SACRAMENTO — Facing a weakening economy that has increased the size of California’s projected fiscal 2009 budget deficit past $15 billion, Gov. Arnold Schwarzenegger yesterday proposed issuing up to that amount in bonds backed by state lottery revenue.

“As the deficit grew these last few months, I knew that we could not solve this crisis by cuts alone,” Schwarzenegger said. “We had to get creative and find new revenues without raising taxes.”

The lottery plan, introduced as part of the governor’s “May Revise” budget proposal yesterday, would have to be approved by two-thirds votes in the Legislature and then by voters in November.

The proposal balances the carrot of revenue from the lottery bonds against the stick of a temporary 1% sales tax increase that would be imposed if the plan fails at the polls or is blocked by litigation.

The proposal, which coincidentally would sell as much debt as the state’s current fiscal 2009 deficit projection, is actually a securitization of future lottery revenues, akin to the securitization of revenues from the master settlement with tobacco manufacturers, said Mike Genest, the state finance director.

The governor would raise $15 billion by securitizing lottery revenue, of which $5 billion would be issued in fiscal 2009. Technically, lottery bond proceeds would finance a budget reserve, but the budget situation is so dire that the reserve would immediately be tapped in fiscal 2009.

The plan is tied together with Schwarzenegger’s long-running efforts to implement budget reform. “People think the lottery is the key to this year’s budget,” Genest said. “Wrong. Budget reform is the key to the budget.”

The plan calls for “ modernizing” the lottery to generate new revenue, allowing the state to pay debt service on the securitization without impacting the $1.2 billion the lottery annually generates for education.

But Genest said education would be subordinate to debt service in the plan, which was crafted by financial advisers Lamont Financial.

“That gives us a much better cost of money in the securitization process,” Genest said.

Since Schwarzenegger’s initial 2009 budget proposal in January, state economists have revised their economic projections downward.

Without any actions to close the budget gap, general fund revenues for fiscal 2009 would be $94.8 billion, down 3% from $97.7 billion in fiscal 2008.

After actions that have already been taken, such as the sale of $3.3 billion in deficit bonds in February, and those newly proposed, such as $5 billion in lottery bond proceeds, the May Revise revenue projection is now $103 billion in fiscal 2009 after $101.2 billion in 2008.

A year ago, Schwarzenegger introduced the idea of privatizing the lottery through a concession agreement. At the time, State Treasurer Bill Lockyer suggested issuing lottery revenue bonds instead. While the governor’s securitization plan is slightly different, it is much closer to Lockyer’s position.

Lockyer late yesterday said his office would review “the revenue and debt assumptions used to support the governor’s state lottery ballot proposal.  But I am always concerned about using one-time revenues to finance ongoing state services.”

The extra money would allow the governor to backtrack from his politically unpopular January proposal to suspend the state constitutional guarantee for K-12 school funding; he also abandoned proposals to close many state parks and release prisoners early. The budget still incorporates cuts across state social welfare programs, which will be unpopular with the Legislature’s majority Democrats.

Minority Republicans, some of whose votes will be needed to provide the supermajority needed to adopt a budget and approve the lottery bond plan, are likely to resist the sales tax increase trigger.

Schwarzenegger, echoing a plan announced Tuesday by the new assembly speaker, Karen Bass, D-Los Angeles, also called for creation of a bipartisan commission to study the state’s tax system.

The budget also includes a plan to improve the state’s cash management by smoothing out general fund disbursements through the year. That would allow the state to reduce its cash-flow borrowing, currently projected at $9 billion for fiscal 2009 if there is no change to cash management practices.

Lockyer said the state has “a smaller cash cushion than we’ve enjoyed in past years.  A late budget could force the state to pay a premium of $100 million or more to issue securities to help us maintain cash flow.”



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