* Surplus seen at $851 million for 2014
* Budget sets aside $1 billion in rainy-day fund
* Economy seen expanding
By Jim Christie
SACRAMENTO, Calif., Jan 10 (Reuters) - Governor Jerry Brown delivered rare good news on Thursday in his state budget plan, saying California's budget deficit is gone after years of financial troubles as he proposed increased spending on education and healthcare.
Brown vowed to push back at legislators eager to increase spending even more by restoring the billions of dollars to social services and other state programs cut in lean years.
"I am determined to avoid the fiscal mess that the last few governors had to deal with," Brown told reporters as he introduced his budget plan for the 2013-14 fiscal year beginning in July. Leading Democratic legislators agree with his plan.
Brown also sees balanced budgets for the next four years. But he warned the state not to get exuberant over its improved finances. "It's very hard to say no. That's going to be my job," he said.
California's economy melted down with the housing market, slashing the state's revenue, but it is finally on the mend. For years, the state's leaders have tackled budget deficits with a combination of deep cuts and accounting gimmicks.
The projected surplus is now the latest surprise.
Businesses are hiring again and voters in November approved temporary hikes to the state sales tax and income tax rates on wealthy taxpayers.
California's job growth tops the national average, unemployment has fallen to below double-digit levels for the first time in nearly four years and more money is expected to flow into state coffers from the voter-approved tax increases.
The state Department of Finance projected unemployment will fall to 9.6 percent this year and 8.7 percent in 2014.
Brown's budget plan projects $98.5 billion in revenues and transfers and plans spending of $97.7 billion, according to the proposal posted on the state Department of Finance website.
That would leave a surplus of $851 million, in addition to a projected $785 million surplus for the current fiscal year, which ends in June, allowing the state to put $1 billion toward a rainy day fund. As recently as November, the state budget watchdog, the Legislative Analyst's Office, projected a $1.9 billion deficit.
Spending in the upcoming year is set to rise $4.7 billion from the current 2012-13 budget. Schools and universities will get a $4 billion boost, health spending will rise $1.2 billion, while transfers to local governments will drop $2.1 billion.
The 74-year-old governor said he aimed to focus education spending on the neediest students and districts, such as children in poor areas like Compton, California.
Brown, a Democrat with a national reputation as a liberal, plays up his penny pinching in California. He has repeatedly stressed the need for spending restraint.
'WALL OF DEBT'
The finance department estimates there is still a $28 billion "Wall of Debt" built up over years of internal borrowing, as well as more than $100 billion in unfunded liabilities in state retirement health and pension systems.
Brown proposed repaying the internal borrowing to reduce its outstanding amount to $4.3 billion at the end of the state's 2016-17 fiscal year.
His plan calls for California to put an additional $42.2 million from its general fund in its upcoming fiscal year toward its unfunded pension liability. California expects savings on its retirement spending due to pension reform that has state employees contributing more to their retirement accounts.
In the municipal bond market, where the yield spread between California bonds and triple-A debt shrank in 2012, prices did not move.
Standard & Poor's Senior Director Gabriel Petek said Brown's budget proposal is encouraging and could help California's credit quality strengthen. S&P in November said California, its lowest-rated state at A-minus, may be in line for an upgrade if it maintains fiscal discipline.
Petek is heartened by Brown's caution, as the governor said the state's finances face risks stemming from talks in Washington over the federal budget, potential lawsuits, healthcare cost increases and an uncertain economic recovery.
"A lot rides on the economy. ... If the economy were to retrench, it puts them in a hard spot because a lot of the levers have already been pulled," Petek said, referring to spending cuts imposed in recent years.
Some liberal lawmakers hope to restore cuts to health and welfare programs of the last few years after Democrats won a supermajority in the legislature in November's vote, giving them the power to raise taxes without Republican support.
State Senate budget committee head Mark Leno, a Democrat, said he expects a smooth budget process despite the call for restraint, embracing the idea that the state's finances should "hold steady."
But Leno wants to let local governments raise spending and has proposed a ballot measure that lawmakers would put to voters to make it easier to raise property taxes to fund schools.
Democrats and their allies eager for more spending are calling for closing "loopholes" more than suggesting outright tax hikes. California Labor Federation chief Art Pulaski echoed Brown's caution and called for a review of tax breaks.
Republican State Assembly Leader Connie Conway backed Brown's messages of fiscal restraint and support for education.
Brown will present a revised budget plan in May after his finance department has a better outlook on the state's revenue trend. That plan will set the stage for final budget talks. Leno said he expects a budget agreement with Brown before the start of the new fiscal year in July.