Budget approved despite governor's threatened veto Stalemate: Day 77 Schwarzenegger, Dem leader deadlock over rainy-day fund - governor sees 'fatal flaw' in compromise by legislators

Don Perata (D-Oakland), center, president pro tem, of the state Senate, talks with Dave Cogdill, (R-Modesto), left, and Senate minority leader and Mike Villines (R-Clovis),right Assembly minority leader in the senate chamber in Sacramento, California, on Monday, September 15, 2008, before the state Senate was expected to vote on the state budget. The state budget is more than two months overdue. less Don Perata (D-Oakland), center, president pro tem, of the state Senate, talks with Dave Cogdill, (R-Modesto), left, and Senate minority leader and Mike Villines (R-Clovis),right Assembly minority leader in the ... more Photo: Robert Durell, Special To The Chronicle Photo: Robert Durell, Special To The Chronicle Image 1 of / 8 Caption Close Budget approved despite governor's threatened veto 1 / 8 Back to Gallery

The state Legislature approved a budget early this morning despite Gov. Arnold Schwarzenegger's threat to veto the spending plan on the grounds that fiscal changes approved by lawmakers do not go far enough.

The budget, already a record-breaking 78 days late, would close a gap of about $17 billion for the fiscal year that began July 1 without imposing new taxes. It does, however, require taxpayers to make earlier payments to the state government.

The Assembly passed the plan by 61-1 after the Senate approved a package of budget bills on a 28-12 vote.

About 12 hours before the last vote was taken at 2 a.m. today, Schwarzenegger sent a letter to Assembly and Senate leaders saying their plan for budget reform wasn't strong enough.

"I have been very clear this entire year that I would be unable to sign a budget without meaningful budget reform," the governor said in the letter.

Schwarzenegger wasn't the only state official to criticize the plan. Treasurer Bill Lockyer, a Democrat, said at a finance conference in San Francisco this morning that the budget was absurd, irresponsible and "gives gimmicks a bad name."

"It's banana republic financing," Lockyer said. The spending plan relies on "phony money and phony estimates," he said.

Legislators "haven't done their job. They haven't done it for several years," Lockyer said. One big problem, he said, is the requirement that the budget pass with a two-thirds vote.

"We need radical reform of the state Constitution," Lockyer said. "I hope this tragedy will provide that."

Schwarzenegger was demanding three changes to the lawmakers' proposal in how the state creates and uses rainy-day funds that are saved during flush years and used during tough fiscal years.

Senate President Pro Tem Don Perata, D-Oakland, said he agreed to adopt two of the changes: increasing the size of the fund and forcing the state to continue making deposits into the fund except when money is transferred from it or when the cap - 12.5 percent of the general fund - is reached.

Perata said he didn't agree with the governor's third idea, which would allow the state to dip into the rainy-day fund only when the state's actual revenue falls below the level that was estimated in the budget.

The compromise budget says the Legislature could tap into the rainy-day fund with a two-thirds vote, but the money could be spent only on debt repayment and other one-time uses.

"We were able to provide support for two of the three, and I would prefer to see this as a victory for him, and he can take some pride in that," Perata said.

If the governor vetoes the budget, Perata said he would seek to override the veto, which would require a two-thirds majority in the Legislature, the same number of votes that was needed to pass a budget.

But Matt David, Schwarzenegger's communications director, said the lawmakers' proposal has a "fatal flaw."

"Without this restriction, the rainy-day fund turns into nothing more than a slush fund that can be raided at any point and up to any amount. The governor's request is fiscally responsible because it guarantees that the rainy-day fund can only be used in slow economic years - like this year - when revenues fall below projected spending," he said in a written statement.

The budget approved by the Legislature includes $7.1 billion in spending cuts, $9.3 in additional revenue and $1.2 billion for reserves. Nearly half the additional revenue comes from future taxes on individuals and businesses that the state would collect earlier.

Many Capitol observers complained that the spending plan relied on accounting gimmicks to help paper over the giant budget gap, and said it would only create a bigger mess next year.

"How long do you think we can go without reaching a point where there are no more deferred payments, when there are no more early tax payments and when there are no more ways to jury-rig the system?" said Larry Gerston, a political science professor at San Jose State University.

Under the compromise budget, regular tax withholdings for individuals and businesses would automatically increase by 10 percent starting Jan. 1, which would allow the state to collect an additional $1.5 billion.

Legislative budget staffers argued that many taxpayers don't withhold enough for taxes on their paychecks and end up paying additional taxes when they file a return each spring. But for those who already withhold too much, the change would simply mean a bigger refund check.

"This is not additional money (for the state), it's simply moving the date when the money would come in," said Jean Ross, executive director of California Budget Project.

The budget would also require individuals and businesses that make quarterly tax payments to pay more in the first six months, a change that could generate as much as $2.3 billion in the current fiscal year.

Lawmakers conceded that the budget was not ideal. But they said some compromise was desperately needed to end an impasse that has resulted in billions of dollars being withheld from schools, health clinics, day care centers and college students.

"Everybody feels that their biggest fears were not realized: for Republicans, it's raising taxes, and for Democrats, steep cuts to health care and education ... and yet everyone didn't exactly get what they wanted," said John Laird, D-Santa Cruz, chairman of the Assembly budget committee.

Assembly Republican leader Mike Villines of Clovis (Fresno County), said the state's budget mess is so huge that it'll take more than this year to make structural fixes.