Deficit Down 22% in Latest Projection

White House budget officials said Wednesday that this year’s federal deficit would be 22% smaller than expected, providing ammunition to supply-side advocates who contended that tax cuts helped pay for themselves.

The revised budget forecast by the White House Office of Management and Budget projected a deficit of $333 billion for the fiscal year ending in September, $94 billion less than the administration estimated five months ago.

The deficit is forecast to be 2.7% of gross domestic product, a broad measure of the nation’s economy. That would be an improvement over last year’s $412-billion shortfall, which was 3.6% of GDP. The record, 6%, was set in 1983 after then-President Reagan’s big tax cuts.

The shrinking deficit estimate breathed new life into a long-running debate over the economic effects of tax reductions and the immediate question of whether Congress should approve additional cuts sought by President Bush.

Administration officials attributed the improvement to an unexpected 14% surge in revenues, and said it demonstrated that the substantial tax cuts the president had previously pushed through Congress were benefiting the economy.

“It’s a sign that our economy is strong, and it’s a sign that our tax-relief plan, our pro-growth policies, are working,” Bush told reporters at the conclusion of a morning Cabinet meeting.

Bush predicted that he would fulfill his pledge ahead of schedule to cut the deficit in half by 2009, as long as Congress held the line on federal spending.

Congressional Democrats and some independent economists said this year’s revenue gains reflected onetime factors and did not appreciably alter what they said was a long-term fiscal deterioration since Bush took office.

“This is hardly a time for celebration,” said Sen. Kent Conrad of North Dakota, the top Democrat on the Senate Budget Committee. As the annual deficit is declining, he said, total national debt is “exploding, and at the worst possible time, just before the baby boomers retire.”

The debate over tax cuts’ effect has political and economic implications. Bush has asked Congress to extend his previous tax cuts and to approve new tax reductions that would cost the government $1.3 trillion over 10 years.

White House officials said the new figures proved that Bush’s previous cuts helped the nation recover from the 2001 recession, and they said the extensions were needed to help sustain the growth.

Their reasoning appears to draw from supply-side theory, which says tax cuts incite people to work harder and businesses to invest more, causing the economy to grow faster than it would if the government kept the money.

“Once again, we are seeing the proof that supply-side economics works,” said Pat Toomey, president of the Club for Growth, an economically conservative fundraising organization.

Yet many mainstream economists have concluded that the supply-side effect is minimal at best, and some analysts said the supporting data in the new budget documents showed that the revenue growth was mainly attributable to other forces.

Among the onetime revenue-boosters that helped improve the deficit picture were: higher capital gains tax collections, which were triggered by a rising stock market in 2004; the expiration of bonus depreciation rules that had reduced business tax collections through the end of 2004; and a one-year “tax holiday” for corporations with overseas earnings.

“Those are not the sort of revenue gains that the supply-siders predicted,” said Robert Greenstein, executive director of the Center on Budget and Policy Priorities, a Washington think tank that frequently criticizes administration policies.

Ed McKelvey, senior economist for Goldman Sachs, a Wall Street firm, said it appeared Bush’s tax cuts had contributed to the recovery and to the stock market’s gains, which in turn were big factors in this year’s higher tax collections. To validate the supply-side thesis, however, there would need to be a significant increase in wages paid and hours worked, and a faster rate of job creation than has been observed so far, McKelvey said.

“The supply-side argument says it in essence is an ongoing effect -- that you lower tax rates; that raises after-tax wages; and that makes people more inclined to work,” McKelvey said. “There’s not much evidence of that.”

White House Budget Director Joshua B. Bolten acknowledged that some of this year’s revenue gains reflected onetime considerations, and that data were insufficient to determine the sustainability of the bonanza.

“I’m guessing that economists will argue about that for some time,” Bolten said. “But what I can say is that the good revenues we are seeing, I believe, are a direct product of the economic growth that’s been ignited by the president’s tax relief, and that we need to keep that tax relief going into the future.”

Bolten said the administration was on track to fulfill Bush’s promise to cut the deficit in half.

The starting point for the administration’s calculation is $521 billion, or 4.5% of GDP, its original 2004 deficit estimate, which proved to be too high for that year. The new projections show the deficit declining to less than half that amount, to $233 billion or 1.7% of GDP, by 2007, before bottoming out in 2008 at $162 billion, or 1.1% of GDP.

A deficit that small would pose no risk to the economy, Bolten said. Over the last 40 years, government deficits have averaged 2.3% of GDP.

But a report by the Democratic members of the House Budget Committee contended that the White House estimates were too rosy and omitted several near-certain deficit-boosters, such as the conflicts in Iraq and Afghanistan and the need to scale back the Alternative Minimum Tax, which was designed to prevent the wealthy from hiding income in tax shelters but had begun biting into the middle class.

A bigger problem, these Democrats noted, is the effect of the administration’s fiscal policies on future government finances. Once the oldest baby boomers become eligible for Social Security benefits, in 2008, they will turn from taxpayers to recipients of federal benefits, putting pressure on the budget.

Instead of pushing through tax cuts, critics said, the administration should have used the surpluses of several years ago to pay down the national debt and put the government in a better position to deal with the coming wave of baby boom retirees.

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Times staff writer Joel Havemann contributed to this report.