You can never have better quality than your source material. If you have a 320x240 VCD, you are stuck with a 320x240 VCD. Sure, you could run it through the KVCD template, and you might end up with a slightly smaller 320x240 VCD, but chances are you will lose a little quality, and unfortunately at that resolution, you don't have much that you can give up...
(On the other hand, I've successfully turned a few 2-CD 480x480 VCDs into very nice 1-CD 352x480 KVCDs. Little to no loss in quality when played back on my personal TV.)
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