WASHINGTON (Reuters) - The budget deficit for fiscal 2010 narrowed to $1.294 trillion from last year’s record $1.416 trillion as tax collections started to recover and bailout spending fell sharply.

The Treasury Department said on Friday the deficit came to 8.94 percent of gross domestic product for the year ended September 30, versus 10 percent in fiscal 2009.

The government called the deficit-to-GDP improvement the biggest since fiscal 1987.

Nonetheless, the budget gap was still the second-highest in U.S. history and too big to ease market demands and congressional calls for budget restraint in Washington.

“It’s still abnormally large in terms of GDP, and doesn’t change the need for fiscal consolidation,” said Alan Ruskin, global head of foreign exchange market strategy at Deutsche Bank in New York. “You would have to see figures in the 6 percent range before you start to change perceptions that there’s been a genuine improvement.”

High deficits have become a hot-button campaign issue in November’s congressional elections, with many Republicans branding President Barack Obama’s spending policies as “reckless.” Democrats counter that bailout and stimulus spending was necessary to prevent the economy from collapse and an even worse fiscal picture.

“Congress created this problem, and Congress needs to fix it by cutting spending to balance the budget. Washington’s addiction to spending is no excuse to raise taxes,” said Rep. Tom Price of Georgia, who heads a group of conservative House Republicans:

DEFICIT SMALLER THAN FORECAST

The budget gap was $177 billion less than the Obama administration had estimated in July, with much of the reduction due to lower-than-forecast spending on financial bailout programs and higher-than-expected tax collections.

“By carefully managing the emergency initiatives to stop the financial panic and by accelerating our exit from those investments, we have significantly lowered the cost to taxpayers, bringing the costs of the financial rescue down by more than $240 billion this year,” Treasury Secretary Timothy Geithner said in a statement.

“However, we still have a long way to go to repair the damage to the economy and address the long-term deficits caused by the crisis,” he added.

Jeffrey Zients, acting director of the Office of Management and Budget, said in statement: “Thanks in large part to the tough decisions this Administration made over the past two years, the economy is recovering and we’re spurring economic growth and job creation.

“Because the President believes that we must also work to get back on a fiscally sustainable path,” Zients added, “our FY 2012 Budget policy process will continue to enforce the three-year, non-security discretionary spending freeze and continue our efforts to put the nation on firm fiscal footing.”

The Congressional Budget Office in August forecast a deficit of $1.07 trillion for fiscal 2011, which started October 1. An Obama administration budget commission is scheduled to make recommendations for deeper cuts when it convenes in December.

Total federal outlays for fiscal 2010 were $3.456 trillion, down $64 billion from a year earlier, while receipts were $2.162 trillion, up $58 billion.

Spending on financial bailouts fell to $30 billion from $272 billion in fiscal 2009. The decline mainly reflects lower outlays from the Troubled Asset Relief Program, lower support to housing finance giants Fannie Mae and Freddie Mac, and lower costs for bank takeovers by the Federal Deposit Insurance Corp.

Meanwhile, the Federal Reserve’s efforts to support the economy more than doubled its profits, to $75.8 billion. The increase reflects income from its purchases of more than $1.75 trillion in Treasury debt and mortgage-backed securities in an effort to push down borrowing rates.

In September, the U.S. budget gap totaled $34.49 billion, compared with a $45.21 billion gap in September 2009. It was the 24th straight monthly deficit, the Treasury said.