O.C. Budget Puzzle Tough to Crack : Crisis: Any way you add them up, the numbers look grim for officials trying to dig out of the county’s fiscal quagmire. Solutions will be harsh.

Think of it this way: A couple who geared their lifestyle to an after-tax income of $46,300 a year suddenly find that they have to get by on $27,500.

Adding to their little headache, they discover that they lack $38,200 needed to repay debts coming due this summer. Then, there’s a nasty lawsuit they have offered to settle for $25,500 they don’t have. Finally, they have to find a way to start paying off $92,400 in gambling debts.

If you think these folks have problems, just multiply their woes by 10,000 and you’ll have a good idea of the trouble Orange County government is in. As county Chief Executive Officer William J. Popejoy confidently predicts, the “quality of life will be impaired.”

Even if our hypothetical couple managed to reduce living expenses to zero, it would be years before they could dig themselves out of the economic hole they’re in.

In fact, budget cuts alone can’t solve their problem.

Could they sell off assets to meet their obligations?

Well, the assets they might sell quickly are judged to be worth about $5,000. Other assets they don’t own free and clear, while buyers aren’t exactly lining up to buy still others. The only other windfall might come from a pending lawsuit. But the proceeds of that lawsuit, which they might not win, have already been pledged to settle some of their gambling debts.

Beginning to get the picture?

“A lot of people . . . are in a state of denial as to the magnitude of this problem. It is awesome,” said Irvine Co. Executive Vice President Gary Hunt, one of three business leaders who crafted Orange County’s plan to settle--for 77 cents on the dollar--with the cities and school districts that invested in the now-bankrupt Orange County investment pool.

Without an additional source of income, it’s beginning to look less and less likely that Orange County can emerge from bankruptcy and get back on its feet.

A tax increase may, in fact, be inevitable.

Even if county government shut down completely--which it cannot legally do--that would free up only the $275 million in taxes and fees that support the portion of the county budget that can be cut. The balance of the county’s income, nearly $1.2 billion, comes from state and federal coffers with strings attached that prevent the county from spending the money except in certain ways.

Like everything else associated with the county’s bankruptcy, the largest by a governmental entity in U. S. history, the numbers producing the county’s budget predicament are immense.

Between what it lost in the investment pool (more than $500 million), its current and future debts ($1.5 billion), and its projected budget deficit ($188 million), the county has taken a hit of more than $2 billion--nearly $1,000 for every person in Orange County, and about $650 for every person in new debt alone.

“If you look at the size of the hole, and you put some reasonableness tests on the other sources of possible money--like privatizing, restructuring government, selling assets, and you add, with a touch of realism, litigation proceeds that one might get from Merrill Lynch and others--you add all that up, and you don’t get to $2 billion,” said Thomas C. Sutton, the chairman of Pacific Mutual Life Insurance and one of the co-authors, with the Irvine Co.’s Hunt and Arnel Development’s George Argyros, of the county’s plan to settle with pool investors.

All of the steps Sutton mentions--from drastic restructuring, to privatizing, selling assets, borrowing and begging--will have to be taken.

And it’s all because the county made losing bets on the direction of interest rates, and then doubled and tripled the same foolish wagers in an effort to offset expected losses.

“Unfortunately, they lost their principal, and the note’s coming due,” said Paul Sachs, who heads the Arthur Andersen & Co. accounting team analyzing the county’s books. “It’s hurting them now (and) they have to adjust their lifestyle to meet the new revenue stream and somehow try to honor that debt.”

If he were counseling our hypothetical couple, Sachs said, he would tell them, “Do the best you can to cut your expenses, try to refinance if you can, but you may have to go out and get an additional job. And if none of that works, you’ll probably have to go bankrupt.”

But the kind of relief bankruptcy provides ordinary citizens, such as the opportunity to erase debts at a fraction of their value, isn’t available to the county. Because of the intermittent way that taxes and fees are collected, modern government must borrow money to keep operating in the periods between feast and famine.

Defaulting on the outstanding bonds the county has issued is simply not an option, because of what that would do to the county’s credit ratings.

