Economist Sees Progress on Budget. DEFICIT REDUCTION

`NOT so bad.'' That's how Wall Street economist Lawrence Kudlow describes the federal budget outlook. The description is considerably more chipper than has been common lately.

Only last month, Peter Davis Jr., an analyst with Prudential-Bache Securities, marked up his forecast of the deficit for the fiscal 1989 budget by $10 billion, totaling $175 billion. That would be considerably worse than the $155 billion deficit in fiscal 1988.

And at Donaldson, Lufkin & Jenrette Securities Corporation, economists Gert von der Linde and Richard Hokenson complained about the ``increased use of contrived accounting gimmickry and `technical dishonesty' in representing the budgetary burden to the public.''

Mr. Kudlow, a former chief economist with the Office of Management and Budget (OMB) under former President Reagan, comments: ``There's an exaggerated view that the budget situation is deteriorating. And that the congressional-White House deal is a sham. As a result, many are throwing up their hands in frustration and disgust.''

Contrariwise, he sees progress. The rate of growth in federal spending has risen from roughly 4 percent in 1986-88 to about 6 percent in 1989, he concedes. But a stronger than expected economy and good corporate profits have accelerated revenue growth to 8 percent. That growth could increase 10 percent this year, he says.

Treasury officials have been reported as saying extra revenues will lower the deficit $13 billion to $18 billion.

Such higher revenues should ease Washington's problem in meeting the deficit targets under the Gramm-Rudman-Hollings legislation. Many economists believe the assumptions regarding the economy and interest rates in the OMB budget for fiscal 1990, starting in October, are too optimistic.

Kudlow, now with the brokerage house Bear, Stearns & Co., is forecasting a deficit of $150 billion to $155 billion this year, about the same as last year. The step-up in revenues has not gone unnoticed elsewhere. Mr. Davis recently put his deficit forecast back to $165 billion. He suggests that revenues in April, the big tax month, will probably come in at about $126 billion, up from $109 billion in April 1988. The Treasury will announce the actual numbers a week from today.

For fiscal years 1990 and 1991, Kudlow puts the ``baseline deficit,'' a deficit that assumes unchanged spending patterns and tax laws, at $140 billion and $115 billion, respectively.

All such deficit projections hang on assumptions about the economy. Kudlow, for example, counts on a ``soft landing'' of the economy - that is, he assumes that growth will slow but not so much as to become a recession.

If a real slump should occur in 1990, the deficit would jump $20 billion to $40 billion, meaning a fiscal 1991 deficit of about $130 billion to $150 billion, Kudlow guesses.

A recession would mean some savings on interest charges on outstanding federal debt. Each 1 percent decline in the interest rate means a saving for the government of about $3 billion the first year and $7 billion to $8 billion the second year. However, as unemployment increases and business profits decline, the drop in revenues would more than offset the reduced interest burden.

Without a recession, the deficit as a share of national output, which peaked at 6.3 percent in 1983 and now stands at 3 percent, is likely to drop below 2 percent by 1991, Kudlow estimates.

Should economic growth drop below 1 percent for two quarters, the deficit targets under Gramm-Rudman become void. So a recession provides an escape hatch for Congress and the administration against automatic cuts in spending, should the autumn deficit projections of the OMB not meet the targets.

The target for fiscal 1990 is $100 billion. But with $10 billion in leeway for error, the cuts will occur only if the deficit projection this coming fall exceeds $110 billion.

Kudlow regards these targets as a ``disciplining force'' for the budget negotiations. ``In an unruly process, which over the last 20 years has completely lacked any forceful institutional constraints, the Gramm-Rudman targets are a welcome, if imperfect, discipline.''

He holds that the Bush administration should have fought harder in reaching the bipartisan budget agreement with Congress. Nonetheless, he says, ``the numbers are not as bad as the critics suggest.''

Within that deal, the toughest nut for the administration and Congress to crack together will be a $5.3 billion increase in revenues. Some economists have advocated an increase in the gasoline tax - for one, Martin Feldstein, former chairman of the Council of Economic Advisers under Mr. Reagan. But Kudlow says congressional sentiment is running strongly against that.

So the tax choice remains unanswered. Will it be more tax on alcohol and tobacco, more user fees, or what?