Schwarzenegger to set stage for huge battle over budget

By Dan Walters -- Bee Columnist

Published 2:15 a.m. PST Monday, January 5, 2004

The story is a familiar one in the world of corporate finance: A company expands production and payrolls, taking on massive new debt, as executives strive for market domination, then gets trapped in a severe cost-revenue squeeze when sales flatten out.

Unwilling to prune costs -- and thus admit their error -- executives conceal liabilities with bookkeeping gimmicks and issue rosy forecasts to keep their stock prices from plunging, but the house of cards collapses amid a flurry of finger-pointing.

We've seen it dozens of times, from Enron to Parmalat. And it's what happened to the state of California, which expanded spending by $8 billion a year in 2000 after receiving a one-year windfall of income tax revenues and has been running up debts, some of them concealed, ever since to cover its deficits. Voters ousted Gray Davis, the governor who presided over this debacle, and elected actor Arnold Schwarzenegger on his promise to clean up the mess in Sacramento.

"We knew this was going to be bad, but the fact is, it's staggering," Schwarzenegger's finance director, Donna Arduin, told legislators shortly after his inauguration. "It's staggering not only because of the magnitude but because of the cost thrown into future years."

She said that without decisive action, California would be in the hole by a mind-boggling $62 billion in three more years.

The basic facts of California's budget dilemma are not in dispute: The state has run up $25 billion in debts during the three years that followed 2000's spending spree. The debts, both acknowledged and indirect, are now coming due, and the operating deficit is widening. California's 2004-05 budget would have had about a $10 billion deficit had Schwarzenegger not reinstated a $4 billion-plus reduction in the property taxes Californians pay on their cars, and then unilaterally ordered the reimbursement of local governments for the lost revenues. So it's now $14 billion, even with an improving economy.

Ideologically polarized legislators see the crisis as an opportunity to score points. Democrats believe that the deficit is so large, and the affected spending interest groups so powerful, Schwarzenegger will be compelled to raise taxes, despite his constant pledges to the contrary. Republicans believe, meanwhile, that the deficit will compel Democrats to slash health and welfare programs or see the state's credit rating, already the lowest in the nation, downgraded further to the point of making the state's bonds and other borrowings unmarketable junk.

Schwarzenegger will unveil his 2004-05 budget Friday -- after giving clues to its content in Tuesday's State of the State address -- and it promises to touch off a months-long battle in the Capitol. Aides insist it will put California's financial house in order without new taxes and will break new ground, casting aside some of the Capitol's unwritten rules of budget-writing.

Clearly, Schwarzenegger will have to be audacious if he is to meet his self-proclaimed goal of balancing the budget without new taxes. Those close to the administration talk about the state equivalent of a lender-imposed corporate workout plan -- a kind of informal bankruptcy -- and using the crisis to marshal public opinion in favor of challenging the status quo. "It gives you the liberty to do creative and necessary things you wouldn't otherwise do," said one.

What kind of things? Schwarzenegger may be poised to take on the state's powerful public employee unions, for one. By signaling a willingness to release some nonviolent prison inmates, he may be telling the California Correctional Peace Officers Association that it will face massive layoffs of dues-paying members if it's not willing to renegotiate the fat contract that Davis gave the union. And if the omnipotent CCPOA caved, other unions would surely follow. There's talk about reconfiguring support for colleges and universities to make affluent families pay more because the state's collegiate fees remain among the lowest in the nation despite the budget crisis.

With a Legislature still dominated by pro-spending liberal Democrats, any plan that balances the budget -- even over several years -- without new taxes will touch off a major political battle. And Schwarzenegger seems poised to do that.

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