SACRAMENTO – California's budget deadlock began to ease yesterday as Senate leaders announced an agreement that avoids new taxes but relies on an unprecedented $10.7 billion bond sale to keep state government running.

The potential breakthrough came too late to prevent Standard & Poor's from downgrading California's credit rating, already the lowest of any state, to near junk-bond status. The downgrade, from A to BBB, will add $1 billion to the state's borrowing costs for $24.1 billion worth of bonds authorized but not yet issued, said State Treasurer Phil Angelides.

The only good news was that California was given a stable outlook, meaning more downgrades are not likely soon.

State Controller Steve Westly, calling it a "shameful" day for a state with the world's sixth-largest economy, said the credit agency's downgrade triggers a $34 million penalty on the cost of an $11 billion short-term loan obtained last month.

"This is the strongest statement that Wall Street can make that we need to put partisan bickering aside and put our financial house in order," Westly said.

The state has been without a budget since the fiscal year began July 1. A divided Legislature is struggling to close the remainder of a record $38 billion budget gap, trimmed by about $14 billion in previous actions.

Republicans oppose any further tax increases. Gov. Gray Davis' administration, using a 5-year-old law, has announced a tripling of the vehicle license fee on Oct. 1, which is being contested in court. That would raise an additional $4 billion.

Democrats have been pushing for a balanced solution with tax increases and spending cuts, easing the need to make deep reductions in health and welfare programs, which account for nearly one-third of the state's general fund spending.

Few details were released after the agreement was announced yesterday by Senate President Pro Tempore John Burton, D-San Francisco, and Senate Minority Leader Jim Brulte, R-Rancho Cucamonga.

But the two leaders expressed confidence the plan will get the required two-thirds vote in the Senate, which is scheduled to vote on the budget Sunday night. The proposal still would need to be approved in the Assembly before going to the governor for his signature.

The two Assembly party leaders, Assembly Speaker Herb Wesson, D-Culver City, and Assembly GOP Leader Dave Cox of Fair Oaks, commended the Senate leaders, while issuing neutral statements saying they will analyze the new proposal.

Davis, praising the plan's protection of public education, urged both houses to pass a budget quickly. He said the state cannot pay some of its bills and that "the casualties of inaction are mounting."

The Senate agreement avoids tax increases opposed by Republicans, while providing an inflation adjustment for aid to the aged, blind and disabled that Burton personally fought to protect.

"They clearly achieved their goal," Burton said of Republicans, "as we clearly achieved ours."

Brulte refrained from declaring victory. But with the agreement, Democrats abandoned hope of persuading at least two Republicans to join with all 25 Democrats in voting for a tax increase.

One important thing for Brulte is that the agreement would not result in a larger deficit next fiscal year than the $7.9 billion shortfall expected under Davis' budget proposal, which contained $4 billion in additional taxes.

"We have hit that out-year deficit target without any taxes," Brulte said.

Brulte said the $38 billion deficit was accumulated over three years, making it virtually impossible to eliminate in only one year. The heart of the Senate agreement is a $10.7 billion bond paid off over five years.

Davis had wanted to pay off the bond with a $2.3 billion half-cent increase in the sales tax, which is currently 73/4 cents on the dollar in San Diego County.

The Davis administration contends that lenders are demanding that payment for the bond be secured by revenue from a new tax. The Senate plan meets the demand through a complicated tax swap.

A half-cent of the sales tax currently going to local government would be eliminated and replaced with a half-cent tax for the state – providing the revenue to pay off the bond but resulting in no tax increase for consumers.

Local government would be repaid with property-tax revenue that now goes to schools. The schools would be repaid with revenue from the state general fund.

Democrats made a last-minute push, rejected by Republicans, for a quarter-cent sales tax swap that would pay off the bond over 10 years, reducing the drain on the general fund and the need for spending cuts.

Burton had said in recent weeks that the two parties were only $2 billion apart, the amount needed to pay for the bond. There were few details yesterday about how that $2 billion gap would be closed under the new Senate plan.

Brulte said the first bond payment does not have to be made until next July, pushing much of the problem into the next fiscal year. His aides said the plan calls for a wide range of current-year cuts totaling nearly $700 million.

Last year, legislators closed the last $1 billion in a budget gap by simply penciling in $1 billion in unspecified state operation cuts, including an early retirement offer. Those cuts were never realized.

Burton acknowledged that last year's budget, which contained several one-time gimmicks and inflated revenue projections, postponed problems and was a "get-out-alive" budget.

Speaking of the new Senate agreement, Brulte told reporters yesterday: "Anybody who writes this is a get-out-alive budget will be seriously mistaken."

The Senate proposal is close to the school-funding agreement that Davis negotiated with the Education Coalition, which includes associations representing teachers, administrators and local school boards.

"We look at it as a great success if this budget ultimately ends up passing," said Kevin Gordon of the California Association of School Business Officials.

Local government would be hit with a one-time cut of $1.2 billion, mainly from revenue losses for the first quarter of this fiscal year before revenue from the vehicle license fee increase begins Oct. 1.

The League of California Cities opposes the tax swap, fearing, among other things, that after the state bond is paid off, a vote by citizens might be needed to restore the local half-cent sales tax.