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It is not easy being the Governator these days. Arnold Schwarzenegger, boss of America’s most populous state, may be forced to pay for state services with interest-bearing IOUs, rather than cash, within months as California faces a fiscal crisis. This extreme step – almost like creating a parallel currency – is reminiscent of emergency measures taken during the Great Depression or of financing provisions peculiar to leveraged buy-outs called “pay-in-kind” notes.

The cash crunch speaks to how rapidly states in the US have seen their finances crumble. California’s projected budget gap of $11bn is the largest of any state, but it is by no means alone, or even in the worst shape – New York and Arizona face gaps of about 20 per cent of their budgets. The National Conference of State Legislatures estimates that states have closed $40bn in deficits this year and face $97bn in additional shortfalls over the next 18-24 months.

The culprit is the sharp downturn in income and spending, which affects California disproportionately. Mr Schwarzenegger’s options are limited and politically unpalatable. Personal and corporate income taxes are already 56 per cent of funding – well above the national average – while revenue sources such as sales and fuel tax are the highest of any state.

That leaves the prospect of raising fees for services – especially awkward for Mr Schwarzenegger, who rose to power when his predecessor, Gray Davis, was ousted by voters angry with his car registration levy. The new governor’s first act was repealing the measure. On the expenditure side, California tied its hands with a constitutional amendment guaranteeing much of its education budget, the biggest cost by far, from future cuts.

It will take a real-life action hero to break California’s political deadlock and reverse Mr Schwarzenegger’s position on public levies. Either that or be prepared for a whole lot of funny money.

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