California Governor Jerry Brown, buoyed by surging revenue fromhigher taxes and a recovering economy, boosted his proposed budgetfor the most populous U.S. state to $107.8 billion for the fiscalyear that begins in July.

The plan would also begin erasing the $73.7 billion unfundedliability of the California State Teachers' Retirement System, thesecond-biggest U.S. pension, by increasing annual contributions bythe state, teachers, and school districts.

“This is good news for California,” said Brown, a 76- year-oldDemocrat. “This budget allows us to pay down our debt.”

The 7 percent increase from the current $100.7 billion ingeneral-fund spending, which pays for most core operations of stategovernment, comes as Brown seeks an unprecedented fourth term. Inhis 2010 campaign, Brown promised to mend state finances that hadbecome so dysfunctional that California sank to the bottom of statecredit ratings and had to issue IOUs to cover expenses.

California's total budget, including federal money and bondfunds, would increase to $156.2 billion under the proposal. It puts$1.6 billion into a rainy-day fund and pays off half of theremaining budget debt former governors racked up to fill deficitsin the last decade.

Surging Revenue

Brown has benefited from a $2.4 billion surge in revenue, mustof it from capital-gains taxes, that has helped the state go from a$25 billion deficit three years ago to a record surplus. Most ofthe revenue increase is consumed by higher costs for health care,schools, and drought relief.

The governor must now wrangle with the Democrat-controlledLegislature, where members of his party are pushing to boostspending on an array of programs cut during the recession.

“We faced a $60 billion deficit three years ago,” said AssemblySpeaker Toni Atkins, a Democrat from San Diego. “This year we lookforward to a surplus. But at the same time that we are beingresponsible, that we are establishing reserves and paying down ourdebt, we have to realize that there are some services and programsthat we need to reinvest in. We need to reinvest in our humancapital.”

Brown persuaded voters to temporarily raise sales and incometaxes in 2012, restrained lawmakers from spending the extra money,and struck a political deal to set up a rainy-day fund to cushionagainst economic downturns and help boost the state's credit.

“The rainy-day fund is a great proposal—it's something thatCalifornia needs,” Ron Schwartz, who helps manage $1.8 billion ofmunis at Orlando, Florida-based Ridgeworth Capital Management, saidin an interview. “It will help them on the credit rating and soit's great to see some responsible steps being taken.”

Still, California has the fourth-highest state unemploymentrate, according to the Bureau of Labor Statistics, and will loseanother 2,000 jobs in suburban Los Angeles as Toyota Motor Corp.moves its U.S. headquarters to Texas. The state owes $340 billionin long-term debt such as unfunded pensions for teachers and healthcare costs for government retirees.

Under Brown's plan for the teacher pension fund, schooldistricts would see their annual contribution more than double, to19.1 percent of payroll from 8.25 percent, phased in over sevenyears. Teachers would pay 10.25 percent instead of the current 8percent, while the state would boost its contribution to 6.3percent from 3 percent.

The contribution changes would bring an additional $450 millionto the fund in the coming fiscal year, rising to $5 billion more ayear by 2021.

Spreads Tighten

The penalty investors demand of California bonds has declined 45percent in the last year, according to data compiled by Bloomberg.California investors get 31 basis points, or 0.31 percentage point,more than top-rated debt for 10-year securities. That's down from56 basis points on June 25.

Voters in California next month will head to the polls in aso-called open primary in which the top two vote-getters,regardless of party, advance to the general election in November.Brown, already the longest-serving governor in California history,leads his nearest Republican rival by 40 points in polls.

The governor is required by law to update his proposal with thelatest tax collection figures before it's considered by lawmakersnext month.

“People seem to think that just because we have $2 billion inunanticipated revenue we are flush with resources,” said SenateMinority Leader Bob Huff, a Republican from Diamond Bar. “But whenyou have Medi-Cal and other programs that cost so much, we do nothave a surplus of money. We have debt we need to take care of and Ithink the governor is wise in keeping a long-term view.”

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