The most important announcement in the Budget on Wednesday will not be about the public sector borrowing requirement, the Treasury's economic forecasts or the outlook for government spending. The Treasury is as clueless as anybody else about what will happen to the global economic and financial system in the year ahead, so its economic forecasts are of no greater interest than the private predictions published at the back of The Economist every week.

Gordon Brown's fiscal rules have been abandoned or suspended since the Northern Rock debacle, so nobody really cares about them. And public spending plans have been set for three years ahead, so the only issue of importance is whether the Government will manage to stick to them in the run-up to a general election, information that only hindsight will reveal.

What, then, is left for the Chancellor to do on Wednesday? It is tempting to echo Richard Lambert, the CBI Director-General, who has suggested that the Budget speech should consist of only one sentence, announcing that there will be no new tax and spending measures or changes in public finances until the economic outlook is clearer in 2009.

There is, however, one crucial statement that Alistair Darling must make on Wednesday that will have more impact on Britain's prosperity and the outlook for the public finances than any amount of tinkering with economic forecasts, corporate or personal tax rates and public finance rules. This is the decision on whether the Government will implement the new tax regime for foreigners living in Britain that was announced out of the blue in last autumn's Pre-Budget Report as part of the preparations for “the election that never was”.

Although this reform initially attracted less attention than the reform of capital gains tax, it actually entailed far greater economic and political risks. The Treasury was well aware that tinkering with the tax arrangements for foreigners who are resident but not “domiciled” in Britain would open up a Pandora's box of economic troubles. Yet Mr Brown, in his pre-election panic, seemed to forget all the Treasury reports that he himself had commissioned, which concluded that Britain derived significant economic and fiscal benefits from maintaining a unique 200-year-old distinction between tax “residence” and tax “domicile”.

The main benefit of the fiscal red carpet laid out to foreigners by Britain has, of course, been the City of London's success in maintaining its status as the financial centre of Europe and, arguably, the world.

The City's international success has not been based solely on tax advantages. Other big advantages have been the English language and legal system, the regulatory regime and even the private school system, which has made London an attractive home for globetrotting foreigners. But with English now a universal language of business and legal and regulatory systems around the world converging, taxation is, in many cases, a critical factor. After all, the City's financial dominance, lost after the Second World War, was restored only because of a US tax change.

When Washington introduced an onerous “interest equalisation tax” on international bank profits, Britain decided to exploit this by creating a tax-free environment for eurobonds. This is generally agreed to have been the origin of London's financial dominance since the 1960s. If Mr Brown now argues that Britain's system of taxing foreigners must be reformed because it is an international anomaly, he had better acknowledge that Britain's international financial dominance is an unsustainable anomaly, too - as is the high proportion of British government revenues coming from taxes paid by foreign companies and non-doms. Britain's unique tax system and its unique success as a financial centre are two sides of the same coin.

In the past few weeks Mr Darling has been hearing about all sorts of other unintended consequences of the non-dom tax reform: the Greek shipping industry is planning to move en masse back to Athens; pharmaceutical companies are preparing to shift expansion plans to Switzerland and New Jersey; aerospace engineers are moving back to France, Germany and Italy; and the museum world is facing demands for the return of artworks loaned by non-doms.

Even Moscow is expected to benefit from the exodus as Russian businessmen wind down their offshore operations and delist their companies from the London Stock Exchange.

Why, then, has the Treasury decided to take such risks with the British economy and public finances? The answer is that the Treasury has not. Treasury officials have consistently opposed reforms to the non-dom regime since the 1960s and are known to have advised against it as recently as last summer. Since then the global credit crisis must have made them even more worried about potential job losses and revenue losses from the City of London. Officials at HM Revenue & Customs (HMRC), by contrast, have long been urging chancellors to move against non-doms. When Mr Brown abruptly decided last autumn to back the HMRC position, the balance of power between the two institutions suddenly reversed - and this shift in the institutional dynamics in Whitehall has greatly increased the potential damage from the non-dom reforms.

Once HMRC got prime ministerial backing in the battle with the Treasury over non-doms, it pressed home its advantage and sneaked in several other measures that foreigners in Britain will find even more oppressive: sweeping demands for disclosure of worldwide assets, the restrictions on trusts and tightened definitions of tax residence, which will make it difficult for foreign businesses to use London as a base or even to hold conferences in Britain or fly through British airports.

Having won its battle with the Treasury over non-doms, HMRC has behaved, according to a senior insider, like a rottweiler unleashed. The most important question to be answered on Wednesday is whether Mr Darling has got this mad dog under control.

After all the evidence submitted to the Treasury in the past few months by foreign chambers of commerce, City institutions and multinational companies based in Britain, it is unlikely that Mr Darling still believes the official forecasts of only a few thousand foreigners leaving Britain.

For example, according to a survey of fund managers and hedge funds published last week by Phoros, which specialises in tax planning for financial institutions in London, “75 per cent of key non-domiciled investment management talent now intend to leave Britain” and “at least 50 per cent” of new hedge funds that would have been launched in Britain will now be set up overseas. As a result of such surveys, Treasury economists appear to have realised that they are likely to lose far more revenue from an exodus than their non-dom levy could possibly raise.

Therefore, a tactical retreat is likely, but what can Mr Darling do without performing a humiliating U-turn? Four possible reforms could undo much of the damage done by Mr Brown's pre-election panic last autumn. The first would be an official announcement that non-doms paying the £30,000 levy would be exempted from inquiries into their international assets. The second would be a public promise not to increase the £30,000 annual levy for five years. The third would be a reversal of the ludicrous travel restrictions that would damage London's position even as a conference centre and transit point. The fourth would be a one-year delay in the implementation of all the non-dom reforms to allow more time for the people and companies affected to prepare for the new regime.

If the Government had any sense, all four changes would be announced in the Budget. But common sense has been notable by its absence in the Brown Government, so far. Will Mr Darling change this on Wednesday?

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