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Big Cuts In the Cards

ALAMEDA, Calif. — What’s that sound you hear? Probably California’s budget problems hitting the fan again.

This afternoon, Gov. Arnold Schwarzenegger will unveil his May revise budget proposal for fiscal 2011. It won’t be pretty.

“There are going to have to be profoundly difficult cuts put on the table to close this budget gap,” said the governor’s finance spokesman, H.D. Palmer.

The scale of the problem doesn’t appear to have changed much since the GOP governor made his initial proposal in January, warning that California faced a structural deficit of $19.9 billion through fiscal 2011, and declaring a fiscal emergency to spur immediate legislative action.

Schwarzenegger projected that the general fund would be short $6.6 billion for fiscal 2010 on $88 billion in revenue, and more than $13 billion short in fiscal 2011 on $89.3 billion in revenue.

Since January, the only significant action on the deficit was a complicated swap of the existing sales tax on gasoline for an excise tax. That move will be revenue-neutral for motorists at the pump, though it is projected to generate more than $1 billion in general fund savings, because California law gives the state more flexibility in spending excise tax.

Lawmakers seem to be operating in the hope taxpayers would help reduce the scope of the deficit, after monthly revenue tallies came in ahead of projections from December through March.

That hoped-for light at the end of the tunnel turned out the be an oncoming train, when April, the state’s big month for income tax collections, turned out to be much worse than expected. April receipts were $3.6 billion below projections in the governor’s March budget. Through March, the state had been $2.3 billion ahead.

“Four months of positive receipts were erased in the last 10 days of April,” ­Controller John Chiang said in a statement when he released the April numbers May 7. “Because a surge in revenues has not come, the governor and the Legislature need to move quickly and forge the consensus needed for a balanced budget. Any delay will only limit their options and expose already-struggling Californians to greater harm.”

But consensus is among the hardest things for California lawmakers to achieve when negotiating a budget.

Passing a budget requires a two-thirds supermajority vote in each house,  meaning at least a few minority Republicans have to play ball with the Democratic majority. But the two parties have hardened their positioning and rhetoric this week.

Democratic Assembly members held a news conference Monday to promote a package of bills that include an oil severance tax, a repeal of year-old legislation allowing businesses greater leeway to apply past tax losses, and a change in property tax assessment practices that would result in more frequent reassessments of business property.

But GOP leaders drew a line in the sand against any new taxes. “Assembly Republicans will not support higher taxes, period,” Minority Leader Martin Garrick said at a press conference Wednesday.

The GOP is promoting its own “jobs” package with a set of bills to add new tax credits, cut targeted business taxes, and eliminate state regulations.

“The way to increase state tax revenues is for the Democrats to join us and take action to bring private-sector jobs back to California,” Garrick said.

The Republican bills would make the deficit even worse than it already is, ­Nathan Barankin, spokesman for Senate President pro tempore Darrell ­Steinberg, D-Sacramento, wrote in an e-mail distributed to reporters.

“These bills will not help close ­California’s budget deficit; instead, they will blow another $20 billion hole in it at a time when the state can’t afford to ­adequately fund education, public safety, and other services for Californians,” Barankin said.

Given the posturing — and the scope of the budget problem — a long, hot summer seems a more likely outcome than a budget bill that passes before the new fiscal year commences July 1. The “headline risk” of seeing the state’s dirty budget laundry aired repeatedly during a long stalemate could impact the spreads on state bonds.

Kenneth Naehu, senior portfolio ­manger and fixed-income strategy head at Bel Air Investment Advisors LLC in Los Angeles, said spreads widened markedly the last time the state saw a lot of headline risk, in 2009, when lawmakers twice spent weeks arguing over budget solutions with the state facing tight liquidity.

“This is a market dominated by retail buyers now,” he said. “Individual investors are very headline-sensitive. Quite frankly, individual investors often have little else to go on.”

Naehu said he tells clients that among the many financial problems facing cities and states, headline risks are the biggest cause of volatility. Headline risk also offers opportunities, he added.

“We were large buyers of California debt when spreads were wider. We haven’t been now that they’ve tightened,” Naehu said, adding that he expects spreads to widen.

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