No happy new year for California budget

A handmade sign painted on the side of a pickup truck reading ''hard worker'' is shown in San Francisco, California, January 25, 2009.

SAN FRANCISCO (Reuters) - It won't be a happy new year for California Governor Arnold Schwarzenegger and state lawmakers, who face yet another daunting challenge in balancing the state's budget -- this time a shortfall of roughly $21 billion, or maybe more.

The writing is on the wall for public spending cuts on top of those that defined efforts this year to close deficits through July 2010 that had swollen to more than $60 billion.

Analysts say the most populous U.S. state must also boost revenue to balance its books as failure to close the budget deficit could limit California's ability to borrow.

The choices facing state leaders can be summed up in two words, said H.D. Palmer, Schwarzenegger's spokesman on budget matters: "Not pretty."

California faces one of the most dire budget situations of any U.S. state because its economy, which would be the world's eighth largest were the state a country, is sputtering and weighed down by a 12.3 percent unemployment rate.

California tied in third place with Nevada, and South Carolina as the U.S. state with the highest level of unemployment in November.

Rising joblessness this year, the result of the housing slump, mortgage credit crisis and timid consumer spending, sent California's revenues tumbling. Analysts expect their slide will persist next year.

They also expect flagging revenues to be the dominant theme in the state budget plan Schwarzenegger will present next month, likely on January 8.

"The consensus seems to be that it will be a long slow recovery and that just suggests to me you're not going to see a turnaround in the things that drive our economy," said John Shirey, executive director of the California Redevelopment Association.

Schwarzenegger's budget planners last week in a report said revenues since the start of the fiscal year in July were trailing already downcast estimates by more than $1 billion.

Ominously, the report said revenues from personal income tax collections, the state's biggest source of revenues, were 12.0 percent below forecast in November.

'TOUGHER NUT TO CRACK'

New spending cuts will be hard to craft because they could threaten the loss of federal dollars, Palmer said.

Schwarzenegger can't propose cutting too deep into programs that receive federal money because funding must be maintained at certain levels to receive financial aide from Washington.

"It's a somewhat tougher nut to crack," Palmer said of the state government's latest massive budget gap over the remainder of the current fiscal year and through the next fiscal year.

On the other hand, he can't rely on more stimulus dollars from Washington to help fill the state's coffers.

Voters present a third complication to his budget-balancing plan: Raising prominent taxes will likely be a nonstarter as voters rejected extending tax increases in May.

Palmer declined to discuss revenue-raising plans but analysts said state officials must consider some.

Larry Gerston, a political scientist at San Jose State University predicted that increasing taxes on cigarettes and raising fees for state services will be proposed to help narrow the projected deficit.

BREAKING POINT

Lawmakers will also back creative accounting. "Legislators are going to reach for every trick and gimmick to limit the amount of cutting they'll have to do," said Jack Pitney, a professor of government at Claremont McKenna College.

But lawmakers are unlikely to support borrowing to help plug the shortfall or raise proceeds to replace spending that will be cut, likely including funds for prisons and higher education not protected by voter mandates, said Gerston.

"We're beyond the breaking point when it comes to bonds," he said. "Within five years, we'll be paying 10 percent of the general fund for bond payments. We're already at 7 percent."

Markets may limit California's ability to borrow in any case. State Treasurer Bill Lockyer has warned lawmakers his office will face difficulty in selling the state's debt if California's reputation for fiscal disarray persists. It has earned California the lowest credit rating of any state..

(Editing by Andrew Hay)