State Lawmakers Find Way to Pare Budget Gap

Times Staff Writers

Lawmakers have struck a bipartisan deal to put a $3.6-billion patch over the state’s budget hole by borrowing from state pension funds and cutting government services.

Even as legislators reported progress, however, Gov. Gray Davis warned that a more comprehensive effort to close the rest of the state’s $35-billion budget gap cannot work without new taxes. That plan depends on additional state borrowing, and investment banking firms will not lend California more money without a new source of revenue dedicated to paying off bonds, Davis said.

The governor and top state officials, all Democrats, are focusing on a half-percent sales-tax increase as the revenue source.

Republicans dispute Davis’ claim and oppose a tax increase.

The agreement on the $3.6 billion, which is expected to be approved in both houses of the Legislature by Monday, is the first significant reduction in the state budget gap in two months. It comes one day after Republicans opened the door to agreement by conceding that spending cuts alone would not solve the impasse.

In exchange for their votes on the borrowing plan, Republicans negotiated about $1.8 billion in program cuts, some affecting spending in the current fiscal year, some reducing projected spending for the fiscal year beginning July 1. Included are a $328-million cut in K-12 education spending and $317 million in cuts to health-care programs.


Under the agreement, instead of using general fund money to make the yearly contribution to the state employees’ pension fund, the state would sell bonds to generate the required amount. That would require paying interest to bondholders in the years ahead, increasing the overall cost. But for this year, it would free up general fund money to help fill the budget gap.

The deal comes with no time to spare. If it is not approved by Monday, the state will lose out on more than a third of the expected savings because not enough time would exist to float the bonds before the first payments to the pension fund are due.

The pension bonds were originally proposed by Davis in January. But the nonpartisan legislative analyst’s office warned that they were bad fiscal policy, and Republicans said they would support them only if Democrats offered significant cuts to government programs in exchange.

“No one in our caucus likes” pension bonds, said Assembly Republican Leader Dave Cox of Fair Oaks, “but it’s something that we believe we can do and it’s the right thing to do. We were delighted that we were able to take this first step.”

Among the cuts that Republicans insisted upon is a change in Medi-Cal rules that will require recipients to file reports twice a year proving they are still eligible to receive subsidized health care. The move could result in tens of thousands of Californians losing their health insurance, according to statistics from the state Department of Finance.

Republicans say the reporting requirement is a responsible measure that will cut fraud in the system. Advocates for Medi-Cal patients call it an onerous requirement that will harm the poor.

The deal also includes deferring a $500-million payment to the benefits program for retired teachers, which will likely need to be made up sometime in the 2003-04 fiscal year.

Davis applauded lawmakers for moving forward on the budget as the June 15 constitutional deadline for legislators to approve a spending plan approaches.

“They are making good progress,” Davis said. “There are still many difficult decisions ahead of us. However, today’s action proves we can solve our problems if we are committed to bipartisanship.”

Consensus is building in the Capitol among both Republicans and Democrats that achieving a balanced budget will likely require borrowing as much as another $10 billion or more, in effect rolling a portion of the deficit into the future and paying it off over the next several years.

Davis insisted Wednesday that Wall Street investment bankers are telling him the state must raise taxes before they lend California that money.

Davis said he met with about 20 investment bankers on Monday and “to a person they said, ‘You cannot finance the deficit without a new revenue stream.’ They say you can’t do it without ensuring lenders that they’ll be repaid, and the only way to ensure them is to have a new, dedicated revenue source.”

Republican lawmakers balk at the idea of boosting taxes. They want to pledge part of the state’s existing sales tax to repay the new debt.

Cox promoted a Republican plan this week that called for borrowing $10 billion and paying it back over the next five years with no new taxes. “Californians need to know the truth, that their taxes do not in fact need to be raised,” he said.

Republicans believe Davis and his budget chief, Steve Peace, are overstating Wall Street’s desire for a tax increase as a prerequisite to more borrowing. They say they also have been talking to Wall Street bankers and have every indication that the borrowing would be an option as long as the state reins in spending.

Ray Murphy, senior credit officer for Moodys Investors Service in New York, said investors who lend money to the state by buying California bonds want “a certain level of comfort that they will be repaid.”

Murphy said he believes investors would be comfortable if the Legislature “carved out a piece of a very stable revenue source” and gave bondholders first claim on that money, as Republicans are proposing.

But administration officials say the firms that would lend the money tell them California needs to create a “clean” revenue stream that cannot be spent by the Legislature for anything but paying off debt. Such a revenue stream, they say, cannot be created from existing taxes because of constitutional constraints on that money.

Wall Street is particularly concerned about two constitutional provisions. One restricts rolling over debt without a vote of the people. The other, Proposition 98, requires that more than 40% of all general fund revenues goes to schools. Some fear that a legal battle will erupt if a new revenue source is not found.

“In order to make this thing airtight and foolproof, they are going to have to show an absolutely dedicated revenue flow,” said one source not connected with the governor or the Democratic leadership who is familiar with Wall Street’s concerns.

Officials from the investment banks will appear before the Republican and Democratic caucuses in the Legislature over the next 10 days to discuss how borrowing could work.

Lawmakers say they are waiting for the administration to release updated figures on tax revenues on May 14 before they make their next significant budget move.

The updated numbers, referred to as the May revise, “tell you how much money you have and how big the caseload growth has been,” in social service programs, said Senate President Pro Tem John Burton of San Francisco.

Trying to solve the budget shortfall without the latest figures “is like figuring out your budget without knowing what you’re paid or what your mortgage is,” Burton said.

Administration officials told lawmakers to brace for grim news. Early indications are that the numbers are at least $1 billion below original projections.


Times staff writers Gregg Jones, Nancy Vogel and Julie Tamaki contributed to this report.