Gov. Arnold Schwarzenegger's state budget proposal is a realistic first step toward solvency but leaves a $6 billion hole in the following fiscal year and rests on more than $2 billion of shaky assumptions, Legislative Analyst Elizabeth Hill said Tuesday.

Hill said the Legislature should consider tax increases to help close the gap -- a move that the Republican governor has said emphatically he will not make.

"One part of the tool kit -- taxes -- has not been put on the table," Hill said in releasing a preliminary overview of the $99 billion, 2004-05 budget proposal that Schwarzenegger released Friday.

Hill's nonpartisan office advises the Legislature on the budget, and in recent years has warned of the consequences of lawmakers failing to bring spending in line with revenues.

She gave the Schwarzenegger proposal high marks for including realistic estimates of revenue and the size of the state's deficit. Many of the proposed cuts would be permanent and therefore would have a lasting effect on the state's fiscal health, she said.

"In our view, the budget has several positive features and is a solid starting point to jump off for legislative deliberations," she said. The Legislature is required to pass a budget by June 15 for the fiscal year that starts in July.

On the other hand, the Legislature will have to carefully consider the policy implications of the governor's substantial and wide-ranging cuts, Hill said.

The governor's proposal fails to address the full scope of the imbalance, she said, leaving the state facing a $6 billion hole in the fiscal year that starts in July 2005. And that could grow billions of dollars larger if several questionable assumptions fall through.

The proposal counts on $400 million of savings in the prison system, for instance, without offering any details about how those would be achieved. It relies on $500 million of increased revenue from Indian tribes with gambling operations, despite the fact that negotiations until now have garnered little.

It banks on the sale of $930 million in bonds to cover the state's obligations to worker pensions, even though a judge threw out a similar maneuver last year. And it assumes that the state will be able to cut the rates it pays to Medi-Cal providers in spite of a federal judge's recent decision that an earlier cut ran afoul of federal law.

The budget proposal counts on $2.1 billion in savings in transportation. But $800 million of that is an artificial, one-time boost from switching accounting methods, and Hill said the savings would require the California Department of Transportation to add workers to track the cash flow of more than 5,000 projects.

Taking money from transportation also could undermine the economy, which "relies on a well-running transportation system," she said.

Overall, Schwarzenegger's spending plan relies on $2.6 billion more of loans and other borrowing. That's in addition to the proceeds of a $15 billion bond that the governor is asking voters to approve in March to cover accumulated debt.

It also counts on $1.6 billion of other revenues -- such as additional money from the federal government -- and shifting money between funds.

Schwarzenegger argues that a tax increase would hobble a fragile economy and that it's unjustified because the state irresponsibly spent beyond its means.

But Hill said lawmakers should balance the damage to the economy from a tax increase against the ill effects of even deeper budget cuts than the governor has so far proposed, or more borrowing.

While stopping short of endorsing any one tax proposal, Hill mentioned a list of options she presented to lawmakers last February, including ending a variety of tax breaks.

The state, for instance, could limit the deduction of mortgage interest to mortgages of $500,000 or less, instead of the current cutoff of $1 million, and disallow it for second homes. That would save the state $200 million, the Legislative Analyst's Office said.

H.D. Palmer, a spokesman for Schwarzenegger's Department of Finance, said Hill's initial review shows that the governor's proposal should be taken seriously.

"If any legislators had any lingering concerns over the credibility of the budget, those fears were put to rest today," he said.

Indian tribes have shown more willingness to renegotiate gambling compacts than they did a year ago, he said, and the administration has already made inroads on prisons spending.

Palmer said the Finance Department has not had time yet to analyze how Hill came up with a projected shortfall of $6 billion in the following fiscal year, roughly double what the administration has estimated.

But he said that several initiatives Schwarzenegger is proposing to make government more efficient will help to reduce the ongoing deficit.

"We made a deliberate decision not to score any savings in those areas, because it's going to take time to get those done," he said.