Schwarzenegger readies California budget plan

SAN FRANCISCO (Reuters) - Arnold Schwarzenegger will lay out plans for his last year as California's governor this week under pressure to close a $21 billion budget shortfall and fundamentally change how the state is run.

A state of the state speech on Wednesday, followed two days later by a detailed proposal on how to close the budget gap, are sure to ignite a battle with legislators over which social programs can be cut and whether to raise taxes.

A budget shortfall reappeared after a marathon effort to close a huge deficit last year in California, the world's eighth-largest economy, with spending projected to top $100 billion next year.

Likely on the table are deep cuts in social services, such as state healthcare and parks that were partially spared in last year's budget fracas and financial maneuvers that push spending into future years.

Schwarzenegger, who is barred from running again for governor in November by term limits, may also seek new revenue from sales taxes and oil taxes and put off business tax breaks, analysts say.

"When it comes to the budget, the governor's message is necessarily going to be very sober. There aren't many happy things he can say about the budget besides getting assistance from the federal government," said Jack Pitney, a professor of government at Claremont McKenna College.

"They will be on the lookout for every gimmick they can think of," he added.

The state's budget watchdog sees a $6.3 billion shortfall for the remainder of the budget year ending in June and $14.4 billion for the following year -- nearly $21 billion in all.

The governor will call legislators into emergency session, Capitol Weekly reported. That would give legislators 45 days to act. But there is no penalty for failure and previous emergency sessions have expired without success.

The governor's spokesman said the report contained inaccuracies but did not comment further.

Schwarzenegger, a Republican, late last month lobbied federal officials to send California more money and relax federal rules that would allow the state to cut its benefits, which he said are unusually generous.

The recession has forced Washington to consider a new round of funds for states, including California, said Steve Levy of the Center for the Continuing Study of the California Economy.

"I don't think the economy can bail out the budget in any near term, even if we get really strong growth," he said, adding that California is no different from many other states.

California has the lowest general obligation debt rating of any state, reflecting the persistent inability of state officials to pass budgets on time and reconcile tax and spending policies so that large deficits do not plague the state's finances year after year.

Market watchers see a long budget battle ahead that may widen the gap between prices of California bonds and other debt as the end of the state's fiscal year approaches in June.

"I'm looking for spreads to widen as we get closer to June without a solution," said one trader, who asked not to be identified because he was not authorized to comment publicly. He said he expected a serious tone -- and a push for federal funds.

(Additional reporting by Jim Christie; Editing by Kenneth Barry and Dan Grebler)