By Kevin Yamamura
kyamamura@sacbee.com
Published: Saturday, Oct. 2, 2010 – 12:00 am | Page 1A
Last Modified: Saturday, Oct. 2, 2010 – 9:24 am

Three months into the state’s longest budget impasse, Gov. Arnold Schwarzenegger and legislative leaders reached a handshake deal Friday to close the state’s $19 billion deficit, leaders announced after a five-hour meeting.

To bridge the gap, they are relying on about $7.5 billion in spending cuts, as well as delaying a corporate tax deduction and using rosy projections for how much the state will receive in tax revenues and federal dollars, according to sources close to budget talks.

Standing outside Schwarzenegger’s office beside the three other legislative leaders, Senate President Pro Tem Darrell Steinberg, D-Sacramento, said legislators will return to Sacramento next week to finalize their “comprehensive agreement.” The Legislature plans to vet the plan in a joint budget committee Wednesday and hold floor votes Thursday.

“These are very difficult circumstances in difficult times,” Steinberg said. “Not a lot of celebrating. But we all stepped up and did the work we had to do.”

As part of the deal, state leaders will place a measure on the 2012 ballot to strengthen the state’s “rainy-day fund” that is a softer version of one voters rejected last year.

Schwarzenegger and legislative leaders also seem confident that Service Employees International Union Local 1000, which represents 95,000 state workers, will reach a contract deal within the next week that includes pension reductions for future employees. The governor demanded pension cuts and a “rainy-day fund” as conditions to signing the budget.

“The governor has said since Day One he will not sign a budget that increases taxes and that does not reform our budget and pension systems,” said Schwarzenegger press secretary Aaron McLear. “That remains the case.”

Steinberg and Assembly Speaker John A. Pérez, D-Los Angeles, believe the governor must negotiate pension changes with the unions through collective bargaining. Fifteen of 21 bargaining units have not reached contracts on salary reductions to current employees and pension cuts for future workers. Schwarzenegger officials and the SEIU have held informal talks all week.

“The administration is working very hard and very well with SEIU – and will be with all the other collective bargaining units,” Steinberg said. “We’re very hopeful that they’ll reach agreements with at least the vast majority of collective bargaining units.”

At 94 days, the budget stalemate already has surpassed the previous 85-day record set in 2008. With a vote Thursday – Day 99 – the delay is certain to reach the century mark by the time Schwarzenegger signs it.

The stalemate has been painful for a select group of state contractors, child care centers, health care providers and low-income college students, all of whom have gone without payment from the state since July 1. Dozens of child care centers serving low-income families have had to close or reduce hours, while others that rely on state funds have taken desperate borrowing measures.

Schwarzenegger in May proposed eliminating welfare-to-work and state-subsidized child care for 142,000 children. But Democrats were able to minimize cuts as Republicans essentially agreed to approve the Democrats’ budget proposal for social services and health programs, sources said.

Democrats agreed to lower their demand for K-12 spending, but with promises to repay education in future years for cuts absorbed now and in past budgets.

Republican legislative leaders blocked proposals to charge an insurance tax for fire services and divert low-level state prisoners to local jails. They also rejected Democratic ideas to tax oil production and swap higher income and vehicle taxes for lower sales taxes.

While most tax ideas went nowhere, Democrats won one tax concession from Republicans – a suspension for two years in the state’s net operating loss deduction, worth $1.4 billion. Under a 2008 budget agreement, companies were supposed to gain flexibility this year to deduct current operating losses against past profits for tax purposes.

Although Schwarzenegger initially called the suspension a tax hike, Senate Republican leader Dennis Hollingsworth of Murrieta said Monday that “it’s not a tax increase.”

Republicans won changes that reduce taxes for companies in the cable television, software and oil industries, according to one source. Republicans said those industries were unintentionally harmed under a 2008 tax break law. It is unclear how much the changes might cost under the final proposal.

To help minimize cuts, state leaders agreed to a mix of rosy assumptions and onetime solutions. Steinberg said Monday that they will rely on a projection from the nonpartisan Legislative Analyst’s Office that the state will receive $1.4 billion more in 2010-11 than the Department of Finance has predicted.

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