The budget the governor recently proposed for California reflects a significant improvement in the state's finances, says Moody's Investors Service in a report. Structural budget gaps have declined, while the state's economy is showing strength.

Challenges to the state achieving a structural balance remain, however.

"The state's improving economy, combined with recent tax increases and spending controls, has put the state on a path to large surpluses, although one that is typical of the boom-and-bust revenue and economic cycles of California," says Moody's vice president and senior credit officer Emily Raimes in the report "California's Proposed Budget Reflects Improved Finances."

The proposed general fund budget for fiscal 2014 has revenues of $98 billion and spending of $97.7 billion. While the state started fiscal 2013 with a deficit of almost $2 billion, it is expected to end fiscal 2014 with a $1 billion reserve.

In 2012, California voters passed Proposition 30, which raised personal income taxes and sales taxes. Along with economically driven revenue growth, the tax increases are bringing fiscal year 2013 revenues up to $95.4 billion, when spending is budgeted to be $93 billion. The $2.4 billion surplus erases the $2.2 billion deficit that remained at the end of fiscal year 2012, leaving the state with a very small surplus going into fiscal year 2014, and thereby narrowing the state's structural imbalance, says Moody's.

Unlike other states, California will not be able to use surpluses to build its reserves, however.

"For the last few fiscal years, California has balanced its budget with one-time solutions like deferring payments from one fiscal year to the next," says Raimes. "This means future surpluses will be needed for reducing the deferrals and getting back to balance."

California's Gov. Jerry Brown expects the state to reduce its "wall of debt" from $34.7 billion in at the end of fiscal 2011 to less than $5 billion at the end of fiscal 2017.

Additional risks to the state's positive financial position include any potential impact from federal deficit reduction, an economic downturn, and the state abandoning the fiscal conservatism it has displayed over the past two years.

Moody's continues to rate California A1, with a stable outlook.

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