The European Commission will call on Wednesday for tax cuts and lower interest rates to haul Europe out of recession, despite national differences on how to tackle the slowdown.

A draft Commission proposal obtained by Reuters did not set the overall volume of the stimulus plan, but the leaders of France and Germany called for measures totalling 1 percent of the bloc's total output, or 130 billion euros ($164 billion).

In a joint article to appear in France's Le Figaro daily and Germany's Frankfurter Allgemeine Zeitung, Nicolas Sarkozy and Angela Merkel said the 1 percent figure was a "good target" for national governments to match if they could.

But Dutch Finance Minister Wouter Bos raised doubts about the need for governments to go on a spending spree and the Commission to encourage them.

"It's much more important that they set guidelines, for example that we don't stimulate industry in one country at the expense of industry in another country," he said.

Aiming to bridge such differences, the Commission document gives national governments leeway on policies throughout.

"Only through a significant stimulus package can Europe counter the expected downward trend in demand, with its negative knock-on effects on investment and employment," the draft said.

The Commission said the stimulus had to be timely, targeted and temporary, mix revenue and spending instruments, be accompanied by structural reforms and comply with European Union budget rules -- the Stability and Growth Pact.

The text, which EU leaders will discuss at a summit in December, made clear the rise in budget deficits resulting from the stimulus should be repaired as soon as the economy picks up.

"This budgetary stimulus should be foreseen for a maximum period of two years (2009-2010), following which member states' budgets should commit to reverse the budgetary deterioration and return to the aim set out in the medium-term objectives," it said of the goal of balanced budgets for most countries.

HIGHER DEFICITS

The fiscal stimulus, along with the fall in revenue and rise in spending that accompany an economic slowdown, is likely to boost deficits in France, Britain, Ireland, Italy, Greece and Portugal to well beyond the EU ceiling of 3 percent of GDP.

"Member states may be obliged to break the 3 percent reference value in 2009 and 2010 because of the extraordinary circumstances," the draft said.

"However, such excessive deficits will have to be corrected in time frames consistent with the recovery of the economy."

In rare explicit comment by the Commission on interest rates -- the domain of the European Central Bank -- the draft argued that the ECB had further room to ease monetary policy. The bank has signalled it may cut rates on Dec. 4, and markets expect a 50-75 basis point cut from the current 3.25 percent.

"Emerging evidence of lower inflationary pressures in the face of slumping demand provides scope for further reductions in interest rates," the draft said.

The Commission proposals will form the basis of what could be a tough debate among EU leaders at a Dec. 11-12 summit over what form the bloc's action will finally take, with differences apparent on issues such as whether to cut value-added tax (VAT).

Some countries do not want to boost their budget deficits, such as Poland which must keep its shortfall below 3 percent of GDP to qualify to join the euro zone one day.

"I don't think reducing VAT in Poland is an option next year. Next year Poland is cutting (other) taxes and has also decided to cut its budget deficit," deputy Polish Finance Minister Ludwik Kotecki told Reuters.

Britain on Monday announced a 2.5 percentage point cut in VAT to 15 percent, part of a plan to pump 20 billion pounds ($30.2 billion) into the economy. Germany and France said they would not copy it.

The draft suggested temporarily increased benefits to low-income households and the unemployed, or a temporary lengthening of benefit pay-outs, as possible measures.

It said a temporary, across-the-board VAT cut could also boost consumption, but did not propose a coordinated cut for the whole 27-nation bloc.

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