With 6 Days to Go, Budget Talks in Chaos

SACRAMENTO -- After a week in which California lawmakers seemed to pull away from rather than toward a compromise on the state budget, lawmakers now have six days to consider their fateful choice: whether to cut a deal that would allow the $38-billion budget shortfall to be resolved by the constitutional deadline or to stand by as deepening ideological gridlock lets government stumble toward insolvency.

At this critical time in budget negotiations, with the deadline for the Legislature to approve a spending plan arriving at midnight Sunday, Republicans have firmly locked themselves into an antitax position that has thrown talks into disarray. Democrats, meanwhile, say they refuse to cut more deeply into social programs.

Both parties agree that there probably is no turning back from Senate Republican leader Jim Brulte’s threat last week -- a “read my lips” moment -- to end the political careers of any of his fellow party members who join Democrats in voting for a tax hike. A tax increase would require at least eight GOP votes to reach the needed two-thirds majority.

Now Democrats, who have a majority of both houses as well as the governorship, are desperately searching for a way to get out of the budget mess without new taxes. Their ideas include a legally questionable attempt to pass a “revenue-neutral” measure that would raise taxes for a few years and then cut them just as much a few years later. The point: Such a plan theoretically could be approved without Republican votes.

But the larger question in Sacramento is this: Are Republicans trying to force a government shutdown, do they believe Democrats will cave on spending or are they holding fast on taxes because they believe Democrats can find a way to sneak around them to raise an unpopular source of revenue?

Wall Street is searching for the answer, or at least a clear sign, that the state with the largest economy -- which nevertheless bears the worst credit rating -- will snap out of it, balancing revenue and spending in time to avoid running out of cash this summer.

Brulte’s threats came just as a bipartisan deal to close the budget gap was beginning to look likely.

At least a few Republicans were saying privately that they would consider voting for a new half-cent sales tax proposed by Gov. Gray Davis in exchange for an easing of government regulations on business. Those same lawmakers now say they’ve lost their appetite for raising that issue.

Though Brulte’s ultimatum threatens to halt government operations, party loyalists say they are confident that is not what he intends.

“Brulte’s conservative, though he is not a ‘shut down the government for the good of the people’ kind of Republican,” said a GOP consultant, Dan Schnur. “He has some level of confidence a budget can be adopted without tax increases.”

Many in the Capitol expect Brulte and Senate President Pro Tem John Burton, a liberal San Francisco Democrat, to broker the final budget deal. The two senators report being close to reaching a compromise on transportation and local government issues, but say they are nowhere near a deal that closes the budget gap.

Like Brulte, Burton has publicly stated that he will not entertain certain solutions.

“If Republicans follow the line that Brulte put out and they don’t vote for any additional revenue, the state will go broke,” Burton said.

A growing movement to recall Davis from office also is coming into play. The governor lurched to the left when he revised his budget in May, restoring billions of dollars in spending that pleased labor and school officials. Republicans complained that he was pandering to his political base, and some say Brulte’s move was meant to counteract that.

Yet Brulte’s threat angered others in his party who had hoped to bring home major victories for their core constituents by using budget votes to push reform of workers’ compensation, continue tax credits for manufacturers and rein in what they say are frivolous lawsuits against businesses.

If the threat of challenges from within their own party convinces Republican lawmakers that they must hold the line on taxes, that shifts the questions to the Democratic majority, which then must either agree to spending cuts or find a way to raise revenue without Republican support.

Party leaders already have promised to issue an administrative order that would raise the vehicle license fee charged to every California car owner by an average of $136 in the coming months to generate $4 billion annually. Such fees are intended to protect programs. But Democratic analysts are looking at accounting maneuvers that they believe would allow them to use fee revenue to pay off the deficit.

The tenor of negotiations has discouraged many old Capitol hands. One fiscal staffer, who spoke on condition of anonymity, laments that “budgeting has turned into how sneaky can you be, and how late can you wait to slip something through.”

In some respects, that is not a new phenomenon. During the fiscal problems of the early 1990s, Republican Gov. Pete Wilson signed a budget that included illegal borrowing from the Public Employees Retirement System. By the time a court ordered the state to repay the money years later, the economy had rebounded and it wasn’t a problem.

Brulte says Democrats, who have refused to cut back spending despite Republican pleas, have only themselves to blame if the budget gets balanced this year through such maneuvers as an end run around his party’s antitax stand.

“Democrats will do the same things they always do, which is whatever they want,” he said.

