IOUs on the way as lines harden

After trying for weeks to fix a state budget gone out of control, Gov. Arnold Schwarzenegger and state lawmakers stood frozen in conflict Wednesday with the state at the brink of a meltdown.

A day after the state Senate failed in a late-night bid to close part of a deficit now projected at $26.3 billion, California Controller John Chiang took steps to begin issuing IOUs today to tens of thousands of companies and individuals that are owed millions of dollars by the state.

Inside the Capitol, signs of a resolution grew faint. The governor declared a fiscal emergency, proposed suspending the education funding requirements of Proposition 98 and -- as union members protested outside the Capitol -- ordered state workers to take a third unpaid day off each month.

A meeting of Schwarzenegger and the state’s top four legislative leaders ended abruptly within half an hour. Assembly Speaker Karen Bass (D-Los Angeles) charged out of the governor’s office, clearly distraught, and walked briskly down the hall.

“He broke it. He should fix it,” Bass said tersely, alluding to Schwarzenegger’s refusal to accept a budget deal that would have averted IOUs but not closed the entire deficit. “Nothing more to say.”

Chiang was set to print 28,742 IOUs starting at 2 p.m., said Garin Casaleggio, a spokesman for the controller. The initial warrants, which total $53.3 million, will go primarily to people who are expecting state income-tax refunds. The state last issued IOUs in 1992.

Republicans in the state Senate, acting with the governor’s support, blocked $3.3 billion in cuts in a series of party-line votes before midnight Tuesday, a move that effectively forced the state to begin issuing IOUs.

But when he spoke to reporters Wednesday, Schwarzenegger blamed legislators for refusing to meet his terms, for wasting time they could have spent negotiating and for catering to special interests by resisting his proposed government overhaul. The governor said he would not sign legislation that is not urgent or related to the budget.

“Right now, in the midst of a budget crisis, they are debating about cow tails, and I think that this is inexcusable,” Schwarzenegger said, referring to an Assembly committee hearing on a proposal to bar dairies from cropping bovine tails.

The governor, who said he was “looking forward” to working cooperatively with lawmakers again, later mocked them on Twitter for the hearing. Schwarzenegger included a link to a YouTube video, “CA State Budget Crisis vs. Cow Tails,” that was created by one of his staff members to juxtapose the hearing with the governor’s criticism of it.

Senate leader Darrell Steinberg (D-Sacramento) subsequently canceled all hearings on legislation not related to the budget. On Tuesday, Steinberg had expressed deep bitterness toward Schwarzenegger for helping to kill the partial budget package by influencing GOP lawmakers who he said were “under the big thumb of the governor.”

The leader of the Senate’s minority Republicans, Dennis Hollingsworth of Murrieta, appeared more optimistic than his peers as he emerged from the meeting with the governor Wednesday talking of “hope.”

“Everybody is intensely focused,” he said. “Hopefully, we’ll get this done in the next couple of days.”

When the scale of the budget crisis became clear in May, Bass, the governor and other state leaders expressed confidence that they could attend to it swiftly. A budget put in place in February to take the state through the middle of next year had fallen out of balance. Revenues declined amid a continuing economic downturn, and voters rejected a slate of ballot measures that were intended to raise nearly $6 billion.

But a series of legislative budget hearings took weeks to produce a plan to balance the books. Republicans, including the governor, rejected it because it included taxes on tobacco and oil companies. That left negotiations roughly where they started and state coffers set to run out of cash.

Schwarzenegger has repeatedly vowed to veto any budget package that includes new taxes or fails to close the entire shortfall. He is simultaneously pressing lawmakers to adopt sweeping changes to government involving public employee pensions, welfare programs and in-home healthcare.

Officials said the failure Tuesday night to reap the $3.3 billion in savings meant that the state would now owe several billion dollars more to schools. Education funding is based on the previous year’s appropriation.

Schwarzenegger announced that the deficit had therefore increased by $2 billion, to $26.3 billion. His aides presented proposals for $4.9 billion in cuts to compensate.

By suspending Proposition 98, the administration would reduce the minimum guarantee for public schools by $3 billion, a level that would later have to be restored. The third unpaid day off for state workers each month would save $425 million, officials said.

The governor and lawmakers appeared resigned that they could no longer avoid the IOUs. A panel of finance officials will meet today to determine the interest rate for banks and other financial institutions that accept the IOUs. Some banks have already agreed to honor them, including Bank of America, which will accept the scrip until July 10. Other banks have not decided.

Schwarzenegger met with Chiang and Lockyer on Wednesday to discuss the IOUs and planned to call banks to ask for help.

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shane.goldmacher@latimes.com

michael.rothfeld@latimes.com