Mr Gordon Brown is in something of an unenviable position despite the fact that he has billions of pounds more to give away in next week's British budget than his predecessors as chancellor of the Exchequer would ever have thought possible.

The fortunes of the Exchequer have been booming. Only a year ago Mr Brown estimated that public sector net borrowing would be £3 billion sterling (£4.8 billion); by November he admitted there would probably be a surplus of £3.5 billion. Next week that will probably have climbed to a figure in excess of £8 billion.

For a Labour chancellor the transformation - and the financial flexibility offered by it - must seem like a dream come true. But unfortunately for Mr Brown if he gives in to the temptation to announce substantial increases in spending, or large cuts in taxes, he would be practically inviting the Bank of England to increase interest rates. The bank is more than a little hysterical about the prospect of another boom in property prices and a consumer spending surge would certainly see the deciding committee announcing large rate hikes.

As UK economist Mr Roger Bootle pointed out last week, Mr Brown's predicament is similar in some ways to the one faced by one of his Tory predecessors, Mr Nigel Lawson, in 1988. In an ill-fated move he cut taxes when the public finances suggested that this was easily affordable, whereas the state of the economy indicated it would be foolhardy to do so. What followed was an inflationary boom that forced interest rates up to 15 per cent and drove the British economy into recession.

The current incumbent cannot risk even the merest hint of that happening again. But he does have a way out. According to ABN-Amro economist Mr Richard Iley, Mr Brown is likely in next Tuesday's budget to be able to please both the Bank of England and the voters. He should, he says, be able to announce a £5 billion sterling giveaway without threatening his own self-imposed fiscal rules. Indeed the current budget surplus is so large that the chancellor could actually add £10 billion sterling to spending without threatening his target. Mr Brown's other rule - that the net debt to GDP ratio should be kept to below 40 per cent - is no danger at all.

Overall Mr Brown will be able to announce about £2 billion in tax cuts which are likely to be offset by some tax increases as well as up to about £3 billion in additional spending concentrating on areas important to voters such as health and education.

The key to this is in last year's budget. In a move which initially confounded the City, Mr Brown dramatically increased spending but still locked in savings for the Exchequer. Because interest repayments on the national debt and, importantly, social security spending is falling (because unemployment is falling), the chancellor has scope to cut overall spending, present a lower borrowing forecast or a larger surplus and still announce fresh spending in some areas as well as modest tax cuts.

A large part of the tax cutting package will be matched by an increase in indirect taxes which is likely to keep the overall tax burden constant. Further large increases in tax on tobacco and petrol are likely as is another increase in stamp duty on houses. The latter would also go down well with the Bank of England as it ought to act as a brake on the housing market which has been taking off once again.

At the same time an introductory 10p tax band, perhaps up to £1,500, may be introduced but the speculation is that mortgage interest relief allowances and the married couples allowance will both be abolished.

The reason that this budgetary combination will work, according to Mr Iley, is that the Bank of England will be satisfied with the overall impact. But the chancellor will also get headlines for widening the 10p band, giving the National Health Service more money and introducing new measures in the welfare to work programme.

He also has the opportunity to present Labour again as the party of the family, something which will always wins approval with the much courted suburbs in Middle England.

Mr Brown has already committed himself to a shake-up of the tax credit system, with a fundamental shift of resources from "wallet to purse", when he was setting out ideas last autumn for an integrated child credit to be paid directly to the main carer in the family. This could go much further, individualising the credit which would allow many fathers to live at home without affecting the payment.

There is also likely to be a boost for share option holders. The budget may give even more generous tax breaks on share options than those first sketched out last year.

The tax reliefs - aimed at small, high-tech businesses - are expected to go beyond the proposals outlined in November's pre-budget report. Four months ago Mr Brown announced that companies would be able to offer £100,000 of share options to 10 key employees with tax breaks. But the proposal was criticised for being too timid and it appears now that Mr Brown may go further next week.

Observers are expecting that the breaks will be extended to allowing the employees to pay no income tax or national insurance on the share options and to be able to sell the shares at a significantly reduced rate of capital gains tax.

In addition it is expected that he will introduce a new share ownership scheme which will allow firms to give all employees up to £3,000 of shares free of income tax and national insurance contributions and further reforms of the capital gains tax regime.

He is also expected to announce a huge clampdown on cigarette and tobacco smuggling introducing similar penalties as for smuggling hard drugs.

The tough stance is the result of growing panic in the Treasury that it is losing large amounts of revenue as a result of tobacco smuggling as people turn to illegal suppliers for cigarettes and hand-rolled tobacco.