Hopes Rise for Budget Accord : Spending: Governor and lawmakers battle deadline as Democrats abandon plan to raise taxes. Controller warns he may have to begin issuing IOUs.

With the state treasury running on empty, Gov. Pete Wilson and lawmakers shelved their angry rhetoric Tuesday and took the first cautious steps toward a plan to erase the state’s deficit and enact a new budget for the fiscal year that begins today.

They planned to meet well into the night as state Controller Gray Davis warned that without a budget, the treasury will be drained of cash as of today, forcing him to begin immediately paying the state’s bills with IOUs, known as registered warrants.

Whether Wilson or Democratic lawmakers emerge from the budget battle as the political victor, it appeared Tuesday that health and welfare programs would suffer deep cuts, university students would be paying higher fees and the state’s bureaucracy would shrink. The only question seemed to be whether public schools would get enough money to keep up with the expected growth in enrollments.

Faced with the specter of the state using IOUs for the first time since the Great Depression, Democratic leaders abandoned hope Tuesday of raising taxes and postponing repayment of part of the state’s deficit for the fiscal year just ended.

They agreed instead to meet Wilson’s terms: erase the deficit in one year and balance the budget without raising taxes.

The Democrats offered a $40-billion-plus general fund plan balanced by cutting state programs $2.8 billion--about half of it from health and welfare--and taking $1.4 billion from local government. In place of higher taxes, the Democrats proposed more than $3 billion in accounting shifts and one-time economies, including refinancing state bond debt and postponing a scheduled payment to the public employees pension fund.

“This is a good first step,” Dan Schnur, Wilson’s communications director, said of the Democratic proposal as the governor huddled with GOP leaders.

As it has been for weeks, school funding remained the main issue as today’s fiscal deadline approached. Wilson wanted to give schools about $2 billion less than he proposed in January. Democrats had agreed to a $605-million cut.

But Democrats, negotiating with Republicans on Monday, hinted that they might be willing to accept a cut of as much as $1 billion. Wilson signaled Tuesday that he might be willing to soften the blow of his $2-billion reduction by loaning the schools $1 billion, with the repayment schedule to be determined later.

Lawmakers had to act on the schools budget by midnight Tuesday. Otherwise, they could not cut anything from schools without first suspending voter-approved Proposition 98, which requires a two-thirds vote in each house of the Legislature.

Even with the full school reduction that he proposed, Wilson said the state still needed to cut 15% from health and welfare programs, 10% from higher education and as much as 30% in other state programs. Without the schools cut, Wilson said, it would be all but impossible to balance the budget in one year without raising taxes.

The Democratic plan would cut 10% from health and welfare, 8% from higher education and about 10% from the prison system. It would abolish more than 500 advisory boards and commissions, consolidate the Franchise Tax Board and the Board of Equalization and eliminate the Office of Administrative Law, which oversees state regulatory agencies and has been criticized for slowing the implementation of Proposition 103, the auto insurance measure passed by voters in 1988.

Administration officials indicated that they might accept as much as $1 billion of the Democratic plan’s one-time shifts and accounting changes. But they rejected a $900-million Medi-Cal bookkeeping maneuver and a $400-million proposal to withhold taxes from payments to independent contractors.

Assembly Speaker Willie Brown (D-San Francisco) defended his list of one-time measures by saying that they were meant to offset the year-end deficit of $3.8 billion, which, once repaid, would not recur if spending is cut to the level of expected revenues.

“A portion of this is a one-time problem generated by the economy,” Brown said. “You ought to find some one-time revenues to match with that one-time problem. That’s what we did.”

Brown noted that the November ballot includes two initiatives that could have a positive impact on the state’s budget picture. One, proposed by the governor, would save $600 million a year by cutting welfare grants by up to 25%. The other would raise taxes on business and the wealthy and would provide the state another $600 million to spend in the first year.

If voters pass both, Brown said, “You’d be in hog heaven.”

With the budget deadline approaching, Davis said he had no choice but to begin printing IOUs that will be used to pay the state’s bills if there is no settlement.

Davis said that he expected to issue for today alone 18,500 interest-bearing IOUs, with a total value of $34 million.

Most of those payments--12,000--would be personal income tax refunds. If there were no new state budget by the end of July, the controller would have to issue about 800,000 IOUs worth $1.45 billion.

However, payments to schools, universities and investors in state bonds are guaranteed by the state Constitution and would continue to be paid with regular state checks backed by cash.

“I am still hopeful that these IOUs will not have to go out the door tomorrow,” Davis said Tuesday. If a budget is passed, Davis said, he would destroy the IOUs and replace them with regular state checks.

Another category of state obligations will not be funded at all in the absence of a budget. Unless successfully challenged in court, the state will issue neither cash nor IOUs to such social programs as baby food for the poor, meals for the low-income elderly and clinics that test for AIDS.

Times staff writers Carl Ingram, Paul Jacobs and Dan Morain contributed to this story.