Thursday, November 6, 2008


By Michael B. Marois –

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November 6, 2008 16:08 EST (Bloomberg) -- California Governor Arnold Schwarzenegger said his state's finances have deteriorated so rapidly that a budget he signed just six weeks ago has already fallen into a $11.2 billion deficit and taxes must be raised.

Schwarzenegger ordered lawmakers into a special session to consider ways to close the gap. He proposed increasing the sales tax by 1.5 percentage points for three years as well as raising oil severance and alcoholic beverage taxes and motor vehicle fees. In all, taxes and fees would increase $4.7 billion while spending is cut $4.5 billion.

``We have a dramatic situation here and it will take dramatic solutions to solve it,'' Schwarzenegger, a 61-year-old Republican, told reporters in Sacramento. ``We must stop the bleeding.''

California has been hard hit by the housing-market rout and the worst financial crisis on Wall Street since the Great Depression. The state leads the nation in foreclosures and its unemployment rate reached 7.7 percent last month, the fourth highest in the country. Double-digit declines in stock markets have sapped tax revenue from income and capital gains.

Schwarzenegger said this shortfall differs from those in years past, when he resisted tax increases to solve what he said were problems caused by overspending. ``It is now a revenue problem, rather than a spending problem,'' he said.

The Standard & Poor's 500, down 39 percent in 2008, slumped 19 percent in October alone. The Dow Jones Industrial Average dropped 35 percent this year. The declines have erased more than $9.5 trillion from the value of stocks worldwide.

Proposed Cuts

Schwarzenegger's proposal also would expand sales and use taxes to include appliance and furniture repair, vehicle repairs, golf greens' fees, amusement park admissions, sporting event tickets and veterinarian services.

Statewide sales taxes would increase to 8.75 percent from 7.25 for three years. The proposal would add a 9.9 percent per barrel severance tax on oil drilled in this state. The proposal would also add 5 cents for every alcoholic mixed-drink, beer and glass of wine sold in the state.

He warned that if lawmakers don't take action soon, the state would run out of money in February and might be unable to pay some bills, including payroll.

The budget gap has grown from $3 billion the state estimated when it sold $5 billion of short-term notes Oct. 16. That deficit figure was based on tax revenue projections through September and didn't anticipate projected shortfalls in October.

Notes Shelved

The state was supposed to sell another $2 billion of notes this month. That sale has now been shelved, budget director Mike Genest said.

``Now with the announcement of this size of a deficit, I can't imagine us being able to borrow until the Legislature gives us the solutions we need to get back on an even keel,'' Genest said.

California Treasurer Bill Lockyer said he will postpone any bond offering backed by the state's general fund until lawmakers agree on how to solve the problem.

``Current financial market conditions are not favorable, and with our state budget assumptions in flux during the special session, securities disclosure requirements would make it difficult or impossible to access the credit market,'' Lockyer said in a statement. ``Investors will want to see how the state addresses the budget imbalance before lending to us at reasonable rates.''

Lame Ducks

By ordering a special session now, Schwarzenegger is gambling that Republican lawmakers who are stepping down because of term limits or who were defeated during the Nov. 4 general election might be willing to approve the tax increase before a new class of lawmakers takes office on Dec. 1.

California requires a two-thirds legislative majority to raise taxes, a requirement that has hobbled proposals to increase revenue because of steadfast resistance from Republican lawmakers. Schwarzenegger said he was optimistic that fellow members of his party would see the need to boost taxes, given the slumping stock market and economic slowdown.

``No one wants to raise taxes, but we have an obligation to fully fund public education and to fund infrastructure and to make progress in health care,'' said Senate President pro Tem- Elect Darrell Steinberg, who will take over the leadership job Dec. 1.

Foreclosures Help

Schwarzenegger today also proposed a 90-day stay on home foreclosures to help distressed homeowners and stem escalating defaults. Under the measure, lenders would be exempt from the stay if they can prove they have set up a program to help troubled homeowners modify their loans.

The number of California homes in foreclosure totaled 79,511 in the third quarter, said San Diego-based real estate research firm MDA DataQuick. That was more than triple the year- earlier number, and the highest since MDA DataQuick began tracking trustee deeds in 1988.

Schwarzenegger signed a $143 billion budget Sept. 23, a record 85 days past the start of the fiscal year, following a standoff with lawmakers over how to close a $15 billion deficit caused when the housing-market rout erased thousands of jobs and weighed on residents' incomes. Democrats wanted to raise taxes, which Republicans opposed.

Corporate Taxes

Lawmakers ultimately agreed to cut $8 billion in spending, doubling penalties charged to companies that underestimate taxes owed the state, suspending the net operating loss deduction companies can claim when they don't report a profit and temporarily cutting in half the tax credit for research and development.

California, the biggest borrower in the municipal-bond market, has $51.9 billion in general-obligation debt outstanding. The state is rated A+ by Fitch Ratings and Standard & Poor's, the fifth-highest rankings, and a comparable A1 by Moody's Investors Service.

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