Tough Times Predicted for State Budget

Rarely has the California budget faced such a convergence of threats as the trio now bearing down on the state government: The economy was shaky even before Sept. 11, terrorism is undermining the tourist industry, and the financial implications of the energy crisis continue to overshadow the state treasury.

Add to that the fact that Gov. Gray Davis faces reelection next year, and some experts believe that state spending could face its gravest crisis in a decade.

State revenues already are running $1.1 billion below projections three months into the new fiscal year--a sum that largely fails to take into account the hit the California economy has taken since the terrorist attacks.

Davis is mulling over a variety of options to address the state’s deteriorating financial situation, including calling lawmakers back into a special session to consider an economic stimulus package.

Lawmakers are worried that California is on track to wipe out a $2.6-billion reserve that was tucked into the 2001-02 budget. If it does, the state faces the prospect of an estimated $4-billion shortfall--and that’s assuming officials figure out a way to repay roughly $6 billion the state spent on energy purchases with money borrowed from the general fund.

“I would anticipate that as a consequence of falling short of the mark last year that the challenge in front of the Legislature next year is going to be worse than in 1991,” said Sen. Steve Peace, the El Cajon Democrat who heads the Senate Budget Committee, in a reference to the $14-billion deficit that faced lawmakers a decade ago.

Barring an economic miracle--perhaps in the form of an unusually robust Christmas shopping season--state politicos could wind up spending their next session fighting over how to raise money and slash spending.

“My sense is that we’re in for a tough three or four months here,” said Ted Gibson, the state’s chief economist. “We could see losing billions of dollars.”

As if that weren’t enough, the state’s economic witching hour is being foisted on a group of lawmakers who have little experience with hard times. Term limits have ousted many of the legislators who lived through the stresses of the early 1990s. Those now in office have dealt mostly with the far simpler task of divvying up surpluses.

“The Legislature has not been forced to make tough decisions in terms of spending for the last five or six years,” Senate Republican Leader Jim Brulte of Rancho Cucamonga said. “I would fully expect there would have to be some rollback of existing programs. It’s going to be a very, very difficult year.”

That notion is fast sinking in at the state Capitol.

Davis, who is in the process of considering hundreds of bills sent to him this year by lawmakers, has already begun belt-tightening by giving a hard look at any measures that cost money. He has cited increased costs to the general fund as a reason for vetoing a variety of bills.

The governor, for example, rejected a $1-million effort to fund a media campaign to inform new mothers of options available should they decide to give up their newborns. He also vetoed a bill that would have allowed school officials to help students take nonprescription medicine with parental permission. His stated concern: The legislation could wind up costing the state $40 million.

Still pending are high-profile measures that seek to raise workers’ compensation rates, benefits to domestic partners, and aid to struggling schoolchildren and community colleges. All carry a price tag.

Tax watchdogs called on Davis last week to wield his veto pen on every piece of legislation that spends money.

“There is no room for additional or new spending,” said Lewis K. Uhler, president of the National Tax-Limitation Committee.

Uhler and his anti-tax counterparts gathered in front of state Treasurer Phil Angelides’ office as they called on state officials to balance California’s next budget by cutting spending, not hiking taxes, raising fees or borrowing.

But those options are being debated.

Peace said he has talked with Angelides about borrowing to help the state through anticipated rough times given current extraordinarily low interest rates.

“Short-term rates are so low right now,” Peace said. “We’ve got a window of time here.”

California’s ability to borrow, however, may be compromised by another aspect of its current budget conundrum: the financial fallout from the state’s energy crisis, which threatens to make the looming budget problem a full-blown catastrophe.

To avert blackouts, California spent more than $6 billion from the budget this year on emergency electricity purchases after the state’s private utilities ran into debt and became unable to supply their customers.

Davis and the Legislature planned to repay the treasury for the power purchases through a record $12.5-billion bond issue, which customers of the private utilities would pay off as part of their power bills.

But the bond sale, which was initially scheduled to occur as early as last spring, has been delayed again and again, and now is not expected to take place until next year. The state Public Utilities Commission voted down Davis’ plan last week; that has placed the future of the financing in limbo.

If the bond deal is delayed much longer--and the hole that energy purchases left in the budget remains unfilled--Angelides has warned, the state’s deficit could swell to $9.3 billion by next summer.

And that projection, he noted, was based on earlier economic forecasts, before the Sept. 11 attacks dealt a blow to the economy. If state revenues take a hit, as early indications suggest, the deficit could surpass $10 billion, Angelides said.

