HIGH NOON GOVERNOR HOPEFUL OF BUDGET DEAL BY MIDDAY DEADLINE.

Byline: David M. Drucker Sacramento Bureau

SACRAMENTO - Facing a final deadline of noon today to strike a deal with the Legislature to put a fiscal recovery plan on the March 2 ballot, Gov. Arnold Schwarzenegger and legislative leaders inched to a compromise late Tuesday on a spending cap - the key sticking point to any deal.

After missing a Friday deadline set by the secretary of state, the Republican governor has met privately with Democratic and GOP legislators, who have said little about what has changed since talks collapsed last week even as the state's credit rating sank and funding for schools and local government were being put in jeopardy by the stalemate.

``I'm definitely more positive,'' Schwarzenegger said Tuesday night before participating in the annual lighting of the Capitol Christmas tree. ``We've moved closer together and now they're working on it to see if we can work out the details, because conceptually I think that we are pretty much in sync.''

Secretary of State Kevin Shelley, who had set last Friday's deadline for legislative approval to put the issue on the March 2 ballot, on Monday granted an extension that lasts until noon today, not midnight as originally understood.

Wall Street added pressure on the overtime negotiations with another downgrading of California's credit rating, putting it on par with various Third World nations and just above junk-bond status.

Blaming Schwarzenegger's popular decision to repeal the tripling of the car tax and the Legislature's failure to make up for the lost revenue by blocking his $15 billion debt consolidation and fiscal recovery plan, Moody's Investors Service reduced the state's credit score and jeopardized Sacramento's ability to borrow altogether.

``We are dangling above the abyss of junk-bond status. If we get there, not only will rates for borrowing go through the ceiling, but it will dramatically limit our ability to borrow, period,'' said state Controller Steve Westly, who manages the state's cash flow.

Although Westly is a Democrat, he has crossed state Treasurer Phil Angelides who has been harsh in his criticism of Schwarzenegger and some legislators of his own party who want tax hikes by supporting the Republican governor's plan to put the deficit-financing bond and constitutional spending cap up for voter approval in March.

The governor suggested in an interview with CNN that a temporary suspension of Proposition 98 - the voter-approved law that reserves 40 percent of general fund revenues for public education - could be in the offing for fiscal year 2004-05, but said the money would be paid back once the state's finances improve. He refused to comment further on it when asked by reporters.

Rob Stutzman, his communications director, noted there is a difference between limiting the growth of education spending and reducing it.

He said suspending Proposition 98, which would require legislative approval and is not part of his fiscal recovery plan now before lawmakers, would not be considered by Schwarzenegger as reneging on his promise to not cut education.

``Suspension doesn't mean less funding. It just may not grow as fast as it usually does,'' Stutzman said.

State Senate President Pro Tem John Burton, D-San Francisco, considered the key Democratic leader Schwarzenegger has to win over, emerged from an afternoon meeting with the governor in good spirits but without much to report in the way of progress.

Schwarzenegger wants to refinance the state's current debt - a move that would create $5 billion more in spendable cash over the next five years than if the bonds are not sold - and pay off the debt over a period of up to 30 years, although the length of the bond is likely to be shortened. Democrats worry about the interest cost and the fact that the loan payments would come directly from the general fund, which could affect spending for other programs.

But the deal-breaker is the spending cap.

Schwarzenegger wants to ensure that Sacramento ``never again'' accumulates deficits like the $29 billion shortfall projected for 2004-05 and the $38 billion gap that afflicted this year's budget before it was signed by former Democratic Gov. Gray Davis.

Schwarzenegger wants to limit growth to a formula dependent on population and per capita personal income, and allow spending to grow from a dollar amount based on current revenues - about $75 billion - which are lower than usual and would necessitate the need for significant budget cuts.

``What I told the governor, Day 1, is it's a very difficult task, there's a very short time frame,'' Burton said. ``But he wants to get something done, we want to get something done, and with the grace of God and the aid of a broomstick we'll do it.''

Analyst Ray Murphy said Wall Street's downgrading is based on the inability to balance the state's finances although the view is widely held that California's economy is vibrant, strong and full of potential.

Credit rating agencies simply want the state to balance its books, whether via tax hikes, budget cuts - or even passing Schwarzenegger's fiscal recovery plan.

``What we like to see is long-term structural balance,'' Murphy said by telephone from his New York office.

David M. Drucker, [phone]

david.drucker(at)dailybulletin.com