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Deficit Balloons to $10 Billion Amid Slowing Economy

Wed December 26, 2007 - West Edition

SACRAMENTO (AP) Four years after a fiscal crisis helped precipitate the recall of former Gov. Gray Davis, California once again faces a staggering budget shortfall that could force deep cuts in spending for schools, roads, health care and welfare programs.

This time the projected $10 billion shortfall, revealed Nov. 14, is not fallout from a dot-com bust but from the nation’s struggling housing and credit markets.

Tens of thousands of laid off construction workers and mortgage lenders are no longer paying income taxes. Slumping home sales are driving down sales tax-generating purchases of everything from lumber and cement to dryers and refrigerators. And millions more are delaying home equity loans that fuel big-ticket purchases like new cars.

While it would be normal for the troubled housing market to impact the state’s budget, economists say it wouldn’t be choking California so severely if Gov. Arnold Schwarzenegger and the Legislature had delivered on promises to keep state spending in check.

They say a large share of the blame for painful budget cuts to come rests with the governor and Legislature for letting spending balloon by 40 percent since Schwarzenegger took office.

“We never really fixed the problem. There were a lot of smoke and mirrors to make it look good but no fixes,” said Ryan Ratcliff, economist with the UCLA Anderson Forecast in Los Angeles.

When Schwarzenegger took office in 2003, the state’s deficit was predicted to peak at $16 billion, largely from shortfalls following the dot-com bust. He persuaded voters to approve bonds to cover the gap.

Soon, a windfall of tax revenue from a resurgent tech industry and a red-hot housing market allowed Schwarzenegger and the Legislature to ratchet up spending without finding a long-range cure for deficits.

Today, state expenses continue to outpace revenue.

H.D. Palmer, spokesman for Schwarzenegger’s finance department said it’s important to keep in mind that billions in spending increases have gone to pay off the bonds to cover previous debt, and that other new expenses are for infrastructure bonds to help rebuild the state.

“Are we in a tough spot? Yes, the governor’s said as much. It’s going to be a tough year,” Palmer said.

Davis declined to put too much blame on Schwarzenegger on Nov. 14.

“Every governor who serves more than just a couple of years will experience both the good and the bad that comes with our economy. There will be strong years when revenues are pouring in and there will be weak years when we are scratching to find every nickel,” he told the Sacramento Press Club.

California’s budget picture has deteriorated significantly since the summer, the Legislature’s budget analyst said.

Without immediate spending cuts or other fixes, the state’s $4.1 billion reserve will evaporate. California will be nearly $2 billion in the red by the time lawmakers vote on a new budget next summer, according to the analyst’s report.

In addition, the shortfall for the budget year that will begin next July has mushroomed by more than 50 percent, leading to the combined $10 billion shortfall for the two fiscal years. That’s more than the state spends for the University of California and California State University systems combined — about $7.2 billion for the current fiscal year.

The future looks equally grim, with multibillion-dollar deficits projected to spiral upward for the rest of the decade, Legislative Analyst Elizabeth Hill said.

Assemblyman Roger Niello, vice chairman of the Assembly Budget Committee, called the report a wake-up call for lawmakers.

Schwarzenegger directed state agencies to prepare for possible deep spending cuts.

He ordered state department heads to draft plans for a 10 percent across-the-board reduction. If enacted, it would be the largest round of budget cuts since Schwarzenegger took office after the 2003 recall.

The state had faced a projected $5 billion to $6 billion deficit in 2008. Schwarzenegger’s administration has in recent months warned that the continued housing slump and weakened credit markets could exacerbate that shortfall.

The latest housing data underscored the downward trend.

DataQuick Information Systems reported Nov. 14 that the number of new and resale homes sold in Southern California in October was the lowest since the company began keeping records in 1988. The region’s median home price fell 8 percent from October 2006, according to the La Jolla-based company.

The accelerating decline has caused potential buyers to wait before making a purchase, while severely tightened lending standards have eliminated many potential buyers from California’s high-priced housing market.

The plunge in home sales has correlated into an equally steep drop-off in state tax revenue because of lost jobs and purchases in the housing, construction and financial sectors.

The analyst said $2.7 billion of the state’s reserve fund will be eaten up by lower-than-expected tax revenue through next summer. The state will take an additional $1 billion hit on falling local property taxes from shrinking home prices. Additionally, the state must make up for lower property tax revenue so schools will remain fully funded.

Some analysts said the governor should have seen the problems coming sooner.

When Schwarzenegger signed the state’s overdue spending plan in August, he touted it as a balanced budget.

Even before then, however, turmoil in the housing and credit markets had begun biting into state tax revenue and threatening to make next year’s budget even worse.

“I have not made any final decisions yet, but it’s clear that the decisions that will be involved will be tough,” the governor said in a statement Nov. 14. “I have a constitutional requirement to submit a balanced budget to the Legislature in January, and I will fulfill that responsibility.”

He also said the revenue forecast should be an incentive for lawmakers to reform the state’s budgeting process. During last summer’s budget stalemate, Republican and Democratic legislative leaders said they were open to doing so.

Davis said he also hopes for reform. The governor and Legislature must “tackle this larger question of putting a spending limit before the voters so that we will have some stability, otherwise, no governor, governors yet unborn … will be dealing with the same problem we have today.”

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