ANALYST: ARNOLD'S BUDGET FLAWED EXTRA REVENUES SHOULD GO TO REDUCING DEBT, NOT EXPANDING PROGRAMS.

Byline: Harrison Sheppard Sacramento Bureau

SACRAMENTO - Gov. Arnold Schwarzenegger's proposed $125.6 billion budget ``moves the state in the wrong direction'' by spending beyond California's means and extending long-term debt, the nonpartisan legislative analyst said Thursday.

In a strongly worded review likely to foreshadow a budget battle in the Legislature, the analyst's office said Schwarzenegger's plan also fails to account for a number of anticipated expenses that could total as much as $1 billion.

``Our bottom-line conclusion is we are concerned that the plan really puts the state on the wrong path in terms of its long-term goal of achieving fiscal balance,'' Elizabeth Hill said as she released the review.

``We're concerned that the unexpected revenue increases noted in the governor's plan are not being used to reduce our past borrowing debt, but instead we're ratcheting up ongoing spending by about $2 billion.''

The 2006-07 plan unveiled Tuesday by Schwarzenegger - up 7 percent from the current year - built on a surging economy to increase spending on everything from education to transportation. It was lauded by the governor as putting the state ``on the path of fiscal responsibility.''

The plan would not increase taxes but would cut funding for some welfare and health services.

But Hill said the governor's budget fails to account for more than $600 million in potential costs, including $460 million for a pending court case related to cost-of-living adjustments in the CalWORKS grants program and contracts with 18 collective bargaining units expected to be negotiated this year.

Hill said she agrees with the administration's revenue forecast - and recent receipts indicate it may even end up higher - but she disagrees with how the windfall should be spent.

Much of the new revenue is from volatile sources such as business profits and capital gains. The one-time revenues should be used to reduce the deficit, not expand ongoing programs, she said.

A similar situation occurred in 2000, Hill noted, when the state used booming revenues from dot-com capital gains and stock options to expand existing programs - then found itself in trouble when the stock market tanked.

Schwarzenegger administration officials defended the plan Thursday, saying the extra spending is important to Californians and makes up only a relatively small part of the budget.

Finance Department spokesman H.D. Palmer noted that of the $2 billion in new spending that Hill criticizes, $1.7 billion is to repay schools for borrowed Proposition 98 funds, an issue that was the subject of vocal criticism last year.

The rest of the new funding would be for programs such as additional disaster preparedness - including flu pandemic preparations and threats to the state's food and agricultural industries.

He said the administration has made progress in reducing the 2006-07 structural deficit since taking office, when it was projected at $16.5 billion.

It now is $6.3 billion - or $4.7 billion if certain one-time expenditures like early payment of money owed to transportation funds are excluded.

``The governor's budget represents clear and continuing progress in reducing our budget problems in the future years,'' Palmer said.

The CalWORKS suit, he added, remains pending, and the state can't write a budget based on assumptions about every pending lawsuit it faces.

He also said the state doesn't budget in advance for collective bargaining increases because that would give the unions an edge in negotiations.

Still, Assemblyman John Laird, D-Santa Cruz, chairman of the Assembly Budget Committee, said Hill's statement ``was as strong as I've seen.''

He said it appears clear that the governor has had to break some promises he made while running for office in 2003 to balance the budget and protect education funding.

``Earlier this week, (Schwarzenegger) said it was a lot tougher to balance the budget than he ever thought,'' Laird noted. ``This is what we're seeing in these numbers.''

Laird said he agrees with Hill in that he would like the state to make more progress in reducing the deficit.

Legislative Republicans have also been concerned that Schwarzenegger has not done enough to reduce the state's spending deficit.

``Assembly Republicans agree with the analyst's conclusion that we must get serious about eliminating California's structural budget deficit before we will truly be able to plan for our state's infrastructure future,'' Assembly Budget Committee Vice Chairman Rick Keene, R-Chico, said in a written statement.

``However, the growing structural deficit should not be seen as an excuse to raise taxes on our state's already overburdened taxpayers.''

Harrison Sheppard, [phone]

harrison.sheppard(at)dailynews.com