Tax Hikes, Spending Cuts Expected to Hit State Hard : Economy: Laws force government to do the opposite of what is needed to end slump, experts say.

The impending round of tax hikes and spending cuts in California will cost rich and poor consumers billions of dollars in the coming months, increase the price of business equipment and further slow the slumping state economy.

Taken together, these forces could make for a weaker recovery when the upturn finally begins in the state, or even prolong the recession, according to analysts. “We’re doing all the things that make the state come out of the recession more slowly,” said Jeffrey I. Chapman, an economist who runs USC’s Sacramento Center. “We’re doing things backwards.”

Some experts say that slumps are a time to expand government spending, especially at the federal level, not to cut it back. But because California is prohibited from running a budget gap, there is little alternative to a painful combination of tax hikes and spending cuts to combat its $14.3-billion deficit.

The effect of a higher sales tax and other new levies is no mystery to economists: “When you raise taxes, the money comes from someplace. It affects the way people spend,” said David M. Blitzer, chief economist and research director at Standard & Poor’s, a financial research and credit rating agency in New York. “It’s not a free ride.”

Starting next week, California residents will pay an extra 1.25 cents sales tax on each $1 (amounting to an 8.25% levy in Los Angeles County). On top of that, the sales levy has been broadened to cover periodicals, candy and other snack foods; a separate excise tax on alcohol will go up; motor vehicle license fees are set to rise--$60-a-vehicle on the average; basic welfare grants will be trimmed by 4.4% and the wealthy face the prospect of higher income taxes.

These measures, which take a direct toll on people’s purchasing power, represent the latest in a series of difficulties for the state’s traditionally buoyant economy. Moreover, they could reinforce California’s image as a costly place for business, a factor that has been making it harder for the state to keep employers and attract new ones.

“The budget problem is bad not only for government but for business as well,” said Don Butler, president of the Merchants and Manufacturers Assn. in Los Angeles.

But if the budget problem is bad, the solution comes with costs of its own. The one-two punch of tax increases and spending cuts could result in a $5-billion drop in spending power in California this year, said Ted Gibson, principal economist with the state Department of Finance.

In a normal period, such a hit might register little on the state’s gigantic economy, now estimated at $765 billion. The deficit-cutting plan, however, adds to a group of economic minuses including retrenchments in aerospace, overbuilt commercial real estate, shaky bank loan portfolios and fallout in agriculture from the freeze and drought.

Together, these problems have been choking off most economic growth in California. And that means the budget cure comes at a particularly difficult time.

“We lived beyond our means, and now we’re going to have to pay the piper,” Gibson said.

To pay the piper, government will take its place with manufacturing, construction and retail as major employers with doubtful hiring prospects for the near future. In past months, state and local government have been among the fastest-growing sectors in California.

Due to the budget crunch, layoffs are possible, and most state government job vacancies cannot be filled from outside. An estimated 180,000 state government employees already have lost a 5% pay raise that was granted in January--and may lose another 5% before the final budget deal is cut.

Economic ripple effects, meanwhile, are spreading into communities, as state funds are cut back. Budget problems have been seen in Los Angeles, Beverly Hills and scores of cities that stand between the two economically. A report this week by the National League of Cities found that six out of 10 U.S. cities will face a budget crunch this year--jeopardizing jobs and public services.

“My hunch is that another $1 to $2 billion of budget balancing is going on in the local governments,” Gibson said.

Fallout from the state’s fiscal crisis also has important implications for business: For better or worse, strategies to close the budget gap could affect California’s ability to compete with other states for jobs.

The new sales tax levels will be among the highest in the country. The sales tax isn’t just a consumer issue: Costs are pushed up for machinery and supplies used by private firms, although raw materials are excluded.

Sales taxes are “particularly tough on those businesses that are barely getting by,” said Brad Sherman, chairman of the State Board of Equalization, which administers taxes in California.

To employers, such tax proposals are just the latest source of unhappiness with operating in California. Gripes about complex regulations and unsympathetic regulators and high costs for land and labor all have been heard increasingly from executives in recent years.

Those who worry about the state’s desirability as a place to run a business complain loudest about the cost of workers’ compensation, an issue that has gotten tangled up with other proposals in last-minute budget negotiations.

“We’ve got a variety of strikes against us,” said Larry McCarthy, president of the California Taxpayers’ Assn. in Sacramento. “Increasing taxes and not attending to workers’ compensation basically makes California less competitive.”

By dealing with employers’ criticisms about workers’ compensation, government officials would send a meaningful signal of their commitment to improve California’s business climate, McCarthy said.

No one doubts that California will emerge from the economic doldrums, if perhaps more slowly than the nation overall. Some experts worry, however, that another budget fiasco will occur in the next downturn--with related economic disruption--because state government has become dependent on sources of cash, such as the income tax, that are highly linked to the ups and downs of the economy.

This volatility means that state coffers could refill rapidly when the economy finally recovers. A portion of the sales tax increase could be eliminated as early as next July under state law, although county governments will have the option of preserving the higher levels.

But if spending escalates too quickly and there is little change in the sort of taxes that state government relies on, “The next time we have a recession, we’ll be right back in the soup,” said John J. Kirlin, a professor of public administration at USC’s Sacramento Center.