Schwarzenegger rolls the dice: risks high as he deals on budget.

By cutting a string of deals to close a $15 billion state budget gap, Gov. Arnold Schwarzenegger has become California's latest governor to take up high-stakes gambling.

The deals with teachers, university officials and local government leaders, along with a pending compact with state Indian tribes, could lop $4 billion to $5 billion off the 2004-05 deficit. But in exchange for up-front concessions from these groups, Schwarzenegger has committed to making up the billions in cuts in future years.

"Where do you pay that bill from?" asked Kim Rueben, public finance research fellow at the Public Policy Institute of California.

Schwarzenegger said the funds will come from surplus revenues generated by the "booming economy" that he's trying to stimulate with business climate reforms, and from a massive reorganization of state government.

"I'm trying to do both, stimulate the economy and be responsible fiscally," Schwarzenegger said at a press conference last week. "We are trying to manage the government, making sure we are smart about the way we spend money. At the same time, we will do everything to keep businesses here and make the economy boom."

But it's also a high-risk strategy, one employed with different results by two of his predecessors, Republican Pete Wilson and Democrat Gray Davis. If additional revenues or anticipated savings don't materialize, that could force more difficult choices in two years: Namely, the tax increases and Draconian cuts that look likely to be avoided this year.

Davis was recalled after the onset of the current budget crisis, in which the dot-bust caused state revenues to plummet. Combined with an economic slowdown, that meant revenues could no longer support pay and benefit raises granted to state workers and teachers when times were good.

When Wilson took office in 1991, he closed an initial multibillion-dollar deficit with 2equal parts cuts and tax increases. But as the recession deepened, he also resorted to fund shifting and borrowing. Wilson, too, took money from localities and promised to restore it, but never did. Over time, though, the gamble paid off as revenues from the high-tech boom began pouring into Sacramento coffers.

Muted criticism

The state Legislature is expected to go along with the governor's budget plan with minor tweaks, even though the Democratic majority is generally unhappy there are no tax increases.

Most vocal has been state Treasurer Phil Angelides, a Democrat who is gearing up for a gubernatorial run in 2006.

"It will take a revenue surge equivalent to the late 1990s--on the order of $10 billion a year or more--to have a balanced budget under the plan now being put forward by the governor," Angelides said. "And because his plan does nothing to tackle the structural deficit, that surge would have to hold for a sustained amount of time."

Others say the surpluses might not have to be quite so large. Still, they must be significantly more than the current-year estimate of $2.2 billion, $1.2 billion of which is due to a targeted, one-time tax amnesty program.

Administration officials plan a broader tax amnesty next year, but that too is only a onetime deal. Subsequent revenue gains would have to come from ongoing sources.

Angelides and other Democrats in the Legislature say tax increases and the closure of tax loopholes are necessary in addition to spending cuts.

But supporting tax hikes in an election year is risky for Democrats. Also, Schwarzenegger remains overwhelmingly popular in public opinion polls and his clout has been greatly enhanced with his March 2 initiative victories. And he has outmaneuvered them by going directly to the interest groups to cut deals, neutralizing a natural Democratic constituency.

"To make significant changes. Democrats would need to rally their supporters," said Jack Pitney, professor of government at Claremont McKenna College. "But when they sound the trumpet now, no one is going to answer because they've all signed off on these deals."

In early January, Schwarzenegger got the California Teachers Association to agree to forgo $2 billion in funding increases for K-12 education next year. Last week, he cut two deals: one with the state's higher education leaders that would save $660 million, and another with local governments that would net the state $1.3 billion. Still in the works is a multi-year compact for gaming revenues from Indian tribes.

If Democratic legislators begin to reopen all these deals and drag out the budget process, Schwarzenegger can tag them as obstructionist, said Sherry Bebitch Jeffe, professor of political science at the School of Policy, Planning and Development at the University of Southern California.

So while there has been some grumbling, the deals are expected to win legislative approval.

Future shocks

That puts off the toughest choices for future years. In the agreement reached last week with local governments, for example, starting with the 2006-07 budget year, the state must find a way to give back $1.3 billion a year.

And under the terms of the other two deals, the state can't go back to the education community for more funding cuts to close an ongoing structural budget deficit estimated at anywhere from $7 billion to $10 billion.

The big concern now is what will happen in 2006-07 when the provisions of these deals kick in. If the economic recovery doesn't generate at least $4 billion in surplus revenues each year to offset the loss of these diversions, it will force tough decisions on Schwarzenegger and legislators, right on the eve of a gubernatorial election.

"In essence, what the Governor has done is to craft a budget solution that on the surface looks fine, but puts everything over until 2006-07," said Assemblywoman Jackie Goldberg, D-Hollywood. "He's betting that we'll just grow out of this. And I don't know of anybody else who thinks that will happen."

On the other side of the ledger, Schwarzenegger is holding out the promise of several hundred million dollars, if not several billion, in savings from his government reorganization plan. Earlier this year, Schwarzenegger referred to this plan as "blowing up the boxes" of state government.

While the plan has been kept under wraps, some details leaked out last month. Among the provisions, several state departments would be dismantled, including the Business, Transportation and Housing Department. Also, up to 200 state boards and commissions, along with 1,500 political appointees, would be eliminated.

Schwarzenegger has officially booked about $150 million in first-year savings from this reorganization plan. But that's considered a conservative estimate, according to news reports quoting those working on the plan, and that savings would grow in future years as the plan is fully implemented.

Also part of the plan: not filling a sizeable portion of the positions that will open up when an estimated 71,000 state workers retire in the next five years.

The government reorganization plan was initially scheduled for presentation to the Legislature next month for passage this year. But preliminary discussions with Capitol insiders revealed stiff resistance. Also, it was felt that dumping the plan on the Legislature at the same time it was considering Schwarzenegger's first budget would be overwhelming.

As a result, Schwarzenegger has pulled the plan back, now promising to introduce it into the Legislature next January or February. A tough fight is expected as various agencies fight to protect their turf; many expect a severely watered down version to emerge before it passes.

That leaves both major underpinnings of Schwarzenegger's long-term budget approach on shaky ground, especially since the state's revenue stream is notoriously volatile.

"Every budget is a gamble. It's just that this one appears to involve a few more 'Hail Marys,' Pitney said. "He's going to need a good deal of luck here."