One of the governor’s more creative– and controversial– ideas for helping balance the state budget has been rejected by lawmakers in the Assembly.

Governor Schwarzenegger’s plan to shift the state’s contribution to the California State Teachers Retirement System (STRS) to local school districts might have saved as much as $500 million in the coming budget year.

But since its introduction in January, critics have said the plan would place a new burden on local schools that are already strapped for cash, while also leaving the door open that local officials might decide to simply not put the money into the CalSTRS system at all.

Earlier today, the Assembly Budget Subcommittee on Education voted to reject the proposal, with Democrats complaining that it would have made it even harder for schools to spend more on students.

That might be what budget watchers are asking themselves after the state’s tax amnesty program triggered a multi-billion dollar response from companies hedging their bets about what they really owe.

Controller Steve Westly updated the numbers this morning, which aren’t that easy to understand. Overall, the amnesty program looks to have generated some $3.5 billion worth of money being deposited into the state’s bank account.

But how much of that so-called found money is real? Last week, Westly said much of it came from businesses trying to avoid the amnesty program’s steep penalties by filing a “protective claim”– in other words, they sent in the money while also continuing to appeal their tax cases.

And if a company wins that appeal, the state has to give the money back.

Using that knowledge, the current numbers are much more down-to-earth: $675 million appears to be true extra money for the state, while $2.8 billion is “protective claim” money.

(Interestingly enough, Westly says 85% of that “protective claim” money came from only 100 large companies)

So, how much extra cash will the governor and legislators have to work with? No easy answers, although Westly believes more than half of the so-called “protective claim” cash will remain with the state.

If that comes to pass, there could be as much as $2 billion extra to solve the state’s budget crisis. It’s one-time money, true, but it would likely lead to numerous calls to lessen some of the most severe budget cuts now on the table.

It’s doubtful that the governor’s “Kitchen Cabinet” event today with citizens in Santa Rosa will get much media attention, given the bomb he dropped at the Capitol this morning: he’s abandoning pension reform for 2005, both in the Legislature and on the ballot.

Before the event, it was clear from the steady stream of law enforcement officers making their way to the dais that something significant had changed. And while Governor Schwarzenegger was his usual ebullient self, there was a clear sense that criticism of his plan’s impact on death and disability benefits for police and firefighters had sunk in.

There also seemed to be a hint of unhappiness with a new poll (find it here) that shows Schwarzenegger’s job approval dipping below 50%… and it came in a question I asked him about why he was changing his mind on pensions.

“Let me just tell you, that what I do with my agenda, the protesters or poll numbers have absolutely no impact on what I do, because I’m very focused and I shoot for what needs to be fixed.”

Nonetheless, he says he will wait until 2006 to “fix” the pension system– either through negotiations with the Legislature, or by placing a reworked initiative on the June 2006 ballot.

A couple of other observations from today’s big news events:

* The spin on who had won, or lost, this particular battle was intense. Ignoring the substance of what he had just said, the governor wrapped up his news conference by saying, “I declare victory on this, a victory for California.” A short while later, Assembly Speaker Fabian Nunez was quick to reply, “We welcome his retreat on the initiative.”

* It seems clear that the last three days were the final straw. Both Schwarzenegger and families of fallen law enforcement officers pointed to a long and emotional meeting in the governor’s office on Monday. “These were powerful arguments, ” said Schwarzenegger, although he also said he still believes the fears of denying these benefits were a “misconception.”

* So what happens in regards to the governor’s other proposals (budget cuts, redistricting, teacher pay)? Democrats likened the situation to one bullet being taken out of a gun, but the gun “still has three bullets in it”, according to Nunez. And even the governor seemed unwilling to demand specifics in his so-called reform agenda, saying that he only insists on “the outcome.”

A Schwarzenegger appointee to the California State Teachers Retirement System (CalSTRS) board was rejected today by Senate Democrats… as the battle over the governor’s plan to privatize public employee pensions continues.

The Senate Rules Committee rejected nominee Kathleen Smalley, who was the last remaining Schwarzenegger appointee to the CalSTRS board. On February 3rd, a majority of the board voted