Plan Pays Off $10.7-Billion Debt in a Maze of Financial Transfers

The Legislature’s budget plan to pay off $10.7 billion still owed on last year’s state government bills involves a tortuous series of financial transfers that’s as tricky to follow as a game of three-card monte.

Legislators devised the scheme in a budget compromise that would solve several problems at once. It would pay off the state’s debt without raising new taxes, meeting a demand of Republicans. At the same time, it would answer the Democrats’ contention that Wall Street would deny the state credit without a dedicated tax increase.

The solution is to take the money from city and county sales taxes. But to keep the local governments whole, the money would be replaced through zigzag transactions that ultimately would require lawmakers to reduce some state services.

Despite language in the state legislation guaranteeing that every dollar taken from local government would be reimbursed, local officials are skeptical, said Dwight Stenbakken, legislative director for the League of California Cities.

“The history of the state getting control over local taxes is not a good one,” Stenbakken said.

“Our folks see this as just another promise by the governor and the Legislature to set up this scheme. It’s only as good as the next financial problem the state is going to run into.”

Supporters of the plan said it wouldn’t actually raise the risk to local governments because state law already gives the Legislature the power to tap their resources in a budget crisis.

If the plan is adopted, the state would borrow the money on Wall Street and pay off the loan over five years.

To relieve Wall Street’s jitters over the health of the state’s finances, the debt would be repaid out of a dedicated fund that has its own source of tax revenue, independent of the state’s general fund.

The Legislature proposes taking back half of a 1-cent sales tax it enacted on behalf of local government in the 1970s.

That would equal about $2.5 billion a year, enough to pay off the loan plus interest in five years.

Using its authority to allocate local property taxes, the state would allow cities and counties to recoup their losses by dipping into property taxes that now go to schools.

But because school funding is guaranteed in the California Constitution under Proposition 98, the state would have to reimburse local school districts for their property tax losses.

That money would come out of the general fund, the state’s operating budget.

The $2.5-billion repayment to the schools would thus come out of services that have been financed by the general fund.

Because that amount is buried among the proposed budget’s $7.9 billion in cuts, no one can say specifically which programs would be lopped to pay off the debt.

Critics of the plan contend that the state could have accomplished the same result more simply by reducing its portion of the sales tax and reinstating it to pay off the debt.

Those who drafted the plan defend its complications as a reasonable response to concerns raised by Atty. Gen. Bill Lockyer.

Any state sales tax would not be sufficiently independent to make it immune from claims by other state functions, Lockyer told legislators.

Thus it would fail to meet Wall Street’s condition of a dedicated fund.

*

(BEGIN TEXT OF INFOBOX)

Following the budget tax swap

The budget approved by the Assembly on Tuesday proposes a multi-stepped tax swap to pay off last year’s $10.7-billion shortfall in five annual installments of $2.3 billion. How filling the gap affects other government agencies and services:

* State needs to borrow $10.7 billion to pay last year’s bills.

* Wall Street lenders demand repayment through a dedicated tax source independent of state general fund.

* State takes $2.3 billion a year from cities’ and counties’ sales taxes, but promises to reimburse them dollar-for-dollar.

* Legislature authorizes cities and counties to repay themselves by taking a larger share of property taxes.

* School districts get less property tax money.

* Legislature dips into the general fund to maintain the constitutionally mandated funding of schools.

* Spending cut $2.3 billion annually until the loan is paid in five years.

Sources: California Legislative Analyst’s Office and Department of Finance; Researched by Times staff writer Doug Smith