Davis Budget Can Solve Crisis but Is Far From Perfect, Analyst Says

California’s nonpartisan legislative analyst confirmed Wednesday that the budget submitted by Gov. Gray Davis could resolve the state fiscal crisis, but she also laid out an extensive menu of alternative cuts and tax hikes for lawmakers to consider.

Davis applauded the report from Legislative Analyst Elizabeth Hill, saying that it validates the plan he offered in January to close what he describes as a $34.6-billion shortfall over the coming 17 months.

But Hill was critical of key parts of Davis’ approach, and lawmakers immediately seized alternatives that supported their own views.

“She’s got a lot of ideas that are good,” said Senate President Pro Tem John Burton (D-San Francisco), “which are the ones that agree with my thinking, and she’s got some that are bad, which are the ones I disagree with.... That’s the beauty of the [legislative analyst’s office]. They’re independent and they call the shots the way they see them.”

Hill urged the Legislature to “put everything on the table, including both program reductions and taxes.” Nowhere does she suggest that the “enormous” budget problem can be solved without raising some tax.

With the report, the stage is set for even more serious negotiations and compromises between the Democratic governor and both houses of the Legislature. Although Democrats hold majorities in the Assembly and Senate, they cannot act without some Republican support: The state Constitution requires that lawmakers approve any spending plan by a two-thirds vote. Davis cannot accept or veto any budget until it reaches his desk, which means that Republicans have significant sway over what is the most weighty legislation of any year.

Hill’s report credits the administration with presenting a fiscally sound proposal, and backs up the governor’s findings on the size of the budget gap, which critics had suggested he exaggerated. Now, Hill has provided lawmakers with ways to redraw the spending blueprint.

“The actions proposed by the governor reflect his priorities for dealing with the shortfall,” Hill wrote. “In evaluating and acting on these proposals, the Legislature will be confronted with applying its own priorities.”

Lawmakers appeared eager to take up the challenge.

“As complex as this issue is, at one level it is straightforward,” said Assemblyman Joe Simitian (D-Palo Alto), a Budget Committee member. “We need to cut expenditures, we need to increase revenues, and we need to do it sooner rather than later.”

Added Assemblyman John Campbell (R-Irvine), vice chairman of the lower house’s Budget Committee: “Clearly doing ‘nothing’ doesn’t work. We think it reinforces the urgency that we need to get on with the reductions that the administration proposed.”

Republican leaders, who have argued against any tax hikes, said they are determined not to follow the lead of Democrats if it means higher taxes for Californians.

Looking at specific programs, the report recommends that the Legislature consider cutting areas that are protected in the governor’s budget, such as the state prison system; Hill and her staff also noted that Davis preserved several big tax breaks for corporations, including a manufacturers’ credit that they say could be eliminated this year.

As legislators debate the full range of budget options, the legislative analyst suggests that many other new taxes and fees deserve consideration -- ranging from changes in the mortgage-interest deduction to an across-the-board income tax surcharge. The office also offers an alternative to Davis’ plans for shifting about $8 billion in programs away from the state and onto counties, along with the money to pay for them.

In December, Davis said the state’s budget hole had ballooned to nearly $35 billion through the spring of 2004. Hill released a report several weeks later declaring that the number was actually $26.1 billion, but most of the difference was the result of the governor’s including spending recommendations in his proposed budget and then cutting those same programs.

Those differences are still there, Hill said at a news conference Wednesday, but they do not affect what both the administration and her office agree will be needed in terms of savings to bring the state into the black.

She said the governor’s projections in that regard are only $1.3 billion different than hers. That relatively small difference is the result of the analyst having a more optimistic economic forecast for the second half of 2003 than the administration’s.

“Our forecast assumes that an earlier and stronger economic acceleration in California will produce more revenue growth in 2003-04 than the administration is anticipating,” Hill said.

But she warned that there are serious risks on the horizon, including the possibility of “a protracted war and an associated spike in oil prices, further weakness in the European and Asian economies ... and a further slump in the U.S. stock market (which would adversely impact U.S. consumer and business spending).”

She also maintained that Davis may be overstating the potential impact of money from Native American gambling. Davis’ proposed budget included $1.5 billion from Indian casino gambling, but Native American leaders and others have expressed doubt that the tribes and the state can strike agreements that will result in that money flowing to the state next year.

While agreeing on the broad scope of the problem, Hill suggested taking a different route to balancing the budget in several key areas. She also challenged some of Davis’ spending projections:

* Hill estimated, for instance, that the cost of several state government programs will be $273 million higher than the governor assumed. She said the cost of running the state’s prisons and the Healthy Families Program, which provides health insurance to children of the working poor, is likely to be higher than the administration projected. .

* Hill warned that Davis’ proposal to make the counties and courts responsible for $8 billion worth of programs now provided by the state may be problematic, although his plan includes tax increases to pay for it. She said that the new tax money probably wouldn’t fully fund the cost, and that counties are not equipped to take over some of the programs the governor proposes shifting to them, such as assistance to immigrants, long-term care and some food stamp administration.

But Hill agreed that the philosophy behind the shifts is sound. Her office suggested approving the transfer of most of the programs proposed by Davis to the counties, and adding another $4 billion worth of other programs where a shift could make sense, including adoptions, state welfare programs, adult parole and some juvenile justice services.

Analyzing Davis’ proposed tax hikes, Hill took issue with some of his recommendations.

Davis has called for increasing the sales tax by 1 cent on the dollar, hiking the personal income tax for high earners and adding $1.10 in tax to a pack of tobacco.

Hill said most studies have shown the sales tax to be “regressive,” meaning that it hits low-income earners hardest by consuming a larger share of their overall budget. While California households earning $30,000 or less may spend about 3% of their income on sales tax, wealthier families earning $100,000 or more spend only half that percentage, the report says.

According to Hill’s report, the personal income tax on high earners can be unreliable, as receipts go down with the economy. An alternative, she said, would be to put a 5% surcharge on the income tax of all Californians, which would raise $1.5 billion.

The report also suggests reducing the credits and exemptions many taxpayers are now given. Lowering the credit for dependents could raise $895 million, she said. Hill’s proposal would eliminate the deductibility of interest on home mortgages in excess of $500,000 on primary residences. It would completely eliminate the interest deduction on second homes. The mortgage-interest measures would boost state revenues by $220 million.

Hill also suggested the elimination of some tax breaks for big business.

Manufacturers, for instance, enjoy a tax break intended to help maintain a set number of manufacturing jobs in the state; eliminating that provision would raise $400 million, Hill said. A suspension of research and development credits could raise $770 million.

But gaining support for such moves would be difficult in the current legislative climate. Republicans have vowed to oppose any tax increases. They have specifically warned that piling more taxes on business would cost jobs.

Senate Republican Leader Jim Brulte of Rancho Cucamonga said his caucus has no plans to reverse course.

“We maintain our belief that we have to freeze state spending, do an across-the-board reduction in programs and enact spending caps so that no future governor or Legislature can spend us into bankruptcy,” he said.

One place where Hill proposed cuts to which Republicans and the governor are opposed is in the state prison system. She suggested that lawmakers may want to let certain nonviolent offenders out of prison early to save money.

She also proposed more “user fees” to pay for environmental programs, such as charging landowners $6 per acre for fire protection and increasing the taxes on pesticides to pay for regulation of them.

She did say that some higher education fee hikes the governor proposed are too steep.

Hill suggested that students in the University of California and California State University systems pay a 15% increase as opposed to the 25% in Davis’ plan. Hill said the governor’s proposed increase in community college fees from $11 to $24 a unit is reasonable, and should even be raised $1 more so certain low-income students would become eligible for more federal grants.

*

Times staff writer Gregg Jones contributed to this report.