The state of California is headed toward bankruptcy. The state has the dubious honor of having the lowest bond rating of any state, worse than even corrupt Louisiana, and its politics is not conducive to compromise. Years of extreme redistricting has created safe Democratic and safe Republican seats. Thus the only challenge to a state representative’s reelection comes not from an opposition candidate, but from a primary. This means that Republicans heading to Sacramento get more conservative and Democrats ever more left-wing. Instead of moderating government spending or raising taxes with increased spending, the state legislature is filled with entitlement-loving liberals and tax-hating conservatives. Add to the picture the constant state referendums passed by voters for more state spending though with no parallel increase in taxes and it is not surprising California has reached the brink.

The final straw came when voters rejected a ballot initiative that would have increased taxes. The state legislature must now make drastic cuts in spending, including shortening the school year, or else California will go bankrupt.

And now The Wall Street Journal reports:

California State Controller John Chiang said he will have to issue IOUs starting July 2 if immediate solutions aren’t quickly adopted.

At the same time, California’s Department of Finance said it will take the unusual step of drawing on a debt reserve fund July 1 in order to make a payment coming due on the state’s Economic Recovery Bonds.

“Next Wednesday, we start a fiscal year with a massively unbalanced spending plan and a cash shortfall not seen since the Great Depression,” Chiang said.

About $15 billion of the ERBs were sold in 2004, backed both by the state’s full faith and credit and by sales tax revenues, which now are plunging in the Golden State. Curently, there are $8.6 billion of the ERBs outstanding.

The state faces a $26 billion deficit and a compromise has not been reached. Democrats propose “levying a 9.9% tax on oil production, a $1.50-a-pack boost in the cigarette tax and a $15-per-vehicle registration fee.”

Republicans want to see a reduction in spending. Democrats will probably be forced to make some cuts, but are loath to go against their spending instincts.

One of the reasons California faces such a revenue shortfall is that its tax structure is so heavily titled toward the rich. The top 1% of Californian earners pay 25% of state tax revenues. As The Economist once put it, the state economy is as deep as the ocean yet it taxes only the foam. With the recession, the rich lost much in stock options and their contributions, both in income and capital gains taxes, naturally fell. If Democrats want to see taxes increase, it is only far that, say, cigarettes and vehicle registration fees that everyone pay are increased.

But the Republicans, who are in the minority in both houses but maintain veto power, may oppose such moves. What will happen to America’s largest continental state and its wealthiest, and one of the biggest economies in the world remains yet to be seen.

As for a change in redistricting that will lead to more consensus-seeking politicians that will be more likely to avoid such a predicament. The state legislature has passed a law that will allow retired judges, instead of professional politicians, to start drawing mixed Republican-Democratic districts starting with the 2010 election. That should help.