UPDATE 3-California counties, cities to fight budget deal

* Los Angeles County votes to bring lawsuit

* Counties, cities statewide to join court challenge

* Highway, redevelopment funding grab is called illegal (Adds comment from governor's office; quotes, details)

By Steve Gorman

LOS ANGELES, July 21 (Reuters) - The day-old pact among California leaders to close the state's $26.3 billion budget gap came under fire on Tuesday as county and city governments threatened to sue to block a plan to seize local tax revenues as part of the deal.

City and council officials vowed to seek a court order barring the proposed diversion of $2 billion from local redevelopment agencies and $1.7 billion in highway tax revenues into state coffers to help close the budget deficit.

Opponents argue that such moves are illegal because the state is prohibited under its constitution from grabbing revenues raised at the local level or earmarked specifically for county and municipal purposes.

They cited a recent state appeals court ruling that a similar diversion of $740 million in local public transit funds last year was unconstitutional.

A spokesman for Governor Arnold Schwarzenegger insisted the budget plan, which also includes $15.5 billion in spending cuts and no tax increase, would withstand court scrutiny.

"We are fully confident the budget agreement is constitutional," spokesman Aaron McLear said. "We understand there are groups who would rather raise taxes to solve the budget. But the governor simply will not do that."

The Board of Supervisors for Los Angeles County, the state's most populous county, voted to file suit against both diversions if the budget deal is enacted as agreed to on Monday by Schwarzenegger, a Republican, and leaders of both parties in the state Legislature.

ALREADY SQUEEZED AT THE LOCAL LEVEL

Local governments across California are struggling with budget woes of their own, and many would be forced to cut their spending further to make up for money lost to the state.

The executive directors of the California State Association of Counties, which lobbies on behalf of all 58 counties in the state, and the League of California Cities, which represents 480 municipalities statewide, reiterated their intention to challenge the highway tax proposal in court.

A separate group, the California Redevelopment Association, is preparing a lawsuit to block the seizure of redevelopment funds, which are raised through local property tax levies.

Chris McKenzie, executive director of the league of cities, said he hoped prospects for a court battle that the state is likely to lose might be enough to turn lawmakers against the budget accord. Votes by the Democratic-controlled state Assembly and Senate were expected on Thursday.

"It could threaten to unravel the whole deal," McKenzie said, adding that he sees the governor, who like many legislators is barred by law from seeking another term in office next year, as going for a quick fix.

"They don't care because they're not going to be here when the court enters a judgment and they have to reimburse us," McKenzie said. "He's proposed unconstitutional raids of local government funds that will require years of lawsuits to confirm what everybody knows, and that is it's illegal."

The state has asked the California Supreme Court to overturn the appellate court decision on the transit fund diversion, McKenzie said. The state also has said it plans to appeal a separate lower-court ruling that found an earlier taking of local redevelopment funds to be unconstitutional.

County officials say the proposal to take $1.7 billion in Highway User Tax Account funds over two years would force the layoff of 4,000 county employees and leave local jurisdictions without money to repair or maintain their roads. Cities and counties are allotted 6 cents of every 18 cents per gallon collected on the sale of gasoline.

Paul McIntosh, head of the Association of Counties, said local governments also are wary of a separate proposal to borrow nearly $2 billion in local property tax revenues.

"We want to see language in the legislation that makes the repayment ironclad so we can go to Wall Street and borrow against that payment," he said.

The Service Employees International Union, which represents over 95,000 state workers, is weighing a legal challenge over a provision of the budget deal to extend through June 2010 the current furlough of civil servants for three days each month.

(Reporting by Steve Gorman; Additional reporting by Gina Keating and Jim Christie; Editing by Leslie Adler and Richard Chang)