A few months ago, politicians in Washington were arguing over what to do with the federal budget surplus, projected to total some $5.6 trillion over the next 10 years.

In recent weeks, the discussion has degenerated into a partisan food-fight about whether there is going to be one at all.

Due to the slowing economy, the federal government last week revised the 2001 surplus, figured as recently as January to be $281 billion, down to $160 billion.

Now, Democrats charge that the White House is perilously close to dipping into the Social Security and Medicare trust funds to fund the first tranche of its tax cut. (Never mind that about 25 percent of the Senate Democrats voted for it.)

What accounts for the dramatic downward guidance?

Well, it turns out that highly-paid stock analysts and venture capitalists aren't the only ones who misjudged the direction of the stock markets.

For a while, as the Nasdaq and the Standard & Poor's 500 indexes slogged through a second-straight down year, Washington budgeters -- on both sides of the aisle -- continue to base their plans on unrealistic expectations of the amounts of capital-gains taxes that will be paid.

In 1991, Americans paid just $27 billion in capital-gains taxes, according to the Congressional Budget Office. Those payments comprised 6 percent of individual tax receipts.

In 1991, Americans paid just $27 billion in capital-gains taxes, according to the Congressional Budget Office. Those payments comprised 6 percent of individual tax receipts.

In 1998 and 1999, capital gains brought in a whopping $84 billion and $98 billion, respectively. In 1999, 11 percent of all taxes paid by individuals came in the form of capital-gains taxes. These funds played a significant role in helping the federal budget swing from an annual deficit of $290 billion in 1992 to the $124 billion annual surplus in 1999.

But when the markets and the economy stumble, capital-gains taxes fall. The last time the economy slid into recession, capital-gains taxes fell 20 percent in 1990 and slumped another 17 percent in 1991.

Receipts remained flat in 1992, when the current expansion began. Given this history, budget estimators should expect less rather than more to be paid as capital gains taxes in 2000, 2001 and 2002.

But the CBO, whose numbers were used by both the Bush administration and congressional Democrats to draft their competing budget plans, expects precisely the opposite.

For fiscal 2000 (October 1999 through September 2000), the agency believes capital-gains taxes soared 20 percent from 1999's record, to $118 billion, or 12 percent of total individual tax receipts. In fiscal 2001, the CBO expects capital-gains taxes to rise another 9 percent, to a record $129 billion, and then fall just 3 percent to $125 billion in 2002.

Given that the Dow is treading water and the Nasdaq is down about 18 percent for the year, those figures just don't add up. After all, falling markets are like a double-edged sword. They generate fewer capital-gains- creating events.

In the first half of 2000, there were 233 initial public offerings. In the first half of 2001, there were 48. That's an 80-percent decline. And many stock options are deeper underwater than the wreck of the Titanic. Plus, investors can write off losses against the amounts they owe.

In May, Gov. Gray Davis, while announcing a smaller projected state budget, said that "a declining Nasdaq, more than anything else, is responsible for the drop in revenues this year."

The governor further predicted that Californians' profits from stock options and capital gains would fall some 30 percent this year, to $138 billion from $201 billion.

Sadly, that doesn't sound overly pessimistic.

Nationwide, it's a pretty safe bet that capital-gains taxes paid in fiscal 2000 and 2001 will fall well short of both the 1999 total and the current projections. (As for 2002, that's anybody's guess.)

There is a real likelihood, then, that the federal government may have to rely on Social Security and Medicare trust funds that were previously regarded as untouchable for current spending. And a shortfall of $20 billion or $30 billion could make a huge symbolic difference.

With mid-term elections rapidly approaching, the shortfalls in capital- gains taxes may help set off a new round of bitter partisan bickering. And unless the markets recover dramatically -- and soon -- the recent downward revisions of the federal budget surplus are likely to continue.