Alistair Darling faces the most acute budgetary dilemma of any chancellor for more than a generation as he prepares his PreBudget Report due this month. In the short term, he is under pressure to produce a big fiscal stimulus to accelerate recovery from the recession, while, in the medium term, he needs to demonstrate that the public finances are coming back under control. The former involves tax cuts and extra public spending while the latter will require higher taxes and a spending squeeze. The difference lies in timing, but reconciling the two aims will be very tricky.

The pressure for fiscal action has grown in recent weeks because of increased pessimism about the severity of the recession. The fear is that the Bank of England’s 1.5point cut in interest rates, while welcome, may not be enough in view of the banks’ caution about lending.

What is now being considered goes beyond the rise in public borrowing already under way as a result of the downturn, with a large shortfall in tax receipts, aggravated by the problems of the financial and property sectors, and increases in spending on unemployment benefits.

The question is whether the Government should go further by changing existing spending and tax plans, and by how much. So far, ministers have talked only about bringing forward some capital projects from later years.

On the tax side, Mr Darling has already announced £3.5 billion of cuts this year, mainly through a £2.7 billion rise in basic rate thresholds, as well as postponement of increases in petrol duty and a reduced rate of stamp duty for some housebuyers. He has, anyway, to decide this month how to finance these cuts in later years, as well as how to compensate the 1.1 million losers from the abolition of the 10p tax rate who have not benefited from the higher thresholds. The advocates of a fiscal stimulus argue for a further boost, either through increases in welfare benefits or targeted tax cuts. It is unclear how much the Treasury is considering, or what would be enough to make a quick impact.

Mr Darling will want, however, to avoid being accused of profligacy, given that the underlying or structural budget deficit was already high before the recession started, and therefore will not disappear when the economy recovers. The Tories have argued that any tax cuts should be funded, or offset by spending savings elsewhere. Before the severity of the recession became apparent, the main focus was on how much fiscal policy would now have to be tightened. But higher taxes and a spending squeeze have only been postponed, almost certainly until after the next election.

So Mr Darling will have to show both that the Government is helping people through the recession and that he has a credible plan to restore the public finances to health once recovery starts. It will be hard to avoid the impression of giving with one hand now, and taking back even more later.

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