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California credit quality may improve with tax measure: S&P

SAN FRANCISCO (Reuters) - California's credit quality looks to improve after voters approved a measure on Tuesday that increases taxes to avoid education spending cuts in the near term and bolster the state's budget in coming years, Standard & Poor's Rating Services' analysts said in a note on Wednesday.

"The measure does more than temporarily increase operating revenues and, in our view, is the linchpin to the governor's broader, multiyear strategy for reversing the state's negative budget position," the analysts said.

"By providing a temporary but significant boost in tax revenues and permanently lowering its general fund spending baseline, we believe Proposition 30 helps alleviate the state's chronic fiscal strain," the analysts added.

They said improvement in California's credit rating depends on whether its legislature will be able to enact substantive fiscal reforms now that it has additional revenue from Proposition 30 to stabilize the state's finances.

"There is potential, in our view, for material improvement of the state's credit quality if lawmakers reach agreement on reforms that help stabilize the state's fiscal performance while the temporary taxes are in effect," the analysts said.

But if lawmakers fall short, California's budget deficit could return when Proposition 30's tax increases expire and "we would be unlikely to view the state's credit quality as significantly improved," the analysts said.

S&P rates California's general obligation debt 'A-minus' with a positive outlook. The rating is lower than all other states other than Illinois.

Brown, a fixture in California politics, and Democratic lawmakers opted to put Proposition 30 to voters after failing to win support from Republicans for tax increases.

Brown and Democrats also passed a budget which depended on voters approving Proposition 30. Failure would have triggered $6 billion in cuts aimed mainly at education spending in the middle of the current school year, including $5.4 billion in cuts to schools and community colleges.

Proposition 30 raises the state sales tax by a quarter-cent for four years, and increases for seven years, income tax rates for individuals who earn more than $250,000 a year.

S&P's analysts said that revenue raised by the measure may help California pay down 74 percent of its approximately $34 billion in off-balance-sheet obligations from budget liabilities and payment deferrals over the past decade.

Revenue from the measure will also help pay for the state's so-called "realignment" initiatives pushed by Brown, the analysts said.

The initiatives involve handing responsibility for some programs, such as jailing low-level criminal offenders, to local officials. Helping secure funds for realignment will help reduce the state's base spending over the long term, the analysts said.

One concern for S&P over Proposition 30 is that the measure "could exaggerate the state's tendency for revenue volatility" as 80 percent of its new revenue will come from high-income taxpayers, the analysts said.

California relies heavily on income taxes for its revenue. Revenue has plunged in recent years due to the housing crash, financial market turmoil, recession and high unemployment, forcing California's leaders to rely on spending cuts and various one-time moves to keep the state's books balanced.

(Reporting By Jim Christie; Editing by Chizu Nomiyama and Carol Bishopric)

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