“If we default, any future borrowings will be at much higher interest rates,” said Popejoy, adding that inflated interest rates would be a form of “hidden tax.”

Orange County’s fiscal woes stem, of course, from the investment pool it operated, which suffered an overall $1.69-billion loss. The county estimates its share of that loss was at least $510 million. The accounting firm of Price Waterhouse, which is working for the 186 cities, schools and special districts with money in the pool, believes another $300 million of the losses should be borne by the county.

Its investment funds squandered, the county can no longer rely on interest income to supplement the $265 million in local taxes and fees it channels into its general fund. The loss of that interest income has spelled disaster for the county’s budget: Where planners penciled in $162 million in interest income this fiscal year, accountants are crossing their fingers for $10 million next year.

That is the main reason why the county’s operating budget won’t balance, and why Popejoy contemplates shrinking the county government work force of 15,000 by up to 2,000 employees. When the fiscal year starts July 1, Orange County will have $188 million less than it once expected--income around $275 million instead of $463 million.

That means no county department and relatively few, if any, county services will escape unscathed. Even the once untouchable budget of the Sheriff’s Department is certain to fall under the ax.

So far, many programs for the poor, sick and young have been slashed the most.

“The county’s most defenseless are going to be hurt the most,” said Supervisor William G. Steiner, the former director of the Orangewood Home for abuse children.

But average residents will also share the burden. Libraries will likely be closed, entrance fees for parks and beaches may be hiked, and there are certain to be longer lines and delays for county services, from paying property tax bills to filing lawsuits.

“County government probably affects your life more than any other level of government,” Board Chairman Gaddi H. Vasquez said, from the people who inspect the cleanliness of restaurants to those who make sure you get the gallon of gas you pay for, he said. “People don’t realize what county government does.”

How far the cuts will go is still being contemplated by Popejoy, who is scheduled to unveil a detailed plan this week. Even if he proposes slashing 2,000 employees from the county payroll--as one of his confidential memos suggested last week--the $188-million deficit won’t be cured. Using the county’s estimate that each employee costs an average of $55,000 a year in salary and benefits, 2,000 layoffs achieves only $110 million in savings.

How the county ever expected to legitimately earn $162 million in interest income from its investments is the source of deep contention between the county and pool participants, and will likely figure prominently in negotiations to settle the bankruptcy.

“Really, $162 million was just unbelievable by anyone’s imagination,” said a source on the creditor’s committee representing pool participants. The county didn’t have enough money in the investment pool to earn anywhere near $162 million in interest, the source added, and maybe not enough to earn the $59 million it claimed as interest income the year before.

Quite aside from lost interest income, the loss of the county’s investment principal also diminishes the county’s ability to borrow its way out of trouble, as officials had hoped to do after the bankruptcy petition was filed.

Even if it is eventually able to borrow on Wall Street, and that may hinge on loan guarantees from the state, the county’s existing debt load is staggering. It must repay $1.001 billion in debts coming due between June 30 and Aug. 10, yet it has only enough cash to cover $619 million--a $382-million shortfall. And that’s just to repay short-term debt, like the $600 million borrowed last year to invest in the pool.

On top of that, the county must come up with $255 million to fund the “recovery notes” that are critical to the bankruptcy settlement plan that offers all the participants 77% of their investments in cash, and the balance in IOUs with different priorities for payment.

Without those notes, the settlement proposal falls apart. Without a settlement that distributes the remaining money in the investment pool, the Irvine Co.’s Hunt predicts a “financial meltdown,” with a cascade of school district bankruptcies, followed by the likely bankruptcies of cash-strapped cities and special districts.

Officials have estimated that the sale of county land, other than the airport, might raise $51 million. Various estimates say John Wayne Airport may be worth $250 million to $500 million, but the county’s net proceeds from an airport sale or from borrowing against it--or even whether it could do either--remain to be determined.

For one thing, any proposed sale or mortgage might not be approved by the Federal Aviation Administration.

“Our main goal is to keep airport costs reasonable to users,” said a manager in the FAA’s Airport Planning & Programming branch in Washington, in written response to questions from The Times. “We would not endorse a sale to a buyer who wants to recover costs by raising user fees. The notion that we would endorse a transaction that provided no benefit for the traveler, but an increase in cost, is not welcome.”

