As deficit grows, Calif. prepares to issue IOUs

SACRAMENTO, Calif. — California's controller will start paying many of the state's bills with IOUs as soon as Thursday after lawmakers failed to close the state's worsening budget deficit, adding a new measure of indignity to a state sinking deeper into dysfunction.

Lawmakers' failure to act on Tuesday, the end of the fiscal year, also widened California's deficit from what already had been a whopping $24.3 billion — more than a quarter of its general fund.

The failure to balance the state's main checkbook and the looming IOUs prompted Gov. Arnold Schwarzenegger on Wednesday to declare a fiscal state of emergency.

Under the declaration, state offices will be closed three days a month to conserve cash. If the Legislature fails to solve the deficit within 45 days, it cannot adjourn or act on other bills until the crisis is resolved.

The partial government shutdown also will lead to a third furlough day for 235,000 state employees, bringing their total pay cut this year to about 14 percent.

"California needed the Legislature to act boldly and with conviction. Their response was not a solution to California's budget problem but an invitation to actually a bigger financial crisis," Schwarzenegger told reporters Wednesday.

On Tuesday, as the previous fiscal year was drawing to a close, the Senate rejected three bills designed to save $5 billion, including $3.3 billion in education funding cuts that had to be enacted. Passing those bills would have given the Legislature time to work out a broader solution to the deficit and delayed the need for IOUs.

Instead, the budget shortfall is set to grow even wider because of California's complicated school funding formula, meaning the state will not have enough money to pay all its bills.

State Controller John Chiang said his office is prepared to issue IOUs totaling $3.3 billion in July.

Senate Minority Leader Dennis Hollingsworth said neither he nor his Republican colleagues wanted to see California resort to IOUs to pay its bills, but he said Democrats had refused to make sufficient spending cuts to solve the shortfall.

"It's unfortunate that we're at this point," said Hollingsworth, a Republican.

It will be the first time since 1992 that California will have issued IOUs. The move is almost certain to further damage the state's credit rating, already the lowest of any state, saddling taxpayers with billions of dollars in higher interest payments on bonds that have yet to be sold.

Issuing IOUs — formally referred to as individual registered warrants — also will have real-world consequences for those on the receiving end. Small businesses that rely on state contracts will be most affected.