Jeremy Warner: It's tough reflating the economy when there's no money

"We must be fast and heavy handed", China said over the weekend in announcing a $586bn stimulus to boost flagging economic activity. With its vast current account surplus and mountainous capital reserves, China has more than enough capacity to be both fast and heavy handed in its app-roach to the downturn. All it has to do is switch investment of the current account surplus from overseas to the domestic economy and the job is done.

The problem that Gordon Brown has in hinting at a similar reflationary package for Britain is that, unlike China, he's got virtually no money to play with and limited scope for borrowing it either. The package announced by China amounts to about 7 per cent of Chinese output. A similarly sized fiscal stimulus in Britain would cost £100bn.

With the budget deficit already set to swell to round about that number next year, regardless of anything by way of tax cuts or increased spending, the Government is in no position to replicate what China is doing. None the less, in his new role as self-proclaimed saviour of the world economy from the evil bankers, Mr Brown has to do something. Cuts in interest rates won't of themselves be enough to stave off a deep recession.

The Government has already talked about bringing existing infrastructure spending plans forward, but this is easier said than done, and however quickly spending departments act, it will take time to have any meaningful economic impact.

A less Keynesian approach to the problem, but in theory much faster acting, would be to cut taxes. All three main political parties seem now to agree that this is the way to go. But how far and in what ways? The proposal put forward by the Centre for Economic and Business Research (CEBR) that VAT be slashed from 17 per cent to 12.5 per cent is actually not such a bad idea, but can nevertheless be easily dismissed. The cost at around £24bn would be too big for the markets to stomach and, in any case, would very likely be illegal under European law, which requires VAT rates to be harmonised within certain bands.

What's more, there is no guarantee it would work. Making things a little bit cheaper isn't going to do a whole lot of good in an environment where there is a general reluctance to spend. There is also a danger that the tax cut wouldn't be passed on by hard-pressed retailers and service providers.

They tried this sort of thing in Japan in the 1990s, and whereas reducing sales tax sometimes produces a temporary boost, the effect soon wears off once everyone gets used to the lower prices, and then is counterproductive when the Revenue tries to claw back the money by whacking the tax back up again at a later stage.

Some of the same reservations apply to tax cuts delivered in the form of Bush-style tax rebates, or increased personal allowances. Again, there is no guarantee these would boost economic activity, as in a recessionary or deflationary environment, householders might use the money merely to pay down borrowings or otherwise save. This is certainly what happened in Japan, though the tonic has worked better in the US. If applied in small amounts through the pay packet, there is a reasonable chance that at least some of the money would get spent.

Yet can the Government afford it on the scale necessary? The Tories, who plan to set out their tax-cutting plans today, think it better to spend any available money on measures specifically aimed at protecting or creating employment, such as national insurance and corporation tax holidays. They might also raise personal allowances and increase the higher rate threshold to take millions of middle-income earners out of the 40 per cent tax band.

Again, however, it is unclear how they would pay for these measures. The Conservatives seem to be saying that anything proposed would be fiscally neutral. Unfortunately, there is no net reflationary effect if tax cuts in one quarter are paid for by increasing them in another. Alternatively, they might run the faintly disingenuous argument that the tax cutting would pay for itself, in that anything that helps support employment also increases the tax base from what it would otherwise have been and limits social security spending.

The last time this kind of thinking was applied was by Michael Foot in the run-up to the 1983 election, when it was widely condemned as economically and fiscally illiterate. What goes around comes around, and now it is the Tories' turn to apply the same fuzzy logic. All of these ideas would no doubt have some merit if it were not for the fact that there is no money in the kitty to pay for them. The Government seems to have taken the view that the seriousness of the times justify ripping up the fiscal rule book, yet there are plainly limits on the willingness of markets to fund the resulting budget deficit, even if a clear road map is estab-lished for steering the public finances back into fiscally responsible shape.

Having already thrown off the cloak of prudence, Mr Brown is plainly enjoying his new-found role as financial man of action. Politically, he's got nothing to lose by being decisive and bold. If he restricts himself to fiddling with tax credits and the winter fuel allowance, he'll be accused of being too cautious, the economy will sink further into the mire and he'll almost certainly lose the next election. If, on the other hand, he throws caution to the winds and tries to bribe the electorate with its own money, he may lose anyway but at least he won't have to clean up the mess. That will be up to the next guy.