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California Officials Jury-Rig Budget Fix

SAN FRANCISCO - California Gov. Arnold Schwarzenegger and legislative leaders late Monday agreed to close the state's $26.3 billion budget deficit with a combination of spending cuts, local government funds, and accounting gimmicks that drew protests from across the state.

Beyond that, the details of the plan remained fuzzy yesterday, as lawmakers' staff worked to write the final bills and the state's treasurer and controller withheld judgment as to whether the agreement will truly balance the budget.

The agreement includes $15.6 billion of spending cuts, $2.1 billion of borrowing, $3.9 billion of new revenues, and $2.7 billion in accounting changes. Added to earlier reductions, the spending cuts reduce the general fund to about $78 billion this fiscal year from about $100 billion last year.

"Getting this budget agreement enacted will be a big step forward, but our state still has a lot of hard work and sacrifice ahead before we are out of the woods," Treasurer Bill Lockyer said in a statement yesterday.

Lawmakers are hoping that the budget fixes will convince investors that it's safe to buy the state's short-term debt, allowing a cash-flow borrowing that would let the state to stop paying bills with IOUs.

Lockyer and Controller John Chiang both said they had not seen enough details of the budget to say if or when that would be possible.

"At this point, it's too early to assess the effect of the budget deal on our cash-borrowing needs," Lockyer said. "Until enactment of the budget changes by the Legislature and the governor later this week, it will not be possible for anyone to estimate or announce the size, sequence, or scheduling of any short-term cash borrowing."

The budget fix will cost local governments, excluding schools, about $4.4 billion. The state will borrow $2.1 billion of city and county taxes, take $1.3 billion from redevelopment agencies, and intercept $1 billion in local gas taxes.

Other spending cuts include $6 billion from schools, $2.8 billion from public universities, $1.2 billion from corrections, $1.3 billion from MediCal, the state's Medicaid program, and $1.3 billion from state worker furloughs.

But Democrats blocked the deepest cuts proposed by Schwarzenegger in May, including the complete elimination of the CalWorks, the state welfare program, and Healthy Families, which provides health insurance to low-income children. The agreement cuts $528 million from CalWorks and $124 million from Healthy Families.

"We have closed the deficit in a responsible manner, and we have protected the safety net," said Assembly Speaker Karen Bass, D-Los Angeles.

Schwarzenegger said the last few hours of negotiations were "like a suspense movie," but called the final outcome a "great accomplishment" because it closed a historic budget gap without imposing new taxes.

The budget plan is lighter on new revenues than Democrats wanted because Republicans refused to support higher taxes, and the state constitution requires a two-thirds majority - which is more votes than Democrats alone can muster - to impose new taxes.

As new revenue, the agreement includes a plan to sell the State Compensation Insurance Fund - a workers compensation program for hard-to-insure private companies - for $1 billion, as well as plans to sell some state office buildings, and to expand offshore oil drilling.

The agreement also includes $2.7 billion of accounting changes that will bring revenues forward from fiscal 2010-11 and delay expenses until the upcoming year. The state will bring forward revenues by speeding up collection of 2010 personal income and corporate taxes. It will delay spending by paying state workers their final June 2010 paychecks a day late, pushing the expense into July.

The Legislature will vote on the deal as soon as Thursday.

Interest groups were lining up yesterday to try to derail the agreement because of its reliance on spending cuts and raids on local government tax collections. The League of California Cities, the California State Association of Counties, the California Police Chiefs Association, the Service Employees International Union representing state workers, and others criticized the budget agreement.

"It's devastating," said Lillian Henegar, the legislative director for the California Redevelopment Association, which represents local redevelopment agencies.

The group fought a successful court battle to turn back the state's $350 million raid on redevelopment agency property tax collections last fiscal year. The new budget deal would grab about $1.3 billion from the agencies. She said the group's lawyers were waiting for details of the legislation to see if lawmakers had found a legal way to tap the local funds.

If the deal passes and meets judicial muster, it would punch a big hole in budgets that are already strained by the economic downturn.

"You take all of that away and most of them would not be able to follow through on debt service and contractual obligations, not to mention laying off staff" and being unable to actively support the economy during the current recession, Henegar said.

The proposed raid on local gas taxes already hurt one local California government. Moody's Investors Service yesterday put Canyon Lake's Baa1-rated gas tax certificates of participation on negative watch.

"This action is necessitated by the increasing possibility that the state of California, as part of its budget balancing solutions, will withhold the gas tax revenues which provide the sole security for the COPs," the agency said in a release.

Canyon Lake has promised to pay its $120,000 annual debt service even if the state intercepts the gas tax. It owes $555,000 on the debt, which was issued in 1994 and has a final maturity of 2014.

Despite the accounting gimmicks and raids on local funds, investors seemed relieved that lawmakers had reached an agreement that would avert a full fiscal meltdown.

Spreads on California general obligation bonds narrowed yesterday, according to Domenic Vonella, an analyst with Municipal Market Data. He said spreads on California's long-term, taxable Build America Bonds have narrowed to 319 basis points from 400 basis points in June and continued to tighten yesterday.

"It's come at the expense of the local credits," he said, citing the state's ability to claim local revenues, such as transportation funds.

While the agreement includes plenty of budgetary "chicanery," it could defuse the state's cash-flow crisis and is based on "extremely conservative" revenue forecasts, according to Milton Ezrati, a senior economist and market strategist at Lord Abbett in Jersey City, N.J.

He said it is less important to perfectly balance California's budget this fiscal year than it is to have conservative revenue projections and to bring expenses back in line with income projections over the long term.

The budget agreement "is extremely important for California because fall is when the state does its financing," Ezrati said. "It had to have a balanced budget to go to the market."

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