Obama budget to get serious with deficit: Lew

WASHINGTON (Reuters) - The U.S. budget deficit will grow this year and next year because of tax cut extensions, but President Barack Obama will lay out a credible plan to reduce the funding gap, his budget chief said on Wednesday.

Obama, a Democrat, will deliver his budget proposal on February 14 and fighting the deficit -- despite the two-year "bump" -- will be a big part of that plan, White House Office of Management and Budget Director Jack Lew told Reuters.

"The budget will show a very serious path of deficit reduction," Lew said in an interview.

The budget deficit now represents 9.8 percent of the U.S. economy, or a towering $1.48 trillion for the current fiscal year, according to the latest estimate by the nonpartisan Congressional Budget Office.

The president has received bipartisan recommendations for a bold overhaul of the U.S. tax code and government spending from a commission he appointed, and Lew said that items from that report will be reflected in the budget proposal.

Obama also wants investment to lift U.S. growth and steps that shield a fragile economic recovery. These include a tax package agreed with Republicans in December, after discussions led by Lew and Treasury Secretary Timothy Geithner, that will initially make the deficit numbers look worse.

Lew said that the budget proposal will show "the fiscal year '11 numbers and '12 numbers are going to ... have a bit of a bump up in terms of the deficit because of the tax legislation."

Extending Bush-era tax cuts for two years, alongside measures to protect aid for the long-term unemployed, will pump an estimated $858 billion into the economy and has encouraged private sector economists to lift forecasts for U.S. growth.

The new budget plan for fiscal 2012 arrives at a delicate time. It will be published shortly before a temporary budget, which is funding current government outlays for fiscal 2011, ends on March 4 and as federal debt is likely to hit a congressionally set ceiling before the end of May.

UNDER PRESSURE

That environment is tricky for the newly-appointed Lew, who held the same job under former President Bill Clinton, for whom he guided the country's finances back to a surplus.

"I've been through more budget cycles than I care to remember. It's probably in the 25-cycle range now," he said with a laugh.

Obama is under pressure to make deep cuts in government spending from Republicans, who have greater strength in the Senate and control of the House of Representatives after winning big in November elections following a campaign built largely around fiscal austerity.

As OMB director, Lew has an important voice in Obama's economic inner circle, which is led by another former Clinton veteran, economic adviser Gene Sperling.

Lew said the coming budget will lay out a pivot to deficit control after the last two years were spent pushing for economic growth.

"It is going to be a point of distinction that we have to get out of this period of needing to get the economy moving and then switching gears to reducing the deficit," Lew said.

Obama announced last week he would propose a five-year freeze in non-security discretionary spending in his new budget that will lower the deficit by $400 billion over 10 years.

The president's deficit commission, which delivered its report in December, sought much more dramatic reductions in spending as well as a shakeup in the Social Security retirement program and a tax code overhaul.

"There definitely will be items that are familiar from the deficit commission" in the budget, he said. "The president's made clear he hasn't embraced it in its entirety. He's looked to it and taken ideas from it."

DRAWING THE LINE

Lew declined to spell out what additional cuts were on the table, if any, but stressed it was essential that spending be tailored in a manner that did not do more harm than good.

"There's not going to be a question of not putting a budget out there with tough choices and tough cuts," Lew said.

"But there will also be the question of how far do you want to go in some of these areas and what are the consequences of going beyond a certain line," he said.

U.S. presidents use their budget proposals as blueprints for policy priorities, but lawmakers in Congress can disregard them. Lew said that did not make the process irrelevant.

"The first people who jump up and say, 'Budgets are dead on arrival,' are reading your budget. It is shaping the way people are thinking about the debate," he said.

Some lawmakers want the White House to hold a summit to plan a long-term deficit strategy.

Lew declined to take a position on that, saying it was important to concentrate on the looming funding and debt limit deadlines while the administration figures out how best to build a bipartisan deficit discussion.

"I think we need to put our budget out there in a little over a week. Focus on near-term deadlines," Lew said, stressing the need to keep politics out of the debt limit debate.

"It is really a question of basic responsibility and prudence that we deal with the debt limit bill in an expeditious way," Lew said. "Were there to be a failure to act, one could create very catastrophic consequences."

(Additional reporting by Emily Kaiser, Timothy Ahmann and Kim Dixon; Editing by Cynthia Osterman)