Other elements of the state’s response to the energy crisis could also add to California’s fiscal problems. The state borrowed $4.3 billion to hold it over until the bonds were sold. The loan was supposed to be repaid by the bonds.

But now that the bond deal has encountered problems, the state is in jeopardy of defaulting on the massive loan. If it does, it would have to pay an estimated $250,000 a day in extra interest and risk having its credit rating drop if it defaults.

“If we can’t issue the bonds--and right now, the prospects are pretty bleak--we’ve got a real problem,” said Gibson, the state’s chief economist. “Everyone is talking about the next budget year, but we could even be facing problems this year if we don’t take care of that soon.”

Although tourism and retail sales have been hurt by a weak economy and the terrorist strikes, Gibson said it is the effect on the stock market--and the stock option tax revenue that has filled state coffers in recent years--that worries him most.

An astounding 23% of California’s general fund came from taxes on stock options and capital gains last year as the Silicon Valley dot-com boom caused an economic ripple effect that lifted the entire state.

This year, state economists had already predicted a serious decline in the dot-com windfall, from $18 billion to $12.4 billion, or down to 16% of the general fund.

But now it looks as if revenues will fall far shorter, because the softening economy and the aftermath of the terrorism have caused the Nasdaq composite index to drop so significantly that the stock of many California technology companies is too low for anyone to exercise stock options right now, Gibson said.

Moody’s Investors Service, which warned last week that it may downgrade California’s credit rating in the aftermath of Sept. 11 and the energy mess, cited the state’s heavy dependence on stock option tax money as a major cause for concern.

The Wall Street rating agency is worried that California’s $2.6-billion reserve is not sufficient to cover the decline in stock and capital gains money it now foresees.

The start on Sunday of what could be a lengthy U.S. military campaign against terrorism makes the state’s financial forecast even more difficult to predict, Moody’s analyst Raymond Murphy said.

“It’s one thing to determine the impact of a onetime shock on the economy like the Sept. 11 attacks, but it’s really hard to determine the impact of a prolonged event like the [military] response to the attacks,” Murphy said. “It adds to the uncertainty.”

Measures by the federal government to stimulate the economy could eventually lead the stock market to regain some of its strength. And Gibson expects the government’s response to the terrorist strikes will result in increased military spending, which should benefit California.

But his short-term outlook is not positive.

Gibson, who has predicted trends for the state for 15 years, wanted to make one thing clear: The current budget problem, though severe, cannot yet be compared to what occurred in the early 1990s.

At that time, the state’s biggest industry, aerospace, was moving many jobs out of California. It was a major economic change that led the industry’s employment base to decline 60% from its former peak of 380,000 jobs.

Faced with a $14.3-billion deficit in 1991, then-Gov. Pete Wilson cooked up a painful and politically unpopular response, which combined billions in tax and fee increases with deep spending reductions that touched many of the state’s neediest residents.

Tax increases may be particularly hard to push through right now, however, with state elections fast approaching.

“Any governor would be loath to raise taxes, particularly in an election year,” Davis spokeswoman Hilary McLean said. “We’re probably going to be looking at trimming, borrowing and other types of cost savings.”

Former Los Angeles Mayor Richard Riordan, the leading Republican challenger to Davis, last week warned that this year’s shortfall could reach $20 billion, but then quickly reversed himself and admitted that he had no firm basis for that number. Regardless of the actual size of the shortfall, Riordan declined to say what he would do about it.

Unlike Davis, many lawmakers are nicely positioned to weather the heat of a tax boost, thanks to recently redrawn district boundaries that placed them in safer seats because they include more registered voters from their parties, said GOP strategist Allan Hoffenblum.

Assembly Speaker Bob Hertzberg (D-Sherman Oaks) has assembled a task force to examine the impact of the terrorist strikes on the state’s public safety and economic well-being. He said last week that lawmakers may need to revise the spending plan for the year as they struggle to deal with the aftermath of the attacks.

For his part, Davis has announced a $5-million campaign to entice Californians to vacation within the state in a bid to jump-start the tourism industry.

As a candidate for statewide office, Davis does not enjoy the luxury of a safe seat or a comfortable district, Hoffenblum said.

“Unfortunately for Gray Davis, they can’t gerrymander the state of California,” Hoffenblum said. “He will have to face this budget crisis going into the election, unlike [former Gov.] Pete Wilson, who faced it coming out of one.”