Democrats challenged the spending priorities of President Bush's budget yesterday, even as both sides conceded in advance that last year's deficit-reduction deal leaves them little room for maneuvering.

Faulting Bush for lacking a real domestic program, Democrats proclaimed themselves protectors of Medicare and soft-pedaled their past calls for defense spending cuts out of deference to the Persian Gulf War.

The administration, while risking criticism for proposing a capital-gains tax cut for investors, sought to preempt the "fairness issue" by calling for cuts in farm and health subsidies to the rich.

In sending Congress a spending proposal for the year that will end a month before the 1992 election, Bush moved belatedly to redeem one of his most memorable 1988 campaign promises, inserting a $100 million line item for the cleanup of Boston Harbor.

He also explicitly staked his fiscal and political strategy for reelection on the belief that both the war and the recession will end in the first half of this year, allowing him to expand in 1992 on the modestly financed domestic initiatives included in this year's budget.

While both parties moved quickly to extract political advantage from the fiscal plans, the reaction even of advocacy groups was far more muted than in other years. The war has inhibited open partisanship and the five-year budget agreement of last October leaves little room for major shifts in spending plans.

Referring to the specific spending limits in that agreement, Sen. Pete Domenici (N.M.), ranking GOP member of the Budget Committee, said: "We're not in a bidding war any more. The spending caps hold us to the same level, Democrat or Republican." Budget Committee Chairman Jim Sasser (D-Tenn.) said Congress is "simply reduced to cannibalizing the budget," trading off a cut in one program for an increase in another.

The Bush cut that drew heaviest fire yesterday from both Democrats and interest groups was the proposal to slice an additional $25 billion off the fast-growing Medicare program by cutting back reimbursements to doctors and hospitals. Rep. Fortney "Pete" Stark (D-Calif.), chairman of the House Ways and Means Medicare subcommittee, said it was "like a Scud missile -- big, slow-moving and unsophisticated but with potential to do a lot of damage."

The Gray Panthers organization said the proposal "reflects the president's failed domestic leadership by not addressing the need for comprehensive health reform."

House Budget Committee Chairman Leon E. Panetta (D-Calif.) criticized the absence of "a comprehensive energy policy" in the Bush budget, and House Majority Leader Richard A. Gephardt (D-Mo.) said the same criticism could be made of other major domestic fields. "We ought to concentrate on the fundamentals of economic growth, which I don't think this budget does," he said. Gephardt promised that House Speaker Thomas S. Foley (D-Wash.) will offer a broad Democratic blueprint when he addresses the National Press Club on Thursday.

Meantime, Democrats teed off on the most publicized feature of Bush's domestic program -- the suggestion that at least $15 billion of federal grant-in-aid programs be wrapped into a package for the states to spend as they please. Gephardt called it "another twist of federalism" that "adds nothing to the debate." House Governmental Affairs Committee Chairman John Conyers Jr. (D-Mich.) warned that "if states are given the discretion to determine any priorities they see fit, big holes may be cut in the federal safety net protecting the most vulnerable and least powerful among us."

The executive director of the U.S. Conference of Mayors, Tom Cochran, voiced strong objections to Bush's inclusion of the Community Development Block Grant program, which now goes to cities, among the programs to be run by the states. "Any sign of this program being cut, tampered with or given away is something we would not tolerate," he said.

The nation's governors, on the other hand, continued to express support for the proposal after a meeting with Bush and most of his Cabinet. Republicans were enthusiastic, but some Democrats, such as Colorado Gov. Roy Romer, suggested the block grant proposal may have been put forward just to "divert people from the question of how inadequate" Bush's proposals are for dealing with the recession, health care, education and training.

That argument was amplified by the Center on Budget and Policy Priorities, a liberal advocacy group. It said that despite the recession, the president was proposing "an overall reduction of $760 million in funding for low-income, non-entitlement programs" while offering "no supplemental assistance for unemployed workers and their families" and eliminating a program that aids workers who lose jobs as a result of foreign competition.

Bush sought to insulate himself against the Democrats' predictable criticism by offering his own proposals "to increase fairness" in two big entitlement programs, suggesting that farm subsidies be denied to people with non-farm incomes of more than $125,000 and that individuals making at least that amount pay for most of their Medicare Part-B benefits.

Democrats say they don't want any expansion of means tests for Medicare, and that a similar proposal already had been rejected by Congress. But administration officials clearly enjoyed putting the onus for defending such benefits on the opposition party.

In a reversal of standard party positions, the president's budget presentation emphasized how much federal aid goes to people well beyond the poverty line -- and also how well senior citizens have done as compared to children.

Administration officials said that if the economic situation allows more room for new spending next year, Bush will try to identify himself even more with programs designed to help young people.

While touching lightly on that 1992 election theme, Bush sought to defend himself against a charge of hypocrisy on his well-remembered 1988 Boston Harbor cleanup pledge. Last year, when his defeated presidential rival, Michael S. Dukakis (D), was governor of Massachusetts, Bush omitted any earmarked funding for Boston Harbor. Gov. William F. Weld, the Republican who was elected as Dukakis's successor in November, said yesterday he had discussed the harbor appropriation with both budget director Richard G. Darman and White House Chief of Staff John H. Sununu.

Staff writers Gwen Ifill and Spencer Rich contributed to this report.