California budget battle looms

SAN FRANCISCO (Reuters) - Californian farmer Joseph Pezzini says orders for his artichokes are rising.

For Pezzini, it's a clear sign consumer spending is picking up in the Golden State following a deep economic slump.

The recovery could not come too soon to ease the state's estimated $20 billion fiscal deficit as the battle over balancing California's 2010-2011 budget nears.

The fight pits cost-cutting Republican Governor Arnold Schwarzenegger against Democrat rivals who want tax hikes.

The governor on Friday updates the budget plan he presented in January and will offer a revised version to guide talks.

For Schwarzenegger, tax hikes could crush the kind of consumer spending Pezzini began to notice last year.

It was around the November Thanksgiving holiday when California's shoppers began reopening their wallets to buy pricier produce like artichokes, says Pezzini, chief operating officer of Ocean Mist Farms in Castroville, California

"We're hopeful that we're getting back to a more consistent, normal market," said Pezzini. "I wouldn't call it a 'V' recovery, but a slow and steady improvement."

California's state controller is likewise tracking improved consumer spending. It is a hopeful sign California's employers may be poised to start rehiring and trim a 12.6 percent jobless rate, one of the highest in the nation.

Sales tax revenue for the current fiscal year through April was up $576 million, or 2.9 percent, ahead of estimates in Schwarzenegger's proposed budget.

But as business improves in California's shops, malls and restaurants, revenue from personal income taxes, the state's most important revenue source, remains troubled. At the end of April, collections were $2.2 billion, or 5.7 percent, below the year-to-date projection in Schwarzenegger's budget plan.

That leaves overall year-to-date revenue $1.3 billion, or 1.9 percent, below forecast.

MIND THE GAP

Schwarzenegger and the Democrat-led legislature have in the past had epic budget brawls. Analysts expect a repeat performance if the governor holds fast to austerity measures like cutting programs for the disabled, households on welfare and those receiving state health-care aid.

California must pass its budget by the July 1 start of its new fiscal year. Some analysts see negotiations dragging on past that, something that could worry credit rating agencies.

Democrats have approved spending cuts as the state economy soured but only after calling for tax increases and defending state programs tooth and nail.

"I don't think that under any measure a cuts-only budget can be considered fair," said Assemblyman Pedro Nava, one of three Democrats who tossed Schwarzenegger's January budget plan into a recycling bin at a press event on Monday.

Last week Schwarzenegger told a business group "there will be no increase in revenues, no tax increases whatsoever. This will all be done with cuts and living within our means."

Schwarzenegger's strategy accompanies a state controller report showing personal income tax revenue slowly improving.

But the gap between income and spending is not shrinking fast enough to significantly narrow the budget deficit, the scope of which will also be unveiled later this week.

California is not alone -- at least 38 states and Puerto Rico are dealing with fiscal 2011 gaps that total $89 billion, according to the National Conference of State Legislatures, a bipartisan research group.

On Monday Schwarzenegger's spokesman on budget matters said the state economy is too fragile for tax hikes.

"The economy is just beginning to come out of the worst recession since the Great Depression and tax increases would just slow that growth," spokesman H.D. Palmer said.

Schwarzenegger has on occasion backed increasing revenue but has long argued California's government is too expensive. He points out California has just over 10 percent of the nation's population but over a third of its welfare cases.

Hard feelings over last year's budget measures -- including $31 billion in spending cuts -- and anxiety about new ones are widespread. State workers have challenged cost-cutting furloughs in court. In February, protests by public university students over fee increases turned violent.

Strident budget politics are among the many reasons California's general obligation debt rating is just a few notches above "junk" status. Fitch Ratings and Standard & Poor's rate the state's GO bonds A-minus. Moody's Investors Service rates them A1.

"Our rating currently assumes that they're going to have a contentious budget," said Fitch analyst Douglas Offerman.

Dan Schnur of the University of Southern California's Unruh Institute of Politics agrees. He is among analysts who predict Schwarzenegger will fail to wrap up a budget by July 1.

"It's hard to see much progress being made over the next couple of months," he said.

(Editing by Andrew Hay)