Schwarzenegger's budget likely to rely on deep cuts.

This week, Gov. Arnold Schwarzenegger meets the critics.

Faced with a deficit estimated at $12 billion to $14 billion, he releases his first budget--and it promises to be austere, with steep cuts likely in higher education, health and social services, transportation and corrections.

The cuts could be especially severe because many of the politically easy revenue generators in previous years--such as borrowing against billions of dollars in tobacco company settlement dollars--have been used up or are off the table.

Any proposal to eliminate services is likely to be opposed by the Democratic-controlled Legislature and the various special interests bearing the brunt of the cutbacks.

And this year, it's not just about a budget--there's also a $15 billion bond measure on the March 2 ballot that would allow the state to pay off its mountainous deficit. If voters turn down the bond and the courts reject the state's attempt to borrow $11 billion in deficit financing bonds, the deficit will balloon to $25 billion or more.

That would leave a cash crunch towards the close of the fiscal year in June and force billions in emergency borrowing--resulting in far more dramatic cuts, and perhaps. the consideration of tax increases, for the 2004-05 fiscal year, which begins on July 1.

"You simply cannot underestimate the magnitude of the problem that the governor faces here," said Dan Carson, director of the health section of the office of state Legislative Analyst Elizabeth Hill. "A structural imbalance of $13 billion to $14 billion out of an $80 billion general fund budget is a very significant amount."

The one bright spot is the recovering economy. Last month, Schwarzenegger announced that the state can expect $1.8 billion more in revenues from businesses and capital gains taxes than originally forecast when the 200304 budget was passed in July.

In his Jan. 10 budget, Schwarzenegger will have updated projections and, given the robust economic growth rates and stock market performance of the last few months, it is expected that more revenues will come in than anticipated just four weeks ago, perhaps up to $1 billion. If so, half of the additional revenues would go to K-14 education as dictated by Proposition 98; the rest could go to shrink the deficit.

But this would do little to ease the difficult choices that lie 'ahead. Assuming he sticks to his campaign promise of not raising taxes, Schwarzenegger must still rely on billions of dollars in cuts to close the deficit.

Program cuts

He has already made $2.2 billion in cuts for the current fiscal year, which ends on June 30. The biggest of these--$890 million--came in transportation programs, including $189 million in congestion relief funds earmarked for local roads and highways.

Health services initially took a $211 million hit, but a court ruling, which stayed implementation of $161 million of these, determined that the state had no authority to cut reimbursements to Medi-Cal service providers. Another $137 million was cut from social service programs, including $44 million in welfare payments.

Finally, Schwarzenegger cut $1 l0 million from higher education funds to the University of California and California State University systems.

"If you want to know where the cuts are going to be in 2004-05, these mid-year cuts are a good indicator of the governor's priorities," said Carson.

According to Schwarzenegger's mid-year spending reduction proposals, about $1.4 billion in cuts carry over into the 2004-05 budget year, including $180 million in welfare payments.

"He has already indicated there will likely be deep cuts to health and social service programs." said Jean Ross, executive director of the California Budget Project. "That means cuts to programs for the elderly, the disabled, children who would otherwise be eligible for the Healthy Families program, among others."

The Sacramento Bee reported last week that deep cuts are likely in the state's prison and corrections system, including the early release of thousands of inmates serving sentences for non-violent crimes and a revamping of the state's parole system.

Governors in other states facing budget shortfalls have taken similar measures over the last couple of years, although former Gov. Gray Davis had resisted. As a Democrat, he would likely have come in for criticism for being soft on crime, but the Republican Schwarzenegger might have more leeway.

Local threat

Another imponderable is local governments.

On Dec. 18, Schwarzenegger declared a fiscal emergency and unilaterally refunded $2.6 billion to cities and counties to make up for the lost $4 billion when he rolled back an increase in vehicle license fees. But in making the announcement, which came after local officials had threatened to go to court over the lost funding, Schwarzenegger refused to say where the money was coming from. That, he said, will come this week with the release of the budget--and it is sure to raise hackles in the Legislature.

Local governments are not out of the woods, either. They won't get back any of the $1.4 billion lost last year when the vehicle license tee increase was repealed. And Legislative Analyst Elizabeth Hill said she didn't believe Schwarzenegger's emergency declaration would stand up to legal scrutiny. If the refund comes out of education or health and social service programs, advocates for those programs have spoken of a legal challenge.

Schwarzenegger also did not guarantee that cities would see a full refund of car tax dollars in the 2004-05 budget year.

"The governor has promised to keep cities whole and we are relieved about that," said Dwight Stenbakken, deputy executive director of the California League of Cities. "But there has been so much tip and down with this car tax over the last few months that we're just telling our folks to be very cautious about it and not to count on all their car tax funds for the coming budget year."

The real drama over the next six months will center on a new governor intent on change and a much-derided Legislature that shows few signs of capitulating to calls for massive cuts.

In an interview just before Schwarzenegger took office, Assembly Budget Committee chair Jenny Oropeza, D-Carson, said she did not believe the budget gap could be plugged without additional taxes.

"He has said he doesn't want to cut education," Oropeza said. "And I have to believe that as a caring person, he will not want to gut our health and social service budget. Now maybe they will come up with a silver bullet that I don't know about. But I've racked my brain for two years and I haven't found any."

How willing is Schwarzenegger to compromise? He already has made two concessions: the refund to local governments and restoration of cuts made in programs for the mentally disabled. On the latter, he admitted making a mistake.

Of course, if the governor does compromise on some of the cuts, the money will have to come from somewhere else--unless the rising economy pumps in enough additional dollars.

"We did our revenue projections a couple of months ago," Carson said. "'It could be that the picture is quite a bit better now. If that's the case, it will make things quite a bit easier for the governor, especially, when he's faced with all these conflicting demands."

Budget Woes

Gov. Arnold Schwarzenegger faces tough choices as he presents his budget to the state Legislature this week.

* Size of current general fund budget: $78 billion

* Projected budget deficit for fiscal year starting July 1: $12 billion to $14 billion

* Size of deficit if bond measures rejected by voters and/or courts: $23 billion to $25 billion

* Announced budget cuts that carry over into the next fiscal year: $1.4 billion

* Projected revenue boost from recovering economy since July forecast: $1.8 billion to $2.8 billion

* Gap in revenues to local governments after car tax rollback and Schwarzenegger backfill: $1.4 billion

Sources: California Department of Finance, Legislative Analyst's Office