? It was at this point the near breakdown in the Blair/Brown relationship produced chaos. Mr Blair worked closely with the Health Secretary, Alan Milburn, on the Ten Year Plan for the NHS. Virtually unnoticed in his 2000 Budget Mr Brown announced his own review of funding for the NHS. A year later, again almost unnoticed, he appointed Derek Wanless to conduct a formal review. Quite separately Mr Blair appointed the former director general of the CBI, Adair Turner, to conduct his own review. There were almost more government reviews than patients waiting for operations.

Out of the confusion it was Mr Brown's persistent focus that prevailed. "We knew Wanless was a supporter of the NHS when we appointed him," said a Brown ally. It was one of the shrewdest moves in this long game. The preliminary report published last November gave the nervy politicians cover for another six months.

Before the publication of the interim Wanless report there were three pivotal moments. One arose during the election campaign last summer when Mr Blair, still neurotic about tax-and-spend, pressed Mr Brown to rule out increases in National Insurance contributions. Mr Brown, who had more or less made up his mind that NICs would be going up, held his ground.

Once the election was safely out of the way Mr Blair became more determined than ever to address the under-funding in the NHS. One of his aides briefed a Sunday newspaper that taxes might have to rise in the light of 11 September. This was another intervention that infuriated the Brown team. The events of 11 September had nothing to do with the need to increase taxes. At a time when "spin" was becoming counterproductive Mr Blair and Mr Brown met and agreed that they would have to play this one ­ the biggest change of gear since Mr Blair became leader ­ fairly straight.

For the Brown team the most nerve- tingling moment of this long haul came at the party conference last year. After Mr Brown's speech, his adviser Ed Balls gave a strong hint that taxes would rise in the next Budget. The Brown entourage still shuddered the next morning in their hotel room as the newspapers reported the briefing on virtually every front page. They had almost done it. They had almost crossed the Rubicon.

They spent another six months crossing it. Last November newspapers started to report that this was old Labour Brown vs New Labour Blair. Sometimes Mr Blair has not challenged stories of rifts for the simple reason that they were true. On this occasion he intervened immediately. He gave a long interview to this newspaper saying that he fully supported a reformed NHS through taxes and gave detailed arguments against other forms of funding.

The details of the Budget were not finalised until the last few weeks. Mr Brown posed the political question to his close advisers: how do we impose this tax increase with the least possible fallout? They agreed to spread the burden on earners and employers. As one government insider put it, "We did not want to place the whole burden on earners. To some extent we are still operating in the shadow of John Smith's alternative Budget when he proposed to hit middle-income earners." Already, though, this has presented problems with the CBI fuming about "a tax on jobs".

Messrs Blair, Brown and Milburn worked closely on the latest range of reforms to accompany the additional cash to the extent that Mr Milburn's previous relationship with Mr Brown has improved considerably. Even last Sunday the two of them were having phone conversations putting the finishing touches to the package.

Now that the Rubicon has been finally crossed there is much nervousness in the Government and some tension. The Home Secretary, David Blunkett, is furious that with crime soaring up the agenda the Treasury is being tightfisted in its dealings with him while handing over billions to health. Mr Blunkett has done what he used to do as Education Secretary. He has gone straight to Tony Blair seeking support. Mr Blair is sympathetic, but the Treasury insists that the Home Office has yet to demonstrate generous funding means a more effective police force. Meanwhile, some of Mr Blair's own aides have urged him to ensure that education continues to be his overiding spending priority. The Treasury view is that education has done well with funding in the first term. There are big rows looming in the build-up to this summer's comprehensive spending review.

As for Labour MPs viewing all this from the outside, they are pinching themselves. Some are delighted. Others, including some to the left of Mr Blair and Mr Brown, are worried that voters are unprepared for tax increases. One former minister warned that it could cost them the election.

Tony Blair is in a more robust mood. He wants to move on to an even more contentious issue by putting the case for the euro. His allies are suggesting that new dividing lines have been established this weekend and the euro is next. Mr Blair's exchanges with Mr Brown over that issue will make the tensions leading up to the Budget seem like a quaint walk in the park.