And there are thorny problems to be solved in seeking large new revenue streams from raising user fees for such things as waste management.

“(Acting Treasurer Thomas E.) Daxon said you could generate upward of $800 million in waste management,” Hunt said. “Well, to get there, you’ve got to increase the rates charged trash haulers from $22.75 to $45 a ton. That means every city has got to increase their fees on garbage collection,” Hunt continued.

“And you’ve got to increase imported garbage from outside Orange County by 6,000 tons a day, (which) means the cities that had landfills will have 6,000 tons of new garbage moving through a day. So those issues have to be exposed and pushed through the process,” Hunt added.

Other revenue-raising or expense-cutting proposals require assistance from the Legislature, new rules or public votes.

A tax increase is one example. All five supervisors are on record opposing a tax increase, which makes the imposition of a temporary half-cent tax, for example--either by board vote, or through an initiative put to voters--an unlikely short-term possibility. Even if county voters could be persuaded to approve a bailout tax, any election would be months away, and such taxes usually do not take effect until months after voter approval.

But those who have studied the county’s near-term problems don’t see how such a tax can be avoided. Chanin and Co. and Sutro & Co., financial advisers to the bankruptcy creditors committee, estimated that raising the county sales tax between one-quarter and three-quarters of a cent would generate from $67 million to $201 million. That revenue, in turn, would raise between $53.6 million and $161 million in tax revenue available to pay off new debts. A half-cent increase, they estimated, would give the county enough steady income to borrow approximately $1.1 billion.

In addition to a sales tax, some county officials are privately considering other revenue enhancements. For example, a “tippler tax” of 20 cents a drink would raise $100 million a year, and boosting the tobacco tax 35 cents would net an additional $30 million annually. Those actions, however, would require legislative assistance from Sacramento.

But the Board of Supervisors has authority to increase some other fees. A $10 tax on business licenses in the county’s unincorporated areas would generate about $390,000 a year and a 5% utility tax in the same areas would yield about $5.5 million.

Daxon believes the county employees’ pension plan is “over-funded” by $200 million and he has suggested the county try to use the money. But that too would require special legislation and would likely be controversial with employee unions.

Virtually all ideas to boost revenue will receive consideration, said Popejoy, who plans to release his recovery plans for the county throughout the month.

“A lot of realities are going to come to the forefront, which is also going to move the body politic to some conclusions about what has to be done,” Hunt said. “And then, the decision is going to rest where the decision belongs, with the voters and elected officials of the county. It’s their choice then to decide whether or not they want to maintain the quality of life that we’ve had here or they don’t.”

* BROWN BRIEFING: Speaker Willie Brown gets details on Orange County crisis. B1

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Mission Impossible?

Orange County is facing major problems: how to cut spending to make up a $188-million loss in general fund revenue and how to pay off $1.6 billion in debt from investment fund losses.

County Income (fiscal year 1994-95) State and federal money: $1.181 billion (funds 10,500 employees) General fund revenue (funds 4,500 employees): $463 million General fund losses: -$188 million ***

General fund expected, fiscal year starting July 1, 1995: $275 million Revenue sources Property taxes: $121 million Motor vehicle fees: $101 million Sales tax: $18 million Fund balance available: $15 million Interest earnings: $10 million Other: $10 million Total: $275 million ***

Looming Debt Cash notes for pool investors: $255 million Cash to redeem bonds this summer: $382 million IOUs for pool investors: $924 million Total: $1,561 million ***

Revenue Possibilities

The county debt equals $650 for each of its 2.4 million residents. Here are some ways the county could raise revenue to pay off the debt: Action: Revenue Sell county real estate: $51 million Half-cent sales tax: $107 million Sell landfills: $550 million Sell John Wayne Airport: $250-$500 million New bond borrowings*: $1.1 billion * Would require a revenue stream equal to half-cent sales tax

Sources: Orange County; Chief Executive Officer William J. Popejoy; report to the Official Creditors Committee by Chanin and Co. and Sutro & Co.; Reason Foundation