Capitol Alert: AG's office questions legality of Assembly budget borrowing

In 2004, Gov. Arnold Schwarzenegger barnstormed around the state for Proposition 58, using an oversized credit card as a prop and vowing that it was time for the state to "tear up its credit card."

Now Attorney General Jerry Brown has concluded that Assembly Democrats' plan to borrow billions to help ease the state's $19.1 billion deficit could be deemed illegal under that ballot measure if challenged in court.

"We conclude that a court could reasonably determine that the proposed transaction violates Proposition 58," the attorney general's office said in a letter to Schwarzenegger's legal affairs secretary.

Assembly Speaker John A. Perez, through his chief of staff, said in a letter to Assembly Democrats Thursday that he remains confident of the legality of their plan.

"Of course, with even the threat of litigation meaning potential delays and uncertainties, we are crossing ever 't' and dotting every 'i' to ensure that (the plan) conforms with Proposition 58," Perez said.

Schwarzenegger's office had asked the AG for a legal opinion on the validity of Assembly Democrats' plan to borrow $8 billion to $9 billion. Debt payments would come from the state's beverage recycling program, which would be back-filled by imposing a tax on oil production.

Brown's office noted that Proposition 58, which voters approved in March 2004, prohibits various kinds of borrowing to fund year-end budget deficits, including options that rely solely on a "designated source of revenue" for repayment.

"In the case of the proposed securitization, the bonds would be repaid solely from the future revenue stream produced by the regulatory fees," said the legal opinion, signed by Constance L. LeLouis, supervising deputy attorney general.

The legal opinion, written Tuesday, concedes that some ambiguity exists in the language of Proposition 58 but concludes that the Assembly plan might not survive a legal challenge.

"We believe that a court could reasonably conclude" that elements of the Assembly borrowing plan "were simply a series of steps by which the state obtained money to fund a year-end state budget deficit in violation of Proposition 58," the legal opinion said.

The AG's office declined to bless the Assembly Democrats' borrowing plan, saying it "could not give an unqualified opinion approving the issuance of bonds based on this transaction."

State finance officials expressed concern Thursday that without the AG's approval, the state would be unable to sell the bonds envisioned by Assembly Democrats, thus creating massive imbalance in the budget and jeopardizing even routine, short-term, multibillion-dollar borrowing to smooth the state's cash flow.

The AG's office said it was specifically requested to examine potential conflict with Proposition 58 so its letter did not address "other legal issues raised by the transaction."

Schwarzenegger, meeting with the media Tuesday, said he considered the Assembly proposal illegal under Proposition 58.

"As you know, under Proposition 58 we cannot borrow," he said. "So the great thing, what we did when I first came into office is, we tightened the noose so that California cannot go out and continue borrowing, because that's what did California in, in the first place.

"That's why we are in this sad situation, because in the old days we were borrowing and borrowing and borrowing. So now we have cut that down, and we also tightened the noose so we can't do that anymore."

Assembly Republican leader Martin Garrick said the legal opinion "confirms what we have said all along -- the Assembly Democrats' borrowing scheme is a lead zeppelin that's not going to fly."

"Given that the centerpiece of the Assembly Democrats" plan has "now been invalidated, it's time for them to start real negotiations with Republicans based on the governor's budget blueprint," Garrick said in a written statement. "Lawmakers need to agreed to reduce spending without raising taxes."

Perez's letter to Assembly Democrats said that their plan ultimately would pass judicial scrutiny because it would repay bonds from fee revenue, not tax revenue, and because the revenue generation is not meant to close the budget deficit in violation of Proposition 58. Instead, the new revenue is designed to benefit the beverage recycling program, but since not all of it would be needed right away, a short term loan could be made to the state, according to the letter.

Senate Democrats had differed with their Assembly counterparts on raising revenue to balance the budget. Rather than borrow money, the Senate plan proposed $4.9 billion in added taxes to help preserve the state's safety net.