President Barack Obama on Monday projected the budget deficit would soar to a fresh record in 2010, challenging his push for fiscal responsibility while driving to defeat double-digit unemployment.

Dubbed an old-style liberal tax-and-spender by his Republican opponents, Obama is under pressure to convince investors and big creditors like China that he has a credible plan to control the country's deficit and debt over time.

While maintaining policies this year aimed at protecting a still-fragile economic recovery, in common with other major industrial nations, Obama will save money by curbing 120 federal projects, including a powerfully symbolic mission to return to the moon, but invest more in education and research.

Initial market reaction was muted and analysts were surveying the numbers with a healthy dose of skepticism.

It is still tinkering around the edges. One has to look at more meaningful things in terms of what will actually reduce the deficit, (which is) the revenue picture, said Marc Ostwald, a strategist at Monument Securities in London.

Polls show voters are worried by the weak condition of U.S. finances, and Obama plans to create a bipartisan fiscal commission to figure out options on taxes and spending.

Obama's budget for the fiscal year to September 30, 2011, which is subject to change by Congress, forecast a deficit of $1.56 trillion in 2010, equal to 10.6 percent of the economy measured by gross domestic product (GDP).

This rise was partly due to spending associated with a package of emergency stimulus measures Obama signed last year.

The increase in the deficit compared with a $1.41 trillion shortfall in 2009 that amounted to 9.9 percent of GDP.

But this funding gap was forecast to dip to $1.27 trillion in 2011, or 8.3 percent of GDP, and fall to roughly half that as a share of the economy in the final year of Obama's term in 2012, meeting a key pledge.

NO CAP-AND-TRADE REVENUE SEEN

The budget incorporates healthcare legislation before lawmakers. But an administration official told Reuters $646 billion in projected revenue from a controversial cap-and-trade climate change bill had been dropped from the budget, implying the White House is doubtful the measures will pass Congress.

To continue job creation and to continue economic growth over time, it is important to bring those out-year deficits down, White House budget chief Peter Orszag told reporters.

Economic growth jumped by 5.7 percent at an annual pace in the fourth quarter, but this has yet to translate into greater hiring, and unemployment of 10 percent is near a 26-year high.

Discontent over the jobless rate translated into political. defeat for Obama's Democrats in a recent election for the U.S. Senate in Massachusetts, foreshadowing significant losses for the party in midterm congressional elections in November.

To boost jobs, Obama is setting aside $100 billion in 2010 in tax credits aimed at small businesses as well as investments in clean energy and infrastructure, before starting to tighten the country's fiscal belt the following year.

We're trying to kind of accomplish a soft landing in terms of our fiscal trajectory to avoid the risk of 1937 where we do excessive deficit reduction too quickly, Orszag said ahead of the budget's formal 10:00 a.m. EST release.

Economists say a premature withdrawal of policies aimed at boosting growth helped prolong the Great Depression in the 1930s and Obama is determined to avoid repeating that mistake. But he must also ensure that investors don't lose confidence in the U.S. ability to put its fiscal house in order.

LONG-TERM CUTS

As a result, the budget outlines measures to cut over $1 trillion from the deficit over the next decade, and almost twice this amount once the declining cost of wars in Iraq and Afghanistan are taken into account, Orszag said.

Obama previewed some of these steps in his State of the Union address last week, including letting tax cuts lapse for affluent Americans, a fee on big banks to recoup losses on a taxpayer bailout during the 2008 financial crisis, and a three-year freeze on domestic spending outside national security.

The White House says that allowing taxes to rise on families making above $250,000 a year will raise an estimated $678 billion over 10 years; the bank fee is projected to recoup $90 billion in that time; while the domestic spending freeze will trim $250 billion from the deficit.

Obama expects to save $20 billion in 2011 from the spending clampdown by ending or paring back 120 programs, including the NASA space agency's project to return to the moon. However, these proposals will need congressional backing and that may be difficult to secure.

Even if all of these measures are adopted, the deficit will remain above the goal of 3 percent of GDP that Obama seeks, and he plans to create a bipartisan fiscal commission to review spending cuts and tax increases to achieve this target.

But Republicans are reluctant to serve on the panel from fear this gives Obama cover to raise taxes, while some members of his own Democratic party oppose cuts in spending.

The fiscal commission will be charged with balancing the budget excluding interest payments on the debt by 2015, or curbing it to 3 percent of GDP when these costs are included.

Obama's emphasis on fiscal restraint could appeal to politically independent voters, who moved away from Democrats in the Massachusetts race. The president, whose own approval ratings have declined to about 50 percent, blames the surge in red ink on his predecessor, President George W. Bush.

Obama argues the deficit was projected to top $1 trillion when he took office in January 2009 amid two wars and a recession that hit government revenues and led to an increase in spending for programs such as unemployment benefits.

(Additional reporting by Caren Bohan, editing by Eric Walsh and Vicki Allen)

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