A federal judge in Philadelphia yesterday reversed the Abscam conspiracy convictions of two Philadelphia city councilmen, saying the government created a phony payoff scheme and then entrapped them.

U.S. District Court Judge John P. Fullam said he was acquitting George X. Schwartz and Harry P. Jannotti because the government's conduct in posing undercover FBI agents as representatives of a fictitious Arab sheik to make videotaped payoffs amounted to a violation of the defendants' constitutional rights. "These conclusions are reached with great reluctance," Fullman said in his 64-page opinion. "No one who has viewed the videotaped evidence in this case would avoid feelings of distress and disgust at the crass behavior the tapes reveal.

"The jury's verdict represents a natural human reaction to that evidence. But, in the long run, the rights of all citizens not to be led into criminal activity by governmental overreaching will remain secure only so long as the courts stand ready to vindicate these rights in every case."

Fullam's reversal of the two convictions is the first blot on the Justice Department's record in the controversial Abscam investigation and raises the possibility of similar legal difficulties in the cases against six members of the House of Representatives and one senator.

Irvin Nathan, an assistant attorney general who reviewed the Abscam cases, said last night that the U.S. attorney's office in Philadelphia already has recommended an appeal.He also noted that some of the grounds for Fullam's reversal were not applicable to the cases against the congressmen.

Fullam said the government had "artificially created" federal jurisidiction in the case against the councilmen.

Reps. Michael (Ozzie) Myers (D-Pa.), since expelled from the House, and John Jenrette (D-S.C.) have been convicted in other Abscam cases. A jury in New York is finishing a case against Reps. John M. Murphy (D-N.Y.) and Frank Thompson Jr. (D-N.J.) Reps. Raymond F. Lederer (D-Pa.) and Richard Kelly (R-Fla.) still face trials, as does Sen. Harrison Williams (D-N.J.).

Fullam held "due process" hearings in the Schwartz-Jannotti case last July in Philadelphia, but then let the case go to a jury before ruling on the constitutional questions. None of the other Abscam defendants has had his due process hearing.

Richard Sprague, Schwartz's attorney, said in a telephone interview last night that he never contested the government's evidence in the case. "My client bit at the bait," he said. "My position was that the government had no information that my client ever did anything wrong in his life and that is was a violation of his Fifth Amendment due process rights for the government to go about seeing if someone totally innocent would succumb.

"I realize he shouldn't have bitten at the bait. That in a sense was wrong. But balance that with the terrible potential of the government dangling bait in front of people. That's the greater danger."

Most of the Abscam investigation was run by FBI agents directed by Thomas P. Puccio, head of the organized crime strike force in New York. The undercover operation moved to Philadelphia early this year just before the inquiry was closed down. Agents posing as representatives of the "sheik" rented a $385-a-day suite at the Barclay Hotel and offered Schwartz, Jannotti and other public offials cash in return for promises to aid the sheik's investment plans in the city.

The two councilmen, since resigned, were indicted in May along with fellow councilman Louis Johanson and his law partner, Howard L. Criden, a key middleman in several of the Abscam transactions with congressmen. Johanson and Criden are to be tried later. Schwartz and Jannotti were convicted in September on conspiracy charges.

Videotapes showed Schwartz taking $30,000 and Jannotti $10,000 in separate meetings with the undercover agents last January.