An indication of how little progress is being made can be seen at the bipartisan budget conference committee hearings, where Republicans complained that no cuts were being made and no consensus was being reached.

The committee chairwoman, Assemblywoman Jenny Oropeza (D-Long Beach), disputed that. “We have had some important dialogue around some important issues, like uh, uh ... “ she said, then paused, unable to cite examples.

Those involved in budget talks say lawmakers are headed again toward passing a “get out alive” budget, as they did last year. Such a spending plan would rely on accounting “Band-Aids” that would simply push the budget problems into next year. The result: a bigger deficit, more damage to the state’s credit rating and hundreds of millions more in borrowing costs to taxpayers.

In the view of some people watching this process closely, that is the worst possible solution.

Wall Street analysts are already weary of California’s dependence on short-term fixes. They say compromises that fail to tighten the belt and raise revenues are unacceptable. Though no one is saying banks will refuse to do business with the nation’s most populous state, investors have grown impatient.

“We are very concerned,” Steven Zimmerman, Standard & Poor’s managing director for the western region, said Friday. “If they get themselves into a stalemate situation and do not address revenues and spending, it will get worse.”

Bond traders say years of fiscal irresponsibility has forced their industry to tag California, which has the largest economy in the nation, with a bond rating lower than that of any other state.

California’s “underlying economics would attest to a higher rating,” Zimmerman said, but “they have had little success in making adjustments in a timely manner.”

The budget problems are already shaking the confidence of some institutional investors concerned about losing money if they buy bonds that then drop in resale value.

The tone in Sacramento is still “very negative,” said David Blair, senior analyst for Nuveen Investments of Chicago. “It’s surprising, given the fact this budget gap is so large and we’re only a month away.”

And financial analysts are warning that worse could come if the state doesn’t take concrete steps to bring spending and revenues into balance.

If the state’s bond rating falls further, into a category known as junk bonds, many institutional investors will be prohibited from buying securities issued for the state and interest rates will soar.

In that case, there also is a strong possibility that the state would not be able to find enough investors to borrow the money it needs to keep government running. The short-term borrowing that California relies on to even out its cash flow would be unavailable.

In recent days, the major rating agencies downgraded New York state’s bond rating -- which remains higher than California’s -- to signal displeasure with a state budget passed there that analysts say will fail to generate enough revenue to cover spending.

The warning to California from Wall Street -- seen as nonpartisan in its pursuit of the bottom line -- was viewed by some closely following the state’s budget crisis as a possible turning point that might force Democrats and Republicans to get serious about negotiations.

Instead, it has deepened suspicions about the motives of Wall Street investors. Some Republicans have taken to referring to the financial analysts as “Team Gray,” suggesting that they are doing the governor’s bidding rather than offering impartial analysis.

Others doubt that.

“I strongly suspect that the Wall Street bankers are far more interested in their investments than ideological purity and will make their decisions based on the realities of the financial markets, not the ideology of the free market,” said Tim Hodson, director of the Center for California Studies at Cal State Sacramento.

Hodson said the Republican position seems to be a shift away from an ideology holding that government would be better off if it were run more like a business -- which would not expect to borrow money without showing profitability.

It is a position that Hodson said has been taken up by Republican leaders at the national level, most notably President Bush, who pushed for and got a tax cut at the same time he asked for additional money for national defense.

Although the breakdown last week was largely attributed to Brulte’s remarks, Democrats have been resistant to compromise as well -- and occasionally have angered Republicans by their willingness to spend money rather than make tough cuts.

Most recently, they used $2.4 billion in federal funds given to the state -- money they had not expected until the Bush administration approved it -- not to patch up the budget hole, but rather to immediately restore spending to programs on the chopping block.

Though political battles are expected, analysts say there is concern that the lines-in-the-sand approach and harsh accusations may foreshadow inaction.

“You never know when rhetoric becomes outcome,” said Claire Cohen, vice chairwoman of Fitch Ratings, a Wall Street bond-rating firm. “There has been a kind of deadlock in California since this fiscal crisis has begun to develop. It’s just got worse over time.”

Indeed, for some the California situation is so bleak that the only comfort in it is that other problems seem to pale by comparison.

“It’s mostly like: ‘Oh my God, some place is in worst shape than us,’ ” said Marcia Van Wagner, chief economist for the Citizen Budget Commission, a nonpartisan watchdog group in New York.

Times staff writers Carl Ingram, Dan Morain, Doug Smith and Nancy Vogel contributed to this report.