Schwarzenegger Hints at Raising Taxes

SAN FRANCISCO—As the sluggish economy continues to bog down state budgets across the country, California Gov. Arnold Schwarzenegger, a longtime foe of one solution—raising taxes—has decided to give voters here a dramatic choice. To close the state's $17 billion budget shortfall, Schwarzenegger proposed yesterday that voters either approve his new plan to borrow $15 billion from Wall Street lenders in exchange for a three-year cut of the state's lottery revenue—or face a 1 percent increase in the state's sales tax. "Our crisis is real and it's very serious," Schwarzenegger said at a press conference announcing the proposal. "We need additional revenues, and we've got to get creative without raising taxes."

Gov. Schwarzenegger proposes to eliminate a $15.2 billion deficit by selling lottery bonds and cutting billions in state programs.

(Rich Pedroncelli/AP)

California is far from the only state grappling with a looming budget gap, but the size of its shortfall—and, as of yesterday, the governor's proposed remedy—make it a special case. Last month, a report by the National Conference of State Legislatures found at least 22 other states are facing budget gaps next year because of slowing revenue. All of those shortfalls combined add up to just over $15 billion. "California's budget gap is larger than most states' overall budgets," says Corina Eckl, director of fiscal affairs at NC SL.

Even Schwarzenegger, a man who came into office wrapping himself in the mantle of an antitax crusader, seems to be acknowledging that the time has come for drastic measures. Since taking office in 2003, he has never budged from his opposition to raising taxes. His first act as governor was to repeal the state's unpopular "car tax," which had tripled annual vehicle registration fees, a move that saved the average driver a little more than $200 a year. Over the past few months, as the slowing economy has begun to eat into state revenues, Schwarzenegger hasn't budged. In his initial budget proposal in January, he proposed a 10 percent cut across all state agencies, which he said would require closing 48 state parks, releasing early from prison as many as 22,000 nonviolent offenders, and trimming $4 billion from next year's K-12 budget. Political experts described the proposal—which some saw as an attempt to pave the way politically for a tax increase—as a deliberate strategy of shock and awe. "He [wanted] to create as much of an emergency as possible," said Daniel Mitchell, a professor of public policy at UCLA's Andersen School of Management, "He was trying to get people's attention."

It worked. Lobbyists swarmed Sacramento this winter, pleading for reduced cuts. But while the rest of the state has been moving in one direction, the governor yesterday said he wanted to move in another. "When we had our budget deficit in January, I was convinced we could do without additional revenues," Schwarzenegger said yesterday, "When we saw the budget getting worse and worse and worse, I saw we needed some." His new spending plan promises not just to tap into new—albeit borrowed—revenue, but to clean up the budget mess, at least in the short term, in one quick swipe. While Schwarzenegger still intends to reduce spending—his plan includes more than $12 billion in cuts—he has walked away from his plans to close state parks or dramatically reduce prison and education budgets.

His new budget proposal, experts say, amounts to one big swing for the fences. Schwarzenegger plans to ask voters this fall to allow him to securitize the state's roughly $3 billion lottery, keeping California running by borrowing against its future earnings. (The lottery, which the governor calls an "underperforming asset," will have to grow by several billion dollars in the next few years for this plan to work.) Schwarzenegger is willing, apparently, to use the specter of a tax increase to get his way. Should voters reject the lottery proposal, which could appear on the ballot as early as November, the plan includes a "trigger" that would boost the state's sales tax—already among the highest in the country—by 1 percent, so lenders can recoup their investments. A similar solution to the state's budget woes in the 1980s was enacted by Gov. George Deukmejian, but the state's revenues picked back up again before voters ever had to pay the tax. A handful of other states, like Illinois, have proposed privatizing their lotteries in recent years, but none have borrowed against anticipated growth in revenue—a far riskier proposition.

Before voters here have their say, Schwarzenegger's proposal will have to fight its way out of Sacramento. When the first details of his plans were released, several Republican lawmakers said the threatened tax hike was something they would never support. Democrats, meanwhile, who control both houses of the state legislature, are also skeptical of the governor's solution. "It sounds risky, almost like a Rubik's cube budget, not a long-term, structurally balanced budget," says Karen Bass, the new speaker of the State Assembly, who was sworn in yesterday. "We're going to put this under a microscope and make sure we protect education and the most needy Californians."