Gov. Arnold Schwarzenegger, flanked by senior state legislators, discusses the budget compromise reached to resolve California's $26.3 billion budget deficit at the Capitol in Sacramento on Monday, July 20. (Rich Pedroncelli/Associated Press)

California Gov. Arnold Schwarzenegger and state legislative leaders agreed Monday on a plan to close the state's $26-billion US budget shortfall, potentially getting the state back on firm financial ground so it can stop issuing IOUs.

The governor and leaders from both parties announced the compromise after more than five hours of closed-door talks.

If the agreement survives its run through both houses of the legislature, it would provide temporary relief to an epic fiscal crisis that has captured nationwide attention, sunk the state's credit rating and forced deep cuts in education and social services.

Offices of prominent legislators began releasing information on the framework of the deal, which includes $15 billion in cuts. Those reductions will come on top of an equal amount of spending cuts enacted in February.

The rest of the deficit will be made up by a combination of borrowing from local governments, shifting money from other government accounts and accelerating the collection of certain taxes.

Education cuts

Legislators' staff confirmed the cuts included $6 billion to K-12 schools and community colleges. Nearly $3 billion will be cut from the California State University and University of California systems, while the state prison system will be cut by $1.2 billion.

Medi-Cal, the state's health program for the poor, will be cut by $1.3 billion.

Welfare, in-home support services and a health-care program for low-income children also would suffer cuts but would not be eliminated as Schwarzenegger had originally proposed.

In exchange, the budget includes some of the reforms to social programs Schwarzenegger desired, including changing the duration that welfare recipients can continuously receive benefits.

Schwarzenegger also succeeded in having a proposal to expand oil drilling off the Southern California coast included in the budget agreement.

No tax hikes

Schwarzenegger and Republican legislators refused to raise taxes, limiting legislators' options. Democrats, meanwhile, had fought to preserve basic social services, including welfare, in-home support and health care for low-income children.

In the end, both sides said they had accomplished their goals under extraordinarily difficult circumstances.

"It was like a suspense movie," Schwarzenegger told reporters after emerging from his office shortly before 7 p.m. "Like I said, we have accomplished a lot."

The Republican governor described the compromise as a "basic agreement" to close the state's massive shortfall. The Democratic and Republican leaders of the assembly and senate were at his side.

Their plan will be distributed to rank-and-file legislators over the next day or two, with votes in the legislature projected for Thursday. The budget requires a two-thirds vote in each house to pass, meaning all Democrats and a handful of Republicans must support it.

Democrats satisfied

Democrats described the budget-balancing deal as one that protects the most vulnerable members of society.

"We have closed the deficit.… We have protected the safety net," said Democratic assembly Speaker Karen Bass.

Monday's announcement ends a little more than two weeks of intense negotiations that began shortly after the start of the fiscal year July 1, after the legislature failed to pass interim steps that could have delayed the IOUs.

The state controller's office has been sending the pay-you-later warrants to thousands of state contractors and vendors that provide an array of state services. State finance officials hope a balanced budget will allow the state to obtain short-term loans to cover its daily expenses until most of the tax revenue arrives in the spring.

If it does get the loans, it would be able to stop sending IOUs, which have served as the most visible symbol of California's cash crisis and opened the state to ridicule. California last issued IOUs in 1992 and has done so only twice since the Great Depression.