BUDGET PICTURE BLACKER NEW AUDIT PREDICTS STEEPER SHORTFALL.

Byline: Harrison Sheppard Staff Writer

The state budget deficit for next year could be as high as $29 billion and would hit $62 billion within a few years if spending continues on its current path, according to preliminary results from an audit released Saturday by Governor-elect Arnold Schwarzenegger's new finance director.

The first findings in the audit by incoming Finance Director Donna Arduin were released just two days before Schwarzenegger is to be inaugurated California's 38th governor and illustrates the massive financial problems he will have to tackle in a short amount of time.

``We knew this was going to be bad, but the fact is that it's staggering,'' Arduin said in a conference call with reporters. ``The fiscal and financial problems the governor-elect is inheriting are breathtaking and time is running out to fix the problem.''

Schwarzenegger's initial budget proposal is due to the Legislature in mid-January. His first action in office after he is sworn in on Monday is expected to be repealing the increase in the vehicle license fee, while maintaining the $4 billion in payments to local cities that the fee increase provided.

The audit presents a number that is triple the official deficit estimate for the 2004-05 budget, but Arduin said it is not that different in actuality. She is using similar projections of state revenue and spending, but more conservative assumptions about factors such as legal challenges to an already-approved state borrowing plan and the incoming governor's plan to cut the car tax.

On Friday, state legislative analyst Elizabeth Hill released figures that said the deficit could be $10 billion next year.

But Arduin assumes, for example, the state will not be able to sell more than $10 billion in bonds, which are currently being challenged in court, and that Schwarzenegger will repeal the car-tax increase while maintaining payments to local cities. Arduin also did not account for the $2 billion in extra state tax revenue that Hill projected based on an improving economy.

One of the ways the governor-elect's team is looking to deal with the massive debt and operating deficit he is inheriting is borrowing funds through a voter-approved bond of more than $20 billion. His aides believe their plan would pass legal muster while the previous plan to sell bonds to balance the current year's deficit will not.

GOP political strategist Arnold Steinberg said voters might accept incurring such massive debt if Schwarzenegger can prove he is clamping down on future spending.

``I think the best way to sell that is combine it with spending limits, where the revenue beyond the spending limits goes to debt retirement,'' Steinberg said.

Schwarzenegger is currently working on a constitutional amendment to cap spending growth by tying it to the rate of inflation and population growth.

Repealing the car-tax increase was one of the chief promises Schwarzenegger made during the recall campaign, and it came as he was facing some doubt about his fiscal conservatism because one of his advisers, billionaire Warren Buffett, had suggested a need to raise property taxes. He was also facing a challenge from the right by state Sen. Tom McClintock, who had promised cutting the car tax would be one of his first moves in office.

Political analysts said Schwarzenegger's promise to repeal the car tax, as well as not raise other taxes except in case of natural disaster or terrorist attack, was highly popular with voters and helped boost his financially conservative credentials.

Arduin was first commissioned by Schwarzenegger to perform the audit a few days after the Oct. 7 election. At that time she was finance director to Florida Gov. Jeb Bush, who loaned her to Schwarzenegger to perform the audit. He later announced he was hiring her as his new finance director, one of his most important positions given the state's problems.

Among the findings in her audit, Arduin said the new governor is inheriting a total of nearly $25 billion in debt because of past decisions. She said the state is running out of room to borrow much more. If the courts do not allow the state to sell the deficit financing bonds that are currently being challenged, she said, ``the state wouldn't be able to pay its bills come June.''

Harrison Sheppard, [phone]

harrison.sheppard(at)dailynews.com