ORANGE COUNTY IN BANKRUPTCY : Cities Plead Their Case in Sacramento : Legislature: They don’t want to forgive county debt or forfeit tax revenue. Local lawmakers say they just might have to do both.

As pressure increased in Sacramento and Santa Ana to shift the burden of Orange County’s bankruptcy from county government to its cities and special districts, a group of city officials flew to the state Capitol on Wednesday to plead their case with Orange County lawmakers.

The delegation from the county chapter of the League of California Cities stayed mum about the meetings, but legislators said the officials realize they now face two unattractive options: Wipe the debts the county owes them off their books, or risk losing tax revenue they rely on.

“You have to choose your poison, is basically what it comes down to,” said state Sen. John R. Lewis (R-Orange). “There ain’t no free lunch in this deal.”

Janet Huston, executive director of the Orange County chapter of the League of California Cities, said the group may formalize its position on the various bankruptcy-recovery proposals, or offer one of its own, as early as today.

“We need to sort out what we heard,” Huston said as she and administrators from Anaheim, Huntington Beach, Laguna Beach, Mission Viejo and Newport Beach left meetings in Sacramento.

“They simply don’t like the [county] plan. They don’t like anything about it,” said Scott Johnson, chief counsel to state Sen. William A. Craven (R-Oceanside). The delegation’s plan to force the cities to forgive the debt also faces major hurdles, Johnson noted, adding: “We don’t know if we could ever get 100% of the cities to agree to anything.”

If the threat to swipe tax revenue from cities and special districts persuades officials at those agencies to forgive the debts owed by the county, the county’s overall shortfall--originally pegged at $2 billion after the county’s $1.7-billion investment loss--could be drastically reduced.

In the most optimistic scenario, county officials might need to find just $225 million in new revenue.

Originally seen as innocent victims of the county’s unprecedented fiscal fiasco, cities and special districts are now being eyed as potential saviors.

Orange County legislators proposed last week that the county divert Measure M sales-tax money from the Orange County Transportation Authority, and that cities and special districts forgive about $750 million in debts the county owes them.

Tuesday, county legal and financial consultants upped the ante, echoing the legislators’ call for a raid on OCTA coffers and threatening to swipe future sales- and property-tax revenue from cities and special districts.

“I don’t think it’s an either-or situation. I think the county’s going for both” debt forgiveness and a raid on revenue, said Peer Swan, chairman of the Irvine Ranch Water District. “The county is setting up a system that leaves them more or less status quo and they’re doing it on the backs of other agencies.”

Jon Schotz, financial adviser to the 200 local government agencies that lost millions last year in the county-run investment pool, said the pool participants’ committee will fight both proposals in Sacramento and plans to offer a solution of its own within a few weeks.

But Assemblyman Curt Pringle (R-Garden Grove) said that “cities and special districts have complained about every single proposal that’s been offered and they have not come up with a plan of their own.”

Since the county first filed for bankruptcy protection Dec. 6., city officials have hoped the crisis would trigger long-awaited reform in county government, transferring assets and power from the Board of Supervisors to the cities and consolidating other agencies. Little progress on that effort has been made so far, but Schotz and others said Wednesday that the cities and special districts will try to refocus attention on asset sales or swaps in response to the new threats.

“A lot of what’s going on now is gamesmanship that will force everyone to the table,” said Anaheim Mayor Tom Daly. “All of the county’s assets should be on the table.

“I don’t think the county has made a good-faith effort to sell its assets. I’m not saying just sell the assets [on the open market], I’m talking transfer the assets, swap the assets for debt--or for revenue.”

Legislators said Wednesday the county’s new proposals may help pressure various agencies toward the debt-forgiveness plan offered by state lawmakers. The proposals include taking as much as one quarter of the $282 million in sales taxes received by cities, about $90 million in property taxes that now go to special districts, and $35 million to $70 million in sales tax belonging to the OCTA.

Of the county’s 31 cities, 13 stand to lose more in sales tax money in one year than they have in outstanding debts from the county. All but two cities, Anaheim and Irvine--both of which borrowed heavily to speculate in the county’s high-risk pool--would lose more by forgiving the debt than they would if the county took the revenue from the quarter-cent sales tax for two years.

Since the county would likely divert the sales tax for up to 30 years so it could finance long-term bonds, all the cities would suffer far more from the revenue raid than the debt forgiveness.

“If the cities forgive what they’re owed, they endure a one-time shot,” said state Sen. Rob Hurtt (R-Garden Grove). “If they go with the other alternative of a tax shift, that’s forever.”

Lewis also pointed out that the delegation’s proposal is “more fair” because cities and special districts would be affected in proportion to their investment in the county pool, rather than based on how much they rely on sales tax revenue.

The Sacramento-inspired plan should be attractive to cities because the lawmakers--like city officials--want to tie bills facilitating the county’s recovery to ones imposing term limits, downsizing county government and imposing a charter.

If the pressure from the county’s threat did force cities and special districts to drop their claims against the county, it would greatly reduce the overall county shortfall.

The county currently owes cities and special districts about $750 million: $342 million in senior claims, which are backed by whatever settlement the county wins in its lawsuits against Wall Street, and $407 million in subordinated claims.

Besides those debts, the county needs to find about $340 million to pay off its bondholders, plus as much as $100 million owed to vendors and $100 million owed schools. The county itself lost about $360 million when the investments went sour last year, but it is unclear how much of that must be repaid. Some estimate it is as little as $100 million.

That would put the overall shortfall, besides what is owed cities and districts, at about $650 million--far less than the $2 billion that was originally estimated.

County officials said Tuesday they have at least $325 million in revenue already available to pay debts, and that they could raise another $100 million by issuing new bonds that extend current leases on county properties.

There are a lot of “ifs” in the way, but that would make the remaining hole about $225 million.

The county’s proposal to take at least $35 million in sales tax revenue from OCTA would be more than enough to back bonds for that amount.