May 20, 2009 6:49 pm

California faces deep budget cuts

In a 40-year career as a bodybuilding champion, film star and politician, Arnold Schwarzenegger is unlikely to have experienced as many conflicting emotions as he did this week.

On Tuesday, California’s governor stood triumphantly beside Barack Obama at the White House as the president praised his efforts to fight global warming and unveiled tough new car emissions standards closely modelled on regulations introduced by Mr Schwarzenegger in his home state.

Yet on the same day back in California, voters were resoundingly rejecting a series of tax rises proposed by the governor that leaves America’s most populous state facing a deficit that will balloon from $15bn to more than $21bn (€15.3bn, £13.4bn).

Deep cuts are expected in California following the ballot defeat, which will hit the state’s creaking school system and weaken provision of essential public services, such as police, healthcare and firefighting.

“Cuts need to be made immediately,” Bill Lockyer, California’s treasurer, told the Financial Times. “We will avoid worse cuts that will be needed later [if] we achieve some savings now.”

Mr Schwarzenegger agreed, saying: “The longer we wait, the worse the problem becomes and the more limited our choices will be.” He urgently needs to agree a new budget with the state legislature and said Republicans and Democrats would “come together to develop a budget solution that gets our state back on track”.

Eroding tax revenues and higher demand for public services meant California’s finances were in a parlous condition even before Tuesday’s vote, with Mr Schwarzenegger’s budget fix likely only to minimise the extent of the problem. The plan was “at best a partial solution to the state’s fiscal problems”, said Mark Baldassare, president of the Public Policy Institute of California.

In a letter last week to Tim Geithner, US Treasury secretary, Mr Lockyer asked for federal bank bail-out funds to be extended to the state, saying that if California were unable to obtain its usual short-term cash flow borrowings “there could be devastating impacts on the ability of the state ... to provide essential services, such as fire and police protection, education and social services”.

California’s budget deficit

California is asking for the government to provide credit guarantees that would clear the way for banks and other lenders to loan it funds. The funds are needed for California’s short-term cash obligations, such as paying public sector workers.

Mr Lockyer said the collapse of the financial services sector had limited California’s fiscal options. “Monoline insurers are no longer available to provide credit enhancement and banks no longer have sufficient reserves to provide letters of credit that they were able to provide in the past. That’s why we’re asking the US Treasury to become a municipal market backstop.”

Mr Lockyer is hopeful the state will be able to agree a new budget by July, which would make it easier to borrow funds needed for short-term cash flow needs.

But with the state assembly requiring a two-thirds majority to pass a new budget, there is no guarantee that a new financial plan will be agreed.

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