LOS ANGELES — An ever-widening budget gap joined with intractable political paralysis to deliver California its biggest fiscal blow in decades on Thursday, when the state’s controller began printing i.o.u.’s in lieu of cash to pay taxpayers, vendors and local governments.
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A computer operator unloading California’s i.o.u.’s Thursday from a printer at the state controller’s office in Sacramento.
It was only the second time the state had adopted the emergency payment method since the Great Depression. The National Conference of State Legislatures had no record of any other state’s ever using them.
It was unclear whether the i.o.u.’s, known as warrants, would be accepted by all of the banks in California, which were caught off guard by the move and seemed hesitant to entrust the state to repay the them — at an interest rate of 3.75 percent — in October, as promised.
The controller, John Chiang, issued 28,742 warrants totaling $53.3 million. If state lawmakers fail to reach a budget agreement by the end of August, the amount would grow to $4.8 billion.
While the emergency move resulted from California’s combination of outsized budget gaps, unusual budget rules and a morass of financial obligations approved at the polls, the action was seen as a warning flag to other states that have failed to close their budgets this fiscal year because of the economic downturn.
“In the past, there haven’t been many opportunities for states to have to issue them,” Brian Sigritz, a staff associate at the National Association of State Budget Officers, said of the i.o.u.’s. “But now some other states may have to look at it.”
So far, other states with lingering budget holes have tried different methods: Connecticut, for instance, has a temporary budget under executive order, and Pennsylvania is considering partial payments to employees.
In California’s misery, Gov. Arnold Schwarzenegger, a Republican, has found some opportunity in standing his ground. Mr. Schwarzenegger has not only refused to sign off on stopgap measures like those proposed this week by Democratic lawmakers, but has also demanded that lawmakers adopt substantive changes in policy as part of any budget deal.
Democrats indicated Thursday that they were beginning to submit to Mr. Schwarzenegger’s demands, taking proposed tax increases that he opposes off the table as they worked to close a budget gap estimated to have grown to $27 billion.
H. D. Palmer, spokesman for the California Finance Department, said Mr. Schwarzenegger had called the i.o.u.’s “the short-term consequence of not getting a long-term solution.”
Mr. Schwarzenegger, weighing the discomfort and embarrassment of the i.o.u.’s against a short-term budget deal, apparently reached the conclusion that the i.o.u.’s were a price worth paying to force policy changes he pushed as early as 2005, even if it meant the budget crisis dragged on.
Among the changes Mr. Schwarzenegger insists be included in a budget agreement are the fingerprinting of recipients of certain state services for the poor and infirm, tighter checks on the job status of those who receive welfare benefits and changes to the state pension program.
“The governor is playing brinksmanship in the middle of the most serious economic crisis since the ’30s with possible consequences for the nation’s recovery as a whole,” said Bruce Cain, a professor of political science at the University of California, Berkeley.
Mr. Schwarzenegger and state lawmakers repeatedly failed to agree on how to close the budget hole by the start of the fiscal year on Wednesday.
So California is now just like a family that spends more than it takes in and holds off on the cable bill while paying the mortgage: its expenses are greater than its revenues. The state, which previously used i.o.u.’s in 1992 and 1933, will issue them rather than checks to those it can get away with not immediately paying.
Most warrants will go to Californians waiting for tax refunds, vendors doing business with the state and local governments, especially in social service areas. Federal and state laws prohibit i.o.u.’s from being issued to state employees, schools or Medicaid recipients.
While it is against federal law for a state to declare bankruptcy, California’s move Thursday will not go unnoticed by Wall Street or escape consequences.
The state’s credit rating is already shaky, and any further downgrades from rating agencies could send interest rates on its bonds soaring, forcing deeper service cuts.
Furthermore, if California comes up short on cash this fall, other creditors will have to wait behind the warrant holders, who would most likely end up in superior credit positions.
In a news conference here Thursday, Mr. Schwarzenegger did not apologize for the state of California’s fiscal affairs and instead stood defiantly against the people he had alternatively battled and wooed for the better part of six years — chiefly Democratic lawmakers, public employee unions and so-called special interests.
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