The Government can afford to introduce a package of radical reductions in personal income tax in the December Budget, according to the Tanaiste, Ms Harney. Speaking on RTE's Questions and Answers programme last night, she said that with corporate tax set to fall to a standard rate of 12.5 per cent, the income tax structure should also be reformed to cut the burden on employees who paid at much higher rates on relatively low income levels.

Ms Harney was speaking after a Cabinet discussion of the Budget, during which the Minister for Finance, Mr McCreevy, warned of the need for a tight package and particularly for spending control. With the Cabinet not believed to have discussed the tax package in any detail, it is not clear the extent to which other Ministers support the Tanaiste's view. There is general agreement that measures are needed to reduce the tax burden on the low paid and tackle poverty. However on RTE last night, Ms Harney supported a package of significant tax reform and said she personally did not agree with the Central Bank's view that personal tax concessions could fuel inflation.

During a five-hour meeting of Cabinet in Government Buildings yesterday, Mr McCreevy urged Ministers to be "realistic" in relation to their expectations on spending.

Mr McCreevy is due to shortly begin a round of bi-lateral meetings on the spending estimates with Ministers, many of whom are believed to be demanding substantial increases.

But Mr McCreevy is understood to have underlined that the cap of 4 per cent on the growth in current Government spending must be adhered to. This is likely to mean difficult negotiations with the Ministers in charge of the big spending departments in the weeks ahead, many of whom will argue that the strong state of the exchequer finances and the prospect of a £1 billion Budget surplus means that sizeable increases in their allocations can be afforded for next year.

Government sources point out that the Government committed to our EU partners, as part of the revaluation of the pound's ERM rate earlier this year, that the Budget would work to keep down inflation.