Money and Main Street

California budget nightmare

Gov. Arnold Schwarzenegger and other state officials face tough fiscal choices now that voters have defeated a series of budget proposals.

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By Tami Luhby, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- Note to Californians: Get ready for larger class sizes, fewer police patrolling the streets and more public offices shuttered on weekdays.

State officials are now scrambling to close a $21.3 billion fiscal shortfall, a gap that grew by $6 billion overnight after residents voted down five budget propositions Tuesday.

The state must make "severe cuts now," Gov. Arnold Schwarzenegger said Wednesday. He and state legislative leaders will have to hammer out a budget deal before the fiscal year ends on June 30. The gap covers the rest of this fiscal year and the next.

"There will be around $5.3 billion in additional cuts in education, there will be severe cuts in health care, which is another area where you know we spend a lot of money, and then of course you have to go and look in other areas like prisons," said the governor, who was in Washington, D.C., meeting with the Obama administration.

While most states are facing cash crunches as the economy weakens, California's problems are larger than most. Only three months ago, state officials agreed on a budget deal that closed a $40 billion gap by cutting $15.8 billion in spending, temporarily raising the state sales tax by a penny, borrowing $5.4 billion and using nearly $8 billion in federal stimulus funds.

The state has also suffered mightily in the economic downturn. Its unemployment rate hit 11.2% in March, fourth highest in the nation, while its median home price dropped 54% over the past two years, according to the California Budget Project.

Meanwhile, revenues are running $2.1 billion below estimates, according to the state controller.

Back at the budget table

Now they are back at the table, facing another massive shortfall. And unless the budget problems are addressed, the nation's most populous state won't have enough money to pay many of its bills on time in the coming fiscal year, the California Legislative Analyst's Office said earlier this month. The state controller already had to delay $3 billion in payments in February because of a lack of cash.

California's options are more limited than most. Leaders are constrained by having the nation's lowest state bond rating, which makes borrowing more expensive, and by a multitude of voter-approved propositions that dictate their spending.

"They are not flush with choices," said Jerry Nickelsburg, senior economist with the UCLA Anderson Forecast. Officials will look to education, health care and prisons because "they are about the only places you can find the money."

The defeated proposals would have allowed the state to divert money earmarked for early childhood education and mental health programs into the general fund and to borrow funds from the state lottery.

Even if these measures had passed, Schwarzenegger said he still needed to cut $3 billion from education spending, reduce funding for the state's Health and Human Services department, reduce the state workforce by 5,000 people and obtain $6 billion through short term borrowing to close a $15.4 billion gap.

Last week, the governor said that if the propositions are defeated, he'd be forced to cut another $2.3 billion from the education budget, eliminate funding for substance abuse treatment, crime prevention, HIV education and prevention and outreach efforts by the state public college systems. He would also have to borrow $2 billion from local governments, forcing them to cut back their spending on law enforcement and other services.

California residents will likely see teachers laid off and a shorter school year, said Daniel J.B. Mitchell, professor of management and public policy at the University of California at Los Angeles. Already, the Los Angeles court system announced it will be closed one day a month to conserve funds.

"There's no end to the things you can cut," Mitchell said.

State officials are also looking to Washington, D.C., for additional help. Treasurer Bill Lockyer last week sent a letter to Treasury Secretary Tim Geithner, renewing his call for the federal government to backstop the state's debt. This will help lower California's borrowing costs, freeing up more money for services.

"It's critical," said Jean Ross, executive director of the California Budget Project. "Otherwise, you end up with California cutting deeper or taxing more." To top of page

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