Amid Dire Warnings, State Again Misses Budget Deadline

SACRAMENTO -- Arguing furiously as the end of the fiscal year approached, California legislators failed yet again Monday to agree on a solution to California’s budget crisis, blowing through an important deadline after a day dominated by frustration and finger-pointing.

Afterward, leaders of the Assembly and Senate said there were no signs the impasse was about to lift. Both houses of the Legislature recessed hours before deadline Monday night, having taken no action on the budget.

“It’s an immovable object and an irresistible force, I guess,” said Senate President Pro Tem John Burton (D-San Francisco), his tie loosened after a floor session in which no progress was made. “It’s not happy and it’s not good and it’s not right, but it is.”

Because of that standoff, the midnight deadline for putting a new budget in place passed without one. By itself, that is not a new phenomenon in California. It has become fairly routine, in fact, in recent years. But new legal rules and the size of this year’s budget gap -- at $38 billion, it is larger than the entire annual spending of most states -- mean that this time, the Legislature’s failure to agree on a plan could have far more damaging consequences than in the past.

On Monday night, as the deadline approached, leading state Republicans released their latest idea, unveiling a proposal that backers say would close the budget gap without new taxes.

“This is a model that should serve as a blueprint for a final solution,” Assembly Republican Leader Dave Cox of Fair Oaks said at a news conference with two dozen Republicans behind him in a show of support.

The plan called for cutting elementary school education by more than $1 billion a year beyond the cuts that the Legislature has already approved. The savings would be achieved, in part, by delaying the age at which children begin kindergarten. About 110,000 children scheduled to begin classes in September would have to wait another year.

The University of California and the California State University also would be hard hit, each system losing about the equivalent of the money needed to run one of its largest campuses.

State prisons would be cut back by $450 million, which Republicans said could be achieved by improved efficiency but which Democrats said would result in the early release of 20,000 inmates.

Whatever else it might do, the proposal did not break the standoff over the state’s $38-billion shortfall. One Democrat, Assemblyman John Laird of Santa Cruz, called it a “compromise for people within the Republican caucus.”

Gov. Gray Davis was equally adamant.

“Let me be clear,” he said in a statement. “I will not sign a budget that slams the door shut on more than 100,000 kindergarten students. I will not sign a budget that denies opportunity to tens of thousands of deserving students who want to go to college.”

The proposal was not even voted on, though Assembly Speaker Herb Wesson (D-Culver City) said he would call a special session later this week to debate it.

Until legislators can agree on a budget -- so far, Republicans oppose any solution that requires new taxes, while Democrats insist on tax increases along with spending cuts -- California is poised to spend the summer in the midst of a rolling shutdown of state services and payments. That begins today, and if it goes much longer, many people could be affected:

* Some payments to schools, community colleges, state universities and the University of California would be cut off -- in some cases, as early as the end of July. Similarly, the state may be unable to pay suppliers of goods and services: everything from companies that supply state prisons with food to those that sell textbooks to schools. And if the logjam continues beyond August, two out of every three state workers could see their pay drop to the state minimum wage of $6.75 an hour.

* Counties, cities, school districts and other agencies are being forced to pass their own budgets without knowing whether the state will cut back on its payments to them later. For some, a short impasse would be manageable, but the implications could grow dire by late summer, when they will be well into the budget year.

* Wall Street analysts warn that California’s credit rating, already the lowest of any state in the nation, could fall again because of uncertainty about when legislators may act to correct the state’s deeply troubled finances. The threat of a recall campaign against Gov. Davis is adding to the insecurity among financial experts, who worry that the recall is hardening positions on both sides of the budget debate, making compromise more difficult.

* Failure to close the budget gap has led to extensive borrowing, driving up the amount the state must spend on interest and fees just to stay afloat financially. Delays only deepen that difficulty, which grows more dire by the week. At the present rate of spending, California could be out of cash by Labor Day.

“The state’s financial situation is very poor and it is deteriorating,” state Controller Steve Westly said last week. “The problem gets worse each day we go without a budget.”

“It’s a tragic place to be,” added state Finance Director Steve Peace. “Real people are going to be affected.”

Last summer, it took a record 67 days for the Legislature to pass and the governor to sign a budget for the fiscal year that ended Monday. Despite the length of that budget impasse, the state was able to pay many of its obligations.

But in early May, the state Supreme Court changed the ground rules governing who gets paid and who doesn’t in the absence of a budget. The court, in a unanimous decision, agreed with attorneys for the Howard Jarvis Taxpayers Assn. that there are limits to what the controller can pay without the specific spending authority contained in a budget bill or the state Constitution.

“Our target [in filing the lawsuit was] the policies of the state of California which reflect massive overspending,” said Jon Coupal, president of the taxpayers association. “It is regrettable there is going to be a lot of collateral damage.”

Westly said the Jarvis decision means he cannot pay community colleges, child development programs, highway expenditures, Cal-Grant scholarships, and non-payroll expenses for the Cal State and UC systems. The controller said he will follow tradition and not pay constitutional officers, state legislators and legislative staff until a budget is adopted.

The Jarvis decision allows the state to make certain payments to schools for debt service and mandated federal programs, such as welfare and Medi-Cal health insurance for the poor.

But California’s public schools could feel the pinch by the end of this month. That’s when the state would withhold about $200 million in so-called categorical funds that pay for special education, transportation, textbooks and other items. With no spending plan in place, the state would hold on to an additional $500 million in August and about $440 million in September.

School districts said they could weather the losses initially because most of their funding comes from a continuous stream of state general fund money. But a prolonged loss of the categorical funds might force districts to dip into their reserves -- or face the prospect of paring or eliminating programs that serve some of the poorest students.

Similarly, most of the state’s 72 community college districts would be able to make it through July and August without state payments by using borrowed money or drawing on reserves, said Robert Turnage, vice president of fiscal policy for the California Community Colleges.

But if the state misses its September payment “there will be real trouble,” Turnage said. Courses would probably be cut, and services such as counseling and libraries could be shut down for one or more days a week.

Overarching much of the debate is the court ruling in the Jarvis case. Chief Deputy Controller Walter Barnes said the court decision requires that 180,000 state employees who do not work overtime be paid only the state minimum wage of $6.75 an hour until a budget is in place. Among those who could find themselves making minimum wage are prison doctors, clerks, computer programmers, librarians, engineers, department managers and professors and staff of the Cal State system.

Because of the reprogramming needed to change the state’s payroll computers, the change is not likely to take effect until the September payroll.

Although the state borrowed $11 billion last month, most of it went to repay the previous year’s loans. After those payments, less than $5 billion was left to pay expenses during the summer.

That’s likely to be the last money that banks agree to lend California until it demonstrates its ability to agree on a budget, Westly said. “The state of California is at the end of its borrowing ability.”

Westly added: “We are rapidly running out of money. The lines cross the end of August or early September.”

Wall Street analysts warn that the state risks a further downgrade in its credit rating.

“The concern this time is the budget hole is much bigger” than in previous years, said David G. Hitchcock, director of state and local government ratings at Standard & Poor’s in New York. Hitchcock said the gap between California’s spending and its income is so large the state is going to have to continue borrowing in coming years “even if they make massive cuts and have a big tax increase.”

Ray Murphy, a senior credit officer at Moody’s Investors Service in New York, has assigned a negative outlook to California. The state’s failure to approve a budget on time was expected, “particularly in a year with such polarization,” he said. “There are so many significant items that require political consensus which we just haven’t seen to date.”

Murphy added that the recall campaign against Davis is “only complicating matters and adding to the uncertainty surrounding the state’s current state of affairs.”

Budget Director Peace said the Davis administration doesn’t know “at what point the rating agencies will take us below investment grade.” But if the state’s credit rating falls into the junk bond range, Peace is certain of one thing: “All of our future borrowing will be more expensive.”

For instance, the state last month borrowed $11 billion to repay last year’s short-term debt and cover cash needs during July and August. The new loan will cost taxpayers more than $210 million in interest and credit enhancement fees paid to seven banks and investment houses. The state’s credit rating is so poor that it paid almost $85 million to the banks to use their credit rating instead.

If the state’s rating drops two more notches to junk bond status, the cost of that loan will automatically increase by $55 million. And if California cannot repay the money when it is due next June, the interest rate on that borrowing will jump more than sixfold to a minimum of 7% a year.

Looming is the question of how the state will borrow $10.7 billion to cover the budget deficit in the fiscal year that just ended. Davis and Democratic legislators want to raise the state sales tax by a half-cent on the dollar. Republican leaders have refused to vote for any tax increase.

If approved as written, the temporary sales tax increase would be entirely devoted to paying off the deficit and would remain in effect until the deficit bonds are repaid in five years.

As those costs mount and troubles emerge, local officials are baffled and angered.

David Janssen, chief administrative officer for Los Angeles County, said state legislators show no interest in compromise to break the budget impasse. And yet, he said, “our political system requires compromise.”

Janssen said it looks like the state’s largest county government will be OK for several months. But if the impasse at the state Capitol lasts longer, “it gets pretty dicey.”

In addition to closely watching the state’s cash situation, Standard & Poor’s Hitchcock said, credit analysts will look at California counties on a case-by-case basis, particularly large urban counties and poor rural ones with high health-care and social welfare costs.

“All are very dependent on state aid,” he said. “Everybody is going to suffer a little bit.”

Times staff writers Peter Nicholas, Duke Helfand, Peter Hong and Nancy Vogel contributed to this report.