State Expert Says Budget Gap Will Outpace Revenue Growth

California’s economy has turned a corner but the billions in extra tax revenue will be dwarfed by a deficit that could reach $14 billion next year, Legislative Analyst Elizabeth Hill reported Friday.

In issuing the first cautiously optimistic economic assessment in more than two years, Hill stressed that spending still will outstrip revenues next year and urged lawmakers not to rely on borrowing to close the gap.

The state’s fiscal problems could be increased by $4 billion a year if Gov.-elect Arnold Schwarzenegger repeals an increase in the vehicle license fee, as he has pledged to do when he is sworn in Monday.

Money from that increase is distributed to counties and cities to finance public safety services; if those grants are to continue, the state would have to find another source for the $4 billion.

When the budget was passed in late summer, the projected deficit in the 2004-2005 budget was $8 billion. Hill said Friday that the state would collect about $2 billion more in taxes next year than had been expected, but that the deficit would still grow to $10 billion because other sources of revenue have not materialized and spending on prisons and Medical is higher than anticipated. Repealing the car-tax increase would bring the total deficit to $14 billion in the fiscal year that begins July 1.

The analyst was most optimistic about the long-term picture for the state, citing job growth that is expected to continue. Already, she said, the state expects to collect $2.2 billion more in taxes this fiscal year than it anticipated when the budget was passed in late summer. Income tax receipts -- the state’s largest source of revenue -- are running ahead of projections, in part because stock market gains have prompted some employees to cash in options. For the first time since the second half of 2001, personal income tax withholding has increased. Sales tax and corporate tax revenues are also up.

During the boom years of the late 1990s, the state increased spending substantially when income tax revenue surged. But after the stock market bubble burst in 2000, the state experienced an unprecedented plunge in tax receipts, and spending was never adjusted accordingly.

The state has closed the budget gap in recent years largely by relying on borrowing, and Schwarzenegger is expected to propose placing a $20-billion bond issue before voters next spring. The bond issue would cover the first-year loss of the license fee and billions in other pending state budget debt.

The incoming administration is releasing its own audit of the budget today. That review, aides say, will outline the scope of state fiscal problems but offer no solutions.

Hill, a nonpartisan financial expert widely respected in the Capitol, said lawmakers should cut programs -- or even raise taxes -- before considering the type of borrowing Schwarzenegger advisors are discussing. Voters would need to approve the bond issue in the March 2004 election for the money to be available in time to avoid a cash crisis in late June, the end of this fiscal year.

Hill said lawmakers should be skeptical of any such proposal because it would send the state down a “slippery slope,” saddling future taxpayers with significant costs to pay for past spending. With interest and fees, such a 30-year bond issue could cost taxpayers almost an additional $20 billion. “This type of borrowing has to be our last resort,” Hill said. “It fails to address the underlying problem the state of California is facing.”

That problem is the chronic imbalance between what the state spends and what it takes in. To address that, Schwarzenegger’s bond proposal is said to be linked to a cap that would keep spending more closely aligned with revenues each year. However, designing such a cap is complicated by other commitments, such as the dedication of money by law to education.

As of July 1, California had $27.6 billion in outstanding voter-approved general-obligation bond debt. State voters have already approved an additional $23.2 billion in bonds that have yet to be sold. In addition, the state has $14 billion in short-term cash flow loans that must be repaid by late June, the end of the fiscal year.

The $20-billion bond issue expected to be sought by Schwarzenegger would take debts that originally had been short-term and wrap them into a single long-term financing. Lawmakers would have to approve the bond offering by Dec. 5 to meet a deadline for putting measures on the March ballot.

Schwarzenegger spokesman H.D. Palmer agreed with Hill’s deficit estimate.

“The numbers released by the legislative analyst today served to confirm the bad news” that he said Schwarzenegger and incoming finance director Donna Arduin “have been learning on almost a daily basis as they have driven deeper into the state’s books.”

Palmer would not comment on whether Schwarzenegger would heed Hill’s advice on borrowing. But he said that as a result of actions taken by Gov. Gray Davis, Treasurer Phil Angelides and legislators, Schwarzenegger would inherit a “significant amount of long-term debt.”

Hill’s warning that the state should cut spending or raise taxes before borrowing more is consistent with the position she has held since the budget problems began a few years ago. Her warnings, however, have not been heeded by the Legislature and Davis, who have papered over the imbalance with borrowing and accounting shifts, allowing the deficit to grow steadily.