California

When Arnold Schwarzenegger appeared on The Tonight Show on Tuesday, he joked with Jay Leno about advice he had given in a recent address to students at the University of Southern California. “I told them to work like hell and marry a Kennedy,” he said, to laughter and applause.

The studio audience loved Mr Schwarzenegger, who is married to Maria Shriver, John F. Kennedy’s niece. Making his 25th appearance on the show, he was in his element sparring with Mr Leno, who poked fun at the California governor’s Austrian accent.

But he has had little to laugh about away from the television studio. In the past two weeks the former movie star has had to deal with the biggest crisis of his short political career after voters in a “special election” spurned revenue-raising measures he hoped would avert financial disaster.

Hailed as the state’s saviour when he replaced Gray Davis, who was ousted in 2003, Mr Schwarzenegger’s poll ratings have reached their lowest ever. Amid a 29 per cent fall in tax revenues since last September, the state faces a budget deficit this year of $24bn (£15bn, €17bn) and the Republican governor is threatening to take a Conan the Barbarian-style sword to spending on health, education and other vital public services. “The people have spoken,” he says in a Financial Times interview. “We have to live within our means.”

With its beaches and laid-back lifestyle, California epitomises the delights and rewards of the American dream. Yet that dream appears to have soured. The state would be the eighth largest economy in the world if it were a separate country, but for the more than 36m people who live there, fiscal meltdown is threatening its very fabric.

No area of public expenditure is being spared in the effort to cut the deficit. At least 200,000 public workers are being asked to take a 5 per cent pay cut and thousands of firefighters, nurses and teachers are expected to lose their jobs. CalWorks, the programme that provides help to the poor and out of work, is to be dismantled. Grants to poor and low-income students are likely to be axed and thousands of jobs will go in the prison system. The early release of some prisoners has been mooted to save money.

Most worryingly, large cuts in Medi-Cal, the state-funded health programme, are being proposed, which would leave an estimated 2m people without adequate health insurance. Money to treat people with Aids and other serious diseases is also at risk.

“Quite frankly, people are going to die,” says Bonnie Castillo of the California Nurses Association. “The vulnerable, the sick, children, the elderly, are all going to have the rug pulled out from under them.” This picture of the poor and dying being denied help is far from the usual one of the Golden State, where a waitress can become a film star and a technology entrepreneur can create a company worth billions of dollars from a garage or basement.

One cause of the problem is the state’s dysfunctional political system. California is one of only three in the US that requires a two-thirds majority in its legislature to approve a budget. With the state’s upper and lower houses evenly split between Republicans and Democrats, securing a two-thirds majority on all but mundane matters is practically impossible. A two-thirds majority is also required to raise taxes, which limits the ability of the governor to balance the books.

California’s system of direct democracy, while laudable in aim, is another headache. “Ballot initiatives” were introduced in 1911 by Hiram Johnson, then governor, who wanted to curtail the influence of the mighty Southern Pacific Railroad and return power to the people. Since then, any issue can be put to a state-wide vote, provided half a million or so signatures are gathered to support a change in the law.

Ballot initiatives were intended to give a voice to voters. “It was supposed to be about mom and pop talking about something around the dinner table and then getting all their friends to sign a petition,” says Dan Mitchell, professor emeritus at the UCLA Anderson School of Management and the School of Public Affairs. “But most initiatives on the ballot don’t start that way.” Instead wealthy individuals and special interest groups “pay a couple of million dollars to employ people to collect signatures outside of supermarkets”.

Ballot initiatives have resulted in controversial laws being passed, such as the amendment to California’s constitution that outlawed gay marriage in California last November. The state’s constitution is bursting with such amendments, which can often impose huge constraints on financial planning, such as the 1998 proposition that committed the state to spending 40 per cent of its annual budget on education.

Mr Schwarzenegger admits the two-thirds majority rules and the ballot proposition process have been a hindrance. “It’s governing with your hands tied behind your back,” he says. The final link in California’s fiscal chain is its tax system. “It’s flawed,” he adds. “It has failed us over and over again when we have a downturn. We in California rely very heavily on rich people paying taxes – income taxes and capital gains.” This imbalance is partly because of legislation passed in 1978 – via a ballot initiative, naturally – that set strict limits on property taxes.

Though California is home to some of the richest people in America, the economic slump has decimated its tax base. To offset against the impact of future downturns, Mr Schwarzenegger tried in the recent vote to increase the size of the state’s rainy-day fund. “You go through these economic cycles,” he says. “There is a downturn and then [during periods of growth] you have a surge in revenues. But we don’t prepare for the downturn.”

Voters rejected that idea, however, and Mr Schwarzenegger is now looking at options to raise money to reduce the deficit. Near the top of the list is the sale of publicly owned buildings, such as the San Quentin prison and the Los Angeles Coliseum, which hosted the 1984 Olympics.

Cuts to health and social programmes, though, have sparked the biggest public response, which leads Prof Mitchell to conclude that the governor may have an ulterior goal.

“California is trying to do what North Korea is trying to do,” he says. “And that is to get Barack Obama’s attention. California doesn’t have a missile to shoot off like North Korea but if we have to put sick and dying children on the street ... ultimately, the Obama administration is not going to be able to run away from that.”

The state has already received federal stimulus money. It is seeking more help, although it has not made a direct request for cash. “We don’t want any more money [from the government] to bail us out,” says Mr Schwarzenegger. “You can get one-time money from the federal government and the next year you have the same problems. We have to make cuts so that next year we don’t have [these problems].”

Instead, the state is asking the government to guarantee its bond sales – to become, as Bill Lockyer, state treasurer, puts it, “a municipal market backstop”. It needs $15bn to meet short-term spending obligations, such as teachers’ and doctors’ salaries. But its fiscal troubles have left it with the country’s worst credit rating. With its deficit set to balloon past $24bn to more than $40bn within 12 months, the cost of issuing bonds will rise sharply.

“If [the US Treasury] backs us, we will get a lower interest rate,” says Mr Schwarzenegger. “That’s what we’re looking at.” Treasury assistance would cut the cost of borrowing but also set a precedent the White House might prefer to avoid as other states and municipalities struggle with the recession.

Critics say Mr Schwarzenegger’s plan to impose swingeing cuts runs counter to the aims of Mr Obama’s stimulus package. “The cuts are an anti-stimulus package by every measure,” says Art Pulaski, executive secretary of the California Labor Federation, which represents close to 2m workers in the state. “Every dollar that comes into California from Obama will be dismantled dollar for dollar by the Schwarzenegger cuts. The state should instead be looking at the billions of dollars in corporate tax giveaways that were in the budget.”

Mr Schwarzenegger, though, suggests California needs a reality check. “The state and its people have to make major sacrifices,” he says. “There are no two ways about it.”

With 18 months left before the end of his final term as governor, he is running out of time to turn California around. He continues to be popular outside the state, mainly thanks to his role as a leading advocate of action to curb greenhouse gas emissions. But at home his approval ratings are likely to fall even further as California absorbs the impact of his budget cuts.

Mr Schwarzenegger says he is unconcerned. “You don’t go into this business to win a popularity contest. I have been sent to Sacramento to lead this state in good times and in bad. I’m just the person trying to lead and bring people together so we are all marching in the right direction.”

When campaigning for his first term, Mr Schwarzenegger said he would shake up the state – invoking the Terminator, the ruthless cyborg that is his best-known character. The worry now is that California may face its own version of Judgment Day.