Analysis: Texas vs California: A tale of two budget deficits

Registered warrants, or IOUs, are printed at the State Controller's office in Sacramento, California, July 2, 2009.

AUSTIN, Texas/SACRAMENTO, California (Reuters) - Texas Governor Rick Perry treated guests to a barbecue lunch paid for by a wealthy businessman. Supporters of California Governor Jerry Brown munched on hot dogs at a union-sponsored picnic.

The stark contrast in inaugural menus last month highlights the different approaches the two most populous U.S. states are taking to deal with massive budget deficits.

Perry, a Republican, campaigned on the strength of the Texas economy and made political hay of the fact the Lone Star state had avoided California's massive deficit, pegged at $25.4 billion through the upcoming budget year.

Now Texas faces a budget deficit estimated as high as $27 billion for the upcoming two-year cycle of 2012-2013. To close the gap, state legislators have proposed steep cuts in funding to education and welfare programs.

California and Texas are in similar budgetary dire straits following a painful U.S. recession that severely crimped state tax receipts and other critical revenue sources.

How the debate plays out in Austin and Sacramento will be watched closely by the $2.8 trillion U.S. municipal bond market, which states could tap to cover their shortfalls. California, which has the world's eighth-largest economy, is the market's biggest debt issuer.

The steps that Texas and California lawmakers take in coming months to control the damage will also test the nation's appetite for new taxation in the face of an anti-tax drive spearheaded by conservative Tea Party activists, who helped propel Republicans to big gains in last year's congressional elections.

"I think it's fair to call the upcoming fiscal year the most challenging budget year on record for states," said Nicholas Johnson, director of state fiscal projects at the Center on Budget and Policy Priorities.

States face a collective budget gap of $175 billion through 2013, even after closing gaps totaling $230 billion over the past two years, the National Governors Association said. Federal help from previous years is drying up.

Brown, a Democrat, wants to fill the gap with a combination of $12.5 billion in spending cuts and $12 billion in tax hikes, and seeks to ask voters for approval.

Brown is no stranger to tax fights. In 1978, during his earlier stint as governor, California voters passed Proposition 13, which constrained the state's ability to impose new taxes.

Texas has a long history of business-friendly policies and conservative tax policy -- the state has no income tax. It has traditionally ranked low among U.S. states in public funding for education and social programs.

TO TAX OR NOT TO TAX?

California's deficit is the largest of any of the 50 U.S. states in absolute dollar terms, but Texas' projected 2012 budget shortfall is equal to 31.5 percent of its 2011 budget, versus 29.3 percent for California, according to the Center on Budget and Policy Priorities.

Experts say Texas' budget has been under pressure for years. The state used about $6.4 billion in federal funds from the 2009 Recovery Act to fill a shortfall in its 2010-2011 budget cycle, but those funds will not be available in the 2012-2013 period.

In Texas, a conservative stronghold where Republicans hold a big majority in the Legislature, attempts to raise taxes to cover the shortfall are likely to fall flat.

Texas weathered a 2003 budget shortfall without raising taxes and "remained true to fiscal discipline while addressing budget challenges similar to those we face today," Perry told a business convention last month.

Texas has an ace up its sleeve -- a $9.4 billion "rainy day" fund the state has built up over the years, funded by a tax on the state's oil and natural gas production.

California voters may have some tolerance for higher taxes. Much depends on the ability of Brown, who was elected last November, to secure a special election to ask voters to extend tax hikes to narrow the budget gap.

Brown aims to root out waste and profligacy, such as cutting state officials' cell phone use, but he exudes belief in government as a positive force.

"Californians will be much more predisposed to raising taxes" than Texans, said Matt Murray, economics professor at the University of Tennessee in Knoxville. "Anything like that in Texas, I don't think it would even make it to the ballot."

(Editing by Peter Cooney)