Cuts in Vat are to form a key plank of Gordon Brown’s emergency economic rescue package to be unveiled tomorrow.

The temporary reduction in sales tax, currently at 17.5%, will be one of a range of measures designed to stimulate consumer spending.

The Treasury refused to confirm the scale of the cut, to be in force by Christmas. However, under European Union (EU) regulations, Vat cannot be lowered below 15%.

A 2.5% Vat cut would cost £12.5 billion a year, making it by far the biggest element of Brown’s £15 billion-plus “fiscal stimulus”. It will be the first time that any government has cut the sales tax.

After considering a range of schemes, ministers concluded that Vat cuts would be the most effective way of stimulating the economy because they provide a direct incentive for consumers to spend. They hope that once the tax is restored to its previous level — after up to two years — the economy will already be on the road to recovery.

The pre-budget report, to be presented by the chancellor, Alistair Darling, will also contain other tax cuts including:

— The extension of a £120-a- year rebate for basic-rate taxpayers.

— The postponement of rises in vehicle excise duty.

— The scrapping of plans to increase corporation tax for small companies.

— A tax exemption for foreign dividends, designed to persuade UK-based multinationals not to relocate abroad.

In a speech to the CBI tomorrow, Brown will defend the expensive and potentially risky stimulus package that will leave Britain on course for a budget deficit of more than £100 billion by next year.

“This is not the time to become prisoners of the old dogmas of the past,” he will say. “All over the world, policy makers are leaving behind the solutions of yesterday and recognising that extraordinary times require extraordinary actions.”

Brown will also say he plans to go to Brussels next month to appeal for EU-wide action on cutting taxes. “A co-ordinated approach in Europe, our largest trading partner, would be of most benefit,” he will say.

Brown may use the summit of European leaders to call on them to follow his lead in cutting sales taxes.

The Tories stepped up their attacks on the prime minister last night, accusing him of an irresponsible “scorched earth” policy.

In an interview with The Sunday Times, David Cameron said: “He knows it’s going to get worse and that he’s going to get found out.”

However, Cameron’s ability to oppose Vat cuts will be hindered by the fact that Kenneth Clarke, the former Tory chancellor, said in an interview yesterday that such a move would “stimulate spending and consumer demand”.

The package Darling will announce will be worth at least £15 billion, or 1% of Britain’s gross domestic product. Treasury sources said suggestions that it could be as much as £30 billion were wide of the mark.

Officials said the key was that a boost was being delivered to the economy. “Economists have different views on which tax cuts would be most effective,” said one official. “The important thing is that this is a significant package.”

In a move targeting the low-paid, Darling will announce an extension of the £2.7 billion giveaway announced in the summer to buy off Labour rebels opposed to the abolition of the 10p income tax rate.

The original rebate, worth £120 a year to basic rate taxpayers, was due to come to an end next April, but the chancellor will say the perk can continue for at least another year.

Proposed increases in vehicle excise duty for larger family cars will be postponed, following a campaign by motoring groups. The move could also help boost struggling car manufacturers and dealerships.

Planned rises in corporation taxes for small firms, which would have brought them into line with larger corporations, will be scrapped. Smaller companies will also be exempted from paying the unpopular empty property levy.

Darling will use his budget statement to urge the banks to resume lending both to business and to homebuyers. He will also call on mortgage lenders not to start repossession procedures against defaulting householders until they have exhausted all other avenues.

Although Treasury officials say an essential part of the package will be putting the public finances back on track in the medium term to reassure the markets, they also said it would be wrong to assume this would all come through tax hikes.

Darling will emphasise new efficiency savings he intends to achieve in Whitehall budgets, worth at least £5 billion a year from 2010 onwards.

Officials are drawing up plans for a sale of government assets including the Met Office, the Ordnance Survey and thousands of acres of Forestry Commission land.

The chancellor will say that the public sector will have to take the strain of getting government borrowing back down by cutting spending growth below the 1.8% a year currently in the plans for the medium term.

Economists said cuts in Vat could translate into lower prices in the shops almost immediately and help stimulate the high street in the run-up to Christmas.

Using official Treasury figures, Capital Economics, the City consultancy, calculates that lowering sales tax from 17.5% to 15% for a year would cost the exchequer around £12.5 billion.

Jonathan Loynes, chief UK economist at Capital Economics, said: “This would be a bold, high-impact way of putting money straight into consumers’ pockets.”

Robert Chote, director of the Institute for Fiscal Studies, said: “This would be an attractive move, creating a window where consumers would be strongly encouraged to go out and spend.

“But there would be the risk that spending would fall when the rate was raised again.”

The Vat rate was last changed in 1991 when the Tories raised it from 15% to 17.5% to help fund poll tax rebates. Until now, the Labour government has preferred to use tax credits or cuts in income tax to put money back into people’s pockets.

In America, the president-elect, Barack Obama, said yesterday that he would introduce a big fiscal stimulus package, promising to “jump-start job-creation”.

Yvette Cooper, chief secretary to the UK Treasury, yesterday criticised Tory opposition to tax cuts. “David Cameron’s Conservatives have decided to stand alone across the world in opposing fiscal action and they would leave families and businesses in Britain to stand alone too in the face of the global storm,” she said.

The package

Vat Expected to be cut, possibly by 2.5% to 15%, to persuade people back into the shops.

Income tax The £2.7 billion rebate worth £120 a year for basic rate payers to be extended to April 2010.

Homeowners Repossession as last resort. Those who miss payments should be granted a minimum three months’ grace.

Foreign dividends A tax exemption to persuade British-based multinationals not to move abroad.

Public works Billions of pounds of road, school and housing projects to stimulate the construction industry.

Asset sales Treasury examining sale of Met Office, Ordnance Survey and Forestry Commission.

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