Analysts: Schwarzenegger's Budget Plan Is Too Optimistic

But the California governor stands by his plan to return the state to fiscal health.

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SAN FRANCISCO—Arnold Schwarzenegger's budgetary swing for the fences last week—which included a risky plan to borrow against the state's future lottery revenue to close the state's $17 billion budget shortfall—may already be drifting foul. Yesterday, the Legislative Analyst's Office, the state's nonpartisan fiscal and policy adviser, issued a sobering assessment of the governor's proposal, declaring many of its projections "overly optimistic."

"The sluggish economy has severely worsened the state's ongoing mismatch between revenues and spending," Elizabeth Hill, the state's legislative analyst, wrote in the report. "A reliance on overly optimistic lottery growth assumptions and a massive bond structure...could result in unsustainable ongoing spending commitments."

Lawmakers from both parties also have expressed skepticism about Schwarzenegger's proposal.

Aaron McLear, a spokesman for the governor's office, told reporters that Schwarzenegger was standing by his plan: "We believe over time, the changes that we make in the lottery will make it more efficient and a better-performing asset."

At the crux of Schwarzenegger's proposal is an unusual—and, some experts say, risky—attempt to close the state's yawning budget gap by securitizing the state lottery. At least 22 other states are facing budget gaps next year because of slowing revenue, but none faces a shortfall as large as California's. Last week, Schwarzenegger proposed that voters either approve his new plan to borrow $15 billion from Wall Street lenders in exchange for a three-year cut of lottery revenue—or see a 1 percent increase in the state's sales tax. The state lottery, which has sales of about $3 billion a year, would have to grow substantially in order to make enough to pay back the lenders.

If the lottery doesn't bring in enough, according to the Legislative Analyst's Office report, California could find itself right back where it started—short on revenue, with few budgetary solutions. All of the lottery's current revenue—about $1.2 billion—is earmarked for education. If gambling income doesn't double in the next 10 years, the report says, that money would have to be used to make bond debt payments, instead.

Hill, a widely respected figure in Sacramento, where her legislative ideas often become the foundation of state laws, believes Schwarzenegger's current budget could leave public schools short as much as $5 billion over the next 12 years.

In her report, Hill proposes a slightly different solution, though she embraces the governor's basic framework. She thinks California should borrow a much smaller amount against its lottery revenue—$2.8 billion in the next fiscal year and another $2.8 billion the next year—which would give the state enough wiggle room to repay the debt without imperiling education. Schwarzenegger's current sales tax "trigger" won't bring in enough revenue to cover his proposals, she says, but the idea of tapping into new revenue is a good one. "We think a sales tax increase is a reasonable choice for a contingency plan," Hill writes in the report. If the state plans to borrow less, she says, it should be able to rely on a sales tax hike to cover its exposure in an emergency.

Lawmakers in Sacramento have until June 15 to finalize the annual budget.