Risk in State Borrowing

California’s state budget is more than precarious. It might even be fiction. Documents for Sacramento’s latest round of borrowing cautioned that revenue and spending assumptions “should not be construed as statements of fact.” Some will dismiss the phrase as legalese, but it wouldn’t be there if state officials were more certain about the financial future. Times are even worse now, with the state shouldering much of the cost of battling enormous wildfires.

As soon as Gov.-elect Arnold Schwarzenegger parks his Hummer after his mid- November swearing-in, he’ll face a $7.9-billion hole in the 2004-05 fiscal year. Two court cases that threaten key elements of this year’s shaky budget could turn next year’s gap into a chasm. At risk are borrowings that taxpayer groups say are illegal: $1.9 billion in bonds to pay current pension obligations and $10.7 billion in bonds simply to cover debt. If these are tossed out -- or if the court challenge stalls the state’s incredibly tight financing schedule -- the $7.9-billion deficit will swell to $20 billion. And that doesn’t include the self-inflicted $4-billion hole Schwarzenegger plans to create by rescinding the vehicle license fee hike.

Schwarzenegger also is said to be considering a bond issue that would consolidate the growing mountain of short-term debt. It’s a risky move, and not just because frustrated voters might say no. California traditionally has used bond issues to fund brick-and-mortar improvements, not saddle tomorrow’s taxpayers with yesterday’s debts. A debt-reduction bond issue could hurt the chances for two issues slated for the November 2004 ballot -- a $12.3-billion bond that would upgrade classrooms and build new schools and a $47.5-million bond that would fund high-speed rail. A report to be issued this week by state Treasurer Phil Angelides will show dramatic worsening in the state’s ratio of debt service (what it costs to repay outstanding debt) to general fund revenue (money available to pay off debt).

After a sobering meeting with Angelides recently, Schwarzenegger emerged to proclaim the budget situation “disastrous.” The next step for the governor-elect is to acknowledge -- quickly -- that borrowing and cutting aren’t enough, unless he plans to break his campaign promise to protect schools, public safety and health care.

Donna Arduin, the Florida state budget guru who will be Schwarzenegger’s finance chief, undoubtedly will find fat as she wields her ax, but not the billions needed to close the hole. Investors, meanwhile, are waiting for proof that California is serious about putting spending in line with revenue. A huge wave of borrowing only makes that harder unless there are new, temporary sources of revenue.

That means Sacramento must embrace serious structural reform, including some form of temporary tax increase. Schwarzenegger’s effectiveness depends on his ability to move a Legislature deadlocked between slash-and-burn and tax-and-spend. It will take his last ounce of star power to bring them together.