Bonds a Stopgap Measure for Overspending in Budget

With the sureness of an emergency room physician, state Finance Director Donna Arduin offers this treatment protocol for an ailing California.

“When you have a patient that is critically ill, there are three steps that need to be taken,” she said. “Stop the bleeding. Sustain their condition. And put them on the road to recovery.”

The $15-billion deficit bond package approved by voters Tuesday stops the bleeding, Arduin said. But lawmakers and Gov. Arnold Schwarzenegger must move fast to keep California from lapsing into a coma because it faces another projected budget shortfall -- this time, $17 billion -- by summer.

“We still need to pass a [2004-05] budget that is fiscally sound, that over the next couple of years will bring us into structural balance,” she said.

The Proposition 57 bonds merely allow California to refinance budget deficits built up over the last three years. The initiative provides a new line of credit to extinguish old credit card bills that had mounted so much that lenders talked of taking control of the state government’s cash if they were not repaid.

Now it’s on to dealing with the shortfall that continues to accumulate.

“All this is, is a temporary fix,” said John Hallacy, managing director of municipal research at Merrill Lynch. “It just means you are fixing the last couple of years and not fixing the problem going forward. It has to be replaced with a more permanent undergirding.”

The state continues to spend beyond its means at a rapid pace, thanks to a chronic “structural” imbalance between the cost of state programs and the revenue coming in from taxpayers. At the current rate of spending, lawmakers must overcome the additional $17 billion by early summer, according to state Legislative Analyst Elizabeth G. Hill. They can cut programs, raise taxes, or hope for an unlikely windfall of sales or income tax revenue equivalent to what California received during the dot-com boom.

The governor wants to do it without any new taxes. He and Arduin presented their plan in January, and it was not well received by majority Democrats in the Legislature. It involved major fee hikes and curbs on enrollment at state universities, denying tens of thousands of low- income Californians access to health insurance programs and delaying billions of dollars of badly needed transportation improvements.

Even if lawmakers adopt the governor’s budget as proposed -- and state finance officials have no problem selling the bonds approved Tuesday -- Hill says the state could still end the 2004-05 budget year with a shortfall of $4 billion.

That’s largely because the governor’s budget relies on some suspect assumptions. Among them is that the state can generate $500 million in revenue by renegotiating Indian gaming compacts and $400 million from unspecified cuts to the state prison system. Other budget solutions may be illegal after recent court decisions, such as a $930-million bond the governor is proposing to sell to cover the state’s payment to the pension system for government workers, and hundreds of millions of dollars in cuts to the Medi-Cal program that may violate federal regulations.

As lawmakers haggle with the governor over what programs the state can and cannot afford, the Schwarzenegger administration is also racing against the clock to come up with proposals for overhauling how the state spends its money. Arduin and other officials have been talking with interest groups about a range of issues, from moving thousands of university students into the community college system for their first two years to renegotiating retirement benefits for state workers.

The state Constitution gives lawmakers and the governor until June 30 to adopt a spending plan. The governor has said on a number of occasions that California’s financial reputation cannot afford to have Sacramento blow that deadline again, as it has eight times in the past 10 years.

Investors say getting an on-time budget that is free of spending or revenue gimmicks would help restore the state’s standing on Wall Street, where California’s credit is rated the nation’s worst. And if the governor can at least come close to meeting his goal of passing a 2004-05 budget by May, it would be a major political victory, further solidifying his standing as a consensus builder able to rein in the ideologically fractured Legislature.

As they work on assembling next year’s budget, the state’s top finance officials will rush to start selling the bonds approved Tuesday. The goal is to get money flowing into state coffers in time to pay off billions of dollars in short-term loans that come due in June.

“The concerns are kind of primal at this point -- near-term solvency,” said Tim Blake, an analyst with Moody’s Investors Service. “Getting out from under the danger of a very serious liquidity problem is significant.”

Even after Tuesday’s vote, Blake said, securing the $15 billion in bond money is still not a sure thing. A group of cities is warning that the plan for paying back the bond may be illegal, and they are considering filing a lawsuit to block it. The plan involves taking sales tax money away from cities to pay back the borrowing, and then replacing that revenue with property tax.

Cities that generate a large portion of their revenue from big-box and other retail stores fear they would not receive the equivalent amount in property tax. But state lawyers have expressed confidence that the courts would not block the tax swap.

Assuming the bond money is secured in time to pay back the short-term loans due in June, Blake said, the state will have taken a step toward fiscal recovery.

But it is still only a first step. He said he didn’t anticipate that Moody’s would immediately change California’s credit rating from where it hovers just above junk bond status.

“The rating is our lowest rating of any state,” he said. “We wouldn’t change that just because bonds are issued.... There is a very large budget gap still facing the state.”