ARNOLD'S PLAN: THE MORNING AFTER DEFEAT IN LEGISLATURE COULD CREATE CASH CRUNCH.

Byline: David M. Drucker Sacramento Bureau

SACRAMENTO - With the Legislature's rejection of Gov. Arnold Schwarzenegger's $15 billion fiscal recovery plan, California state government faces a precarious financial situation in the coming months.

A lawsuit threatens the sale of a $10.7 billion deficit-financing bond passed by the Democratic-controlled legislature just before the recall election, and if successful, the state would run out of cash this June, rendering it unable to cover checks for state tax refunds, student grants and the hiring of teachers, among other consequences.

``Surgery has a side effect, but we don't abandon the patient,'' state Controller Steve Westly, who signs the state's checks and manages its cash flow, said Sunday through a spokesman in an apparent criticism of the Legislature's failure to act.

Westly, a Democrat, backed Schwarzenegger's proposal to refinance part of Sacramento's debt and implement a constitutional spending cap - a move intended to pre-empt future deficits like the $29 billion shortfall projected in 2004-05 - but Democratic legislators blocked the Republican governor's plan.

Schwarzenegger, to keep the treasury flush, guard against draconian budget cuts and honor his campaign promise to avoid tax increases, sought legislative approval to put his recovery plan before the voters on the March 2 presidential primary ballot.

Secretary of State Kevin Shelley has given no indication he would extend the Dec. 5 deadline for ballot measures, so Schwarzenegger is now pressing ahead with plans to put a more stringent limit before the voters next November.

``The administration will defend the existing $10.7 billion bond in court in the hopes that it will prevail. (And) the director of finance will look at a number of options to make sure the state has a cash flow,'' Schwarzenegger's communications director, Rob Stutzman, said after it was clear the governor's fiscal recovery plan was dead.

The Controller's Office confirmed Sunday that despite Westly's dire warnings, he will seek a short-term ``bridge loan,'' called a revenue anticipation warrant, so the state can pay its bills in June if the $10.7 billion bond cannot be sold. But an aide said ``it is too soon to tell'' if the state with a credit rating equivalent to junk-bond status would be able to secure such a loan.

State lawmakers have a history of predicting that Sacramento has finally reached the end of its fiscal rope, only to find one more tactic that enables them to avoid politically unpopular tax increases or budget cuts. Many legislators speculated after the 2002-03 fiscal-year budget was signed that the state had exhausted its supply of accounting gimmicks to paper over what was then a $25 billion deficit.

But this year, faced with a shortfall they pegged at $38 billion, legislators found more ways to skirt the tough choices needed to balance the state's books, including a switch in accounting methods that allowed the state to ``save'' almost $1 billion in MediCal costs, the state- subsidized health insurance system for the poor.

``There needs to be a more precise analysis of where the bucks are going, at the state and local level,'' said economist Steve Frates, a senior fellow at the Rose Institute of State and Local Government at Claremont McKenna College, adding it is otherwise impossible to know how bad things really are.

Frates said county costs for administering MediCal are way too high and only 40 percent of state education dollars get to the classroom because the money is tied up in grants that predetermine how it can be used. And public employee costs - particularly for retirement pensions - are excessive.

A court already has ruled a $1.9 billion bond measure was illegal because the state constitution requires certain borrowing to be approved by the voters, which was part of the governor's argument for a ballot measure.

He also sought a spending cap tying overall expenditure increases to the combined growth rate of population and per capita personal income, but Democrats, who have been thwarted by Republicans in seeking tax hikes, objected because it precluded their ability to fund the future expansion of government and codified the need for massive budget cuts in 2004-05, thus dooming the entire package.

``It's very difficult to limit spending growth when people are going to continue to get old, and go on those programs; when people are going to continue to get sick, and go on those programs; when people are going to continue to commit crimes, and go into prison,'' state Senate President Pro Tem John Burton of San Francisco, the Legislature's top Democrat, said in defending his position.

Schwarzenegger's response to losing the battle Friday was to cut spending in ways that do not require legislative approval, freezing unnecessary travel by state employees and halting the signing or extension of service contracts. His executive order applies to all state agencies, but not to the judicial and legislative branches of government or to the constitutional officers, ``although they are invited to participate.''

David M. Drucker, [phone]

david.drucker(at)dailybulletin.com