Gov. Gray Davis is set to unveil a major overhaul of his budget plan Wednesday that will rely on borrowing to roll part of the state's massive deficit into future years and raising the sales tax a half-cent to repay the debt, sources told The Bee Monday.
Sources also said Davis will abandon a large chunk of his plan to turn over $8 billion in state government services to cities and counties -- the centerpiece of his January budget proposal.

Davis has taken a cue from Republican lawmakers and others who have pressed him to spread out the sting of an unprecedented budget deficit by selling billions of dollars in bonds to wipe out part of the shortfall.

Though GOP lawmakers wanted to roll over part of the deficit without raising taxes, Davis' plan reportedly will call for a half-penny sales tax increase to pay off deficit bonds.

"My preference from the outset was to take the bitter medicine, balance the budget in one year, eliminate the structural deficit going forward," Davis said last week. "The Legislature clearly, on both sides of the aisle, would prefer to spread this out over several years."

Wall Street bankers urged finance officials to include a new revenue stream after Davis' budget writers floated a plan to investment firms that would sell more than $8 billion in deficit bonds. In Sacramento County, adding a half-cent to the sales tax would elevate it to 8.25 cents on the dollar.

In another major reversal from his plan, Davis has scrapped three-quarters of his "realignment" plan -- the cornerstone of his January budget that was met with dismay by local governments and officials who said it aimed to circumvent school funding requirements.

Local government officials and lawmakers rallied against the realignment plan, saying it would sap too much from cities and counties, and the Legislature's lawyers issued a legal opinion in February that cast doubt on the assumption that the proposal would not affect education funding.

The Legislative Counsel's Office concluded that California would be legally required to divert billions of dollars in revenues from Davis' proposed tax increases to schools rather than local governments.

The legal opinion claimed the realignment would siphon off to schools as much as half of the $8.3 billion raised from increasing taxes on shoppers, smokers and top earners.

Rather than shifting a host of state services to local governments, sources said, the scaled-back realignment amounting to about $2 billion would require them to contribute more to running services now administered by the state.

Davis will retain at least some of the tax increases he proposed in January to direct to cities and counties to help offset the new expenses, sources said. But it is unclear which of the tax increases -- which included a cigarette tax hike and tax increase for wealthy workers -- he will keep.

Davis in January released a $96 billion state budget for the 2003-04 fiscal year that included tax increases, borrowing and other measures -- including the realignment -- to fill a gap he estimated would grow to $34.6 billion.

The Legislature approved spending cuts and other savings that have shaved $12 billion from the shortfall, and many lawmakers expect the administration to trigger a hike in the car tax that will bring in $4 billion next year.

But Davis' January budget has suffered a series of setbacks. Questions were raised about the realignment, the sale of about $2 billion in tobacco bonds was postponed, and state workers unions balked at Davis' request to reshape contracts to cut costs.

In addition, officials have said California's budget hole has worsened by billions because of a decline in revenues and higher-than-expected spending.

The Democratic governor will release the so-called May Revision of his spending plan for the fiscal year that begins July 1 under political pressure from groups slated to suffer deep cuts and under the cloud of low popularity marks and an ongoing recall effort.

Though the new plan will continue to call for major program cuts, sources said it seeks to heal some political wounds by restoring some funding to schools, community colleges and local law enforcement -- despite warnings that the state's fiscal situation has not met January expectations.