Governor-elect faces tough budget struggle

October 15, 2003

San Jose Mercury News

By Laura Kurtzman and Ann E. Marimow

When he takes office, Gov.-elect Arnold Schwarzenegger will face the very same problem that flummoxed Gray Davis: an immense budget gap that could reach $25 billion.

During the campaign, Schwarzenegger refused to lay out a detailed plan. But he swore off tax increases, while pledging to protect education, which accounts for half the budget. That boxed him into a very tight corner. His difficulties may be compounded by court challenges that could unravel the borrowing schemes the Legislature enacted over the summer.

Schwarzenegger's credibility as a governor hinges on how well he tackles the budget crisis, which has bedeviled California for the past two years.

``I don't see that he has a magic wand,'' said Stephen Levy, director of the Center for the Continuing Study of the California Economy. ``He has to go through the various things that he thinks he can do and find out what the reality is after he's been governor a while.''

The problem is so large that Schwarzenegger may have no choice but to put a bond issue on the ballot and hope his popularity will win voter approval.

The governor-elect stoked rumors that he will do that when he said Thursday, ``I think the people should make the decision. I will let you know whether we go down that road.''

$8 billion -- at least

Schwarzenegger will inherit a shortfall of at least $8 billion next year, unless tax revenues increase dramatically.

On top of that, the $12.6 billion the state plans to borrow to cover the accumulated deficit and pension payments is at risk. Taxpayer groups have challenged both in court.

What's more, Schwarzenegger has promised to repeal the car-tax increase, which would add an additional $4.2 billion to the deficit.

Schwarzenegger, who has been adamant about not raising taxes, has not said what programs he would be willing to cut, although the campaign has compiled a list of cuts that ``add up to the billions,'' according to Joel Fox, the former head of the Howard Jarvis Taxpayers Association who served as an adviser to Schwarzenegger during the recall campaign.

Fox said K-12 education was spared, which means the cuts would have to come out of the health and welfare programs that serve the poor.

But the new governor may have some advantages his predecessor lacked. He will have new authority to make reductions to state agencies of up to 5 percent to cover unanticipated expenses in other areas of state government. And the economy is showing signs of improvement.

Already, California has taken in an estimated $500 million more in tax revenue than expected in the first three months of the fiscal year.

But Ed Leamer of the UCLA Anderson Forecast cautioned that while retail sales in California have been strong, he does not expect the economy to get up enough speed to eliminate the deficit for several years.

``It will be tight times and tough decisions for at least five years,'' he said.

Leamer, who served on Schwarzenegger's economic-recovery council, said California's lousy credit rating -- which plummeted during the budget crisis to close to junk-bond status -- cannot be repaired without a multi-year plan to reduce spending and temporarily raise taxes.

Republican consultant Dan Schnur said he doubted it would be politically possible for Schwarzenegger to go back on his pledge not to raise taxes unless there is an emergency. Schwarzenegger is indebted to conservative Republicans, who provided half of his votes. Almost two-thirds of those who voted for him believe the budget deficit can be fixed without tax increases, according to an exit poll.

Schnur said Schwarzenegger will face a tremendous challenge if the state's shortfall grows. ``If the deficit goes from $8 billion to $20 billion, I don't know what that means,'' he said.

Borrowing an option

Fox said the new governor would not borrow as a first resort.

``It's a tool,'' he said. ``No one's reaching for it. We know it exists.''

But others surmised it was only a matter of time before Schwarzenegger turned to voters for help. ``I'm willing to bet my mortgage they go to the people,'' said Davis' finance director, Steve Peace.

William Bagley, a former Republican assemblyman, said using bonds to pay operating expenses was a bad idea. ``It does prevent a tax increase, but you're asking my grandchildren to pay for today's day-to-day operation,'' he said. ``It's doable, but it's not good government.''

Schwarzenegger took his first step toward a concrete proposal this week, hiring Donna Arduin, the Florida finance director, to audit state finances and identify wasteful government programs to cut.

He also has said he would seek $2 billion from Indian tribes with casinos and reimbursements from the federal government for state spending on immigration and homeland security.

But to do it, Schwarzenegger would have to succeed where others have failed.

The tribes already have 20-year compacts that they would have to reopen only if they wanted new slot machines. Getting new federal money could be even more complicated.

The morning after the election, Schwarzenegger said he would ask President Bush ``for a lot, a lot of favors.''

The Davis administration acknowledges that a Republican White House might be more inclined to smile upon a fellow Republican, especially in an electoral-vote-rich state like California.

But the pot of money is limited and largely controlled by Congress, where the state already has powerful advocates like Rep. David Dreier, R-Glendora, and Sen. Dianne Feinstein.

Help unlikely

California and other states have been fighting for years for more federal money to cover the cost of incarcerating illegal immigrants convicted of felonies in state and county jails.

Last year, states lobbied for $650 million, 40 percent of which was to go to California. But, because of the federal budget deficit, less than half that was appropriated.

Friday, former Gov. Pete Wilson, who co-chaired Schwarzenegger's campaign, poured cold water on the idea of getting more money, telling CNN he wasn't optimistic about getting Congress to send more federal funds to California.