Budget Deficit Widens as Revenues Fall Short

By HOWARD FINE
Staff Reporter

Despite encouraging signs earlier this year that the state budget deficit might be narrowing, the upcoming May revision will be worse than expected and could add another $2 billion to $3 billion worth of red ink in the upcoming fiscal year.

The additional shortfall, tacked onto the $14 billion projected in January, is likely to put more pressure on Gov. Arnold Schwarzenegger and state lawmakers to reach a budget deal this summer without requiring severe cuts in state services and the diversion of revenues from local governments.

The governor, acknowledging the challenges in recent interviews, even hinted that he might consider some sort of tax increase. But his comments have been vague and it's far from clear whether he's seriously considering what would create a thorny political problem with conservative Republicans.

In a last-ditch effort to avoid such difficult choices, the governor recently ordered state agencies to slice 3 percent from their budgets, on top of budget cuts outlined in January.

"There have been some developments since the January budget that have not pushed us in a forward direction," said H.D. Palmer, spokesman and deputy director at the state Department of Finance. "We have to take those into account and revise the budget blueprint."

One remaining wild card is the annual surge of income tax filings in the weeks following the April 15 tax deadline. Those filings typically account for up to 20 percent of state revenues, and they could offset some of the shortfall if the numbers are significantly above projections.

But income tax receipts from last July through this past February were running $393 million short of the Department of Finance's January projection, making such an infusion unlikely. Total tax revenues for that period were $623 million behind the Department of Finance's $47.3 billion projection.

For March, personal income tax figures are running about $200 million behind projections, according to Brad Williams, senior economist with the state Legislative Analyst's Office. Final March tax revenue figures are due out this week.

"We're definitely not looking for a boom, just a moderate year of growth for the state," said Joe Hurd, senior economist with the UCLA Anderson Forecast.

While last year's stock market run-up could bring in several billion dollars more in revenues from stock sales, Hurd said much of that has already been factored into the forecast.

"While the stock market was up, we have no idea how many people actually sold stock last year that would be reported on their tax returns," Hurd said. "If anything, I suspect the state may have overestimated this."

The one bright spot, Hurd said, is the sharp increase in U.S. jobs figures for March. That could yield a slight boost in withholding taxes over the next couple of months. California job figures for the month were due out late last week.

Legal setbacks

State budget officials have had to grapple with a number of unexpected events since January, each one estimated to cost the treasury hundreds of millions of dollars.

For starters, caseloads have been increasing faster than expected in several health and social service agencies, according to Palmer. In slow economic times, such an increase is typical, but sluggish job growth earlier this year exacerbated the situation.

One factor driving the caseload rise is that state and local governments have had to provide more services to those unable to land a job before their welfare or unemployment benefits ran out. Also, rising health care costs have forced many companies to drop or scale back health insurance, forcing hundreds of thousands of workers to seek government health care.

Several court rulings also will likely add to next year's deficit. The most significant involves a challenge to state corporate tax law from Torrance-based coffee-roast maker Farmer Bros. The company filed suit in the mid-1990s on grounds that the state was allowing deductions on dividends Farmer Bros. received from in-state companies, but not out-of-state companies.

In February, the U.S. Supreme Court declined to hear the case, letting stand a lower court ruling that invalidated this different treatment. State Legislative Analyst Elizabeth Hill said at the time that the ruling would require the state to refund up to $1.5 billion in taxes to corporations in the next several years.

Last week, Williams said that a "substantial portion" of these refunds would be doled out in the 2004-05 budget year.

Also in February, a San Francisco Superior Court judge ruled that the state erred in cutting cost-of-living increases in welfare-to-work grants as of Oct. 1 and must restore those COLAs. The state is appealing the decision, but if it stands, California must come up with an estimated $120 million a year.

Meanwhile, state legislators have been reluctant to make the $2 billion in current-year cuts to state programs that Schwarzenegger outlined in his January budget. So far, according to Palmer, only about $1 billion of those cuts have been made.

Under intense public pressure, legislators restored funding for certain heath and social service programs, most notably the Healthy Families program that provides medical care for children. At the time, it was hoped that a rise in state revenues would help offset this decision, but so far that hasn't happened.

If the rest of the cuts aren't made in the next several weeks, it would mean an additional $1 billion would carry over to the 2004-05 budget.

Local impact

The most immediate impacts are likely to fall on local governments, which had looked to reduce or even reverse Schwarzenegger's decision in January to divert $1.3 billion in local government property tax revenues to state coffers.

"This does make it much more difficult to reduce the $1.3 billion hit on local governments," said David Janssen, Los Angeles County's Chief Administrative Officer.

"For us in L.A. County, this would mean a $300 million hit," Janssen continued. "Only about 8 percent of our budget is truly discretionary. Most of that goes towards public safety and law enforcement, with the rest going into parks, libraries and general administration. If this hit stands, that's where the cuts will have to be made."

Janssen said local officials are in negotiations with Schwarzenegger on alternatives to the property tax shift.

There have been some positive developments in recent weeks.

For starters, the California Teachers Association has said it is willing to negotiate up to $2 billion in cuts on teacher salaries. The California Correctional Peace Officers Association said it is offering up $1 billion in cutbacks on salaries and benefits for prison guards. And Schwarzenegger has reported progress in its negotiations with Indian tribes over gaming revenues, which could pump in an additional $1 billion or more.

In addition, the state received an unexpected bonus late last year when final figures for the 2002-03 budget year showed a deficit $2 billion smaller than previously assumed. That allows more of the $15 billion in bond proceeds from Proposition 57 to be applied to the 2004-05 fiscal year, though that is not yet set in stone.

"When you net everything out, we're likely looking at a $13 billion problem next year," said Assembly Budget Chairman Darrell Steinberg, D-Sacramento.

But that assumes all those promised salary savings will materialize, and that won't happen until budget negotiations are completed. Meantime, the deficit is growing larger, not smaller.

"Since there is not a strong consensus on how to solve the first $14 billion, an additional $1 billion to $3 billion hole would be very difficult," said Williams. "It involves some big questions on taxes and how far you want to cut."

Williams and other budget watchers said that significant additional borrowing would be very difficult, especially since there's an ongoing structural budget deficit of at least $7 billion.

"We've been doing this for the last several years," said John Ellwood, professor of public policy at the University of California, Berkeley. "All you would be doing is making the structural deficit pop right back up again next year."

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