Meltdown 101: California's budgetary troubles

SACRAMENTO, Calif.

California's budget shortfall isn't just an abstract problem involving some out-of-whack numbers. It's a serious crisis that's threatening to hurt people in the wallet -- in July alone, the state is talking about handing out $3 billion in IOUs to everyone from contractors to welfare recipients.

How exactly did California get into this mess, and what are state lawmakers and Gov. Arnold Schwarzenegger doing to try to get out of it? And what does the crisis have to do with the national recession?

Here are some questions and answers about California's fiscal troubles.

Q: How big is the state's budgetary mess?

A: California's $24.3 billion deficit is roughly a quarter of the general fund, which is the state's main bank account for paying its daily expenses. For perspective, lawmakers could eliminate all funding for state prisons and the higher education system and still not save nearly enough money to address the shortfall.

The budget gap is the biggest of any state.

Q: How did the state get into this mess?

A: California's problem is partly of its own making.

Lawmakers and voters have agreed to higher levels of spending over the years without identifying a dedicated funding source. Over time, that means the state's general fund has had more obligations than it can afford to pay. Because of caps on local property taxes adopted three decades ago, the state budget has come to rely heavily on revenue from capital gains and personal income taxes. Both have plunged over the past two years.

That's where the biggest culprit comes in -- the national recession, which has hammered California.

The state has its highest jobless rate (11.5 percent) in modern times, and personal income has declined statewide for the first time since the Great Depression. As a result, personal income tax revenue coming to the state plunged 34 percent for the first five months of the year.

During an unusual February session, Schwarzenegger and lawmakers thought they had solved the budget deficit through the middle of 2010. Since then, rapidly declining tax revenue put that budget package out of balance shortly after Schwarzenegger signed it, leading to the current deficit.

Q: When the federal government can't balance its budget, it just operates with a deficit. Can't California do the same thing?

A: No. Under its constitution, California must balance its budget every year. The federal government also can print money, something states cannot do. The main options available to states in lean economic times are spending cuts, tax hikes and borrowing money.

Q: What happens if California can't balance its budget?

A: If it doesn't happen by Wednesday, which is the start of the fiscal year, serious consequences kick in.

The state controller will begin issuing IOUs to college students who are expecting grants, welfare recipients, the blind and disabled, and private companies that contract with the state to provide a wide array of services. Counties that administer social services also would not get paid, nor would taxpayers who are still expecting refunds.

The IOUs are intended as a cash-saving move until lawmakers pass a balanced budget.

In normal years, California can take out short-term loans so it has enough cash to pay its bills until spring, when the bulk of its tax revenue starts flowing. This year, it expects to need $7 billion to $9 billion in such loans, but the state treasurer's office says it will not even try to sell those bonds unless lawmakers balance the budget.

Lenders are unlikely to go along with such loans if California has a $24 billion deficit and no credible plan to close the shortfall, because they will be worried that the state will not be able to meet its financial obligations. That has led to the immediate cash crisis.

Q: Are there any other ways Californians will be affected?

A: Lack of a balanced budget is likely to mean higher lending costs to pay back all sorts of bonds that already have been approved, which lead to difficult budget decisions in the future about more spending cuts or tax increases. For example, a credit rating downgrade on $53.3 billion of unsold infrastructure bonds would increase long-term borrowing costs by $7.5 billion.

Schwarzenegger also has ordered 235,000 state workers to take three days off a month without pay if there is no balanced budget by Wednesday, a move that would reduce available staff at state offices. The three furlough days will reduce the workers' pay by 14 percent.

Q: What about people outside California? Will they be affected?

A: Not directly. But California's economy is so large that any national recovery from the recession will be slowed as long as California is ailing. The state's economy accounts for 12 percent of the nation's gross domestic product -- a measure of the value of all goods and services produced -- and the state is the nation's single largest retail and auto market.

Q: What is the state doing to try to balance the budget before it's too late?

A: As of Tuesday, Gov. Arnold Schwarzenegger had proposed cutting $16 billion from state programs, borrowing $2 billion from local governments and raiding other government accounts worth about $6 billion to close the deficit.

Democrats have countered with $11 billion in cuts and nearly $2.5 billion in higher taxes, primarily on tobacco products and companies that drill for oil in California. They also want a $15 increase in the vehicle registration fee, which already was raised earlier this year, to ensure that state parks remain open.

Schwarzenegger and Republican lawmakers have steadfastly refused to raise taxes after the state Legislature approved nearly $13 billion in higher sales, personal income and vehicle taxes earlier this year.

As of Tuesday afternoon, Democrats and Republicans remained at an impasse. Democrats want to moderate Schwarzenegger's cuts to welfare and health care programs for the poor, but Republicans refuse to go along with tax increases to make up the difference.

Q: Is there any chance the federal government will intervene with some sort of bailout?

A: California's treasurer asked the Obama administration earlier this year to consider a federal loan guarantee. This would allow the state to borrow at a lower cost -- roughly half the interest rate it would otherwise get -- so it can have enough cash to get through the year. California may need to borrow $7 billion to $9 billion to make it to next spring.

So far, the Obama administration has been noncommittal but has expressed concern that special assistance for California would open the door to similar requests from other states. Some members of Congress, including U.S. Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, are keeping open the possibility of some assistance for the state.

Q: Is there anything California can do to avoid this problem in the future?

A: California has had problems with balancing its budget for many years, in part because of its dependence on personal income tax and capital gains taxes, which rely on a rising stock market.

A special commission is expected to report to Schwarzenegger and the state Legislature by the end of July. It will recommend ways that California can revamp its tax structure to avoid the wild fluctuations in revenue that have contributed to massive deficits.