Nonpartisan Legislative Analyst Elizabeth G. Hill, whom lawmakers of both parties look to for guidance on fiscal matters, said the cooling housing market, high energy prices and a batch of overly optimistic assumptions in the last budget are hitting state coffers hard.
The deficit has grown to more than the state spends on its entire public university system, Hill said. "We're talking big dollars to close this gap."
In less than three months -- since lawmakers passed the last budget and projected a reserve of about $4 billion -- California has plunged into the red. Property, sales and personal income taxes are down sharply as a result of the troubled housing market, and Hill predicted that the housing sector has yet to hit bottom.
Meanwhile, some big savings that lawmakers promised in the budget -- and approved during the summer -- appear unlikely to materialize.
The sale of a government agency that was expected to bring $1 billion to the state treasury is unlikely to occur this year, Hill said, and if a sale did take place the agency might fetch only half the projected amount.
Lawmakers also overestimated by $200 million the revenue the state would receive from Indian gambling and did not account for a planned pay raise for prison guards that is expected to cost $258 million.
The budget also took an unanticipated $140-million hit from the cost of fighting Southern California's wildfires a few weeks ago. A raid of the teachers pension fund that was used to balance an earlier budget has been declared unconstitutional in court, costing the state an additional $500 million this year.
Hill urged lawmakers to consider reducing benefits and suspending cost-of-living adjustments for government programs, rolling back programs created in recent years, eliminating tax breaks and raising taxes.
The analyst's warning follows an order this month by Gov. Arnold Schwarzenegger that all state agencies prepare to cut their spending by 10%.
"Knowing the challenges that we face, throughout the fall, my administration has been examining a variety of options to close next year's budget gap," the governor said in a statement Wednesday. "I have not made any final decisions yet, but it's clear that the decisions that will be involved will be tough."
The governor and legislative leaders were not specific about what spending reductions or tax hikes might be under consideration. They called for the state to begin a comprehensive review of the budget process, possibly with an eye toward changing the tax code to bring more stability to the state's revenue stream.
The personal income taxes on which the state relies to fill its coffers are a volatile revenue source that can leave the budget reeling from even moderate shifts in the economy. A tax code overhaul could involve replacing some of that revenue source with other levies.
Calls for such top-to-bottom reviews were made during the fiscal crisis a few years ago, but ultimately the budget was largely balanced through borrowing. The state is still repaying that debt.
"An honest dialogue about closing the budget gap must include exploring all options," said state Senate Leader Don Perata (D-Oakland).
Republicans called for immediate spending cuts.
"We must tackle this problem head-on, and now," said Dick Ackerman of Irvine, who leads the Senate's Republicans. "We need to look at cost containment, reexamine our budget priorities and maybe even" make mid-year cuts.
California's finances were in disarray when former Gov. Gray Davis was recalled from office in late 2003. He was in the capital Wednesday, speaking at a Sacramento Press Club lunch.
In a ballroom packed with former staffers and reporters -- many of whom had chronicled the financial mess that played a role in his ouster -- Davis said he was not surprised to see the state again wrestling with an enormous shortfall.
He said the state needed a constitutional amendment that would force it to build a sizable rainy day fund that could be tapped in tough times. Without one, Davis told the crowd, "governors yet unborn, who will be governors in the next century . . . will be dealing with the same problem we're discussing today."
Davis resisted attacking Schwarzenegger -- or the rollback of a multibillion-dollar vehicle fee increase that Davis put in place as one of his final acts in office -- even though many Democrats say the governor's popular "car tax" reversal led to the current budget problem.
Times staff writer Michael Rothfeld contributed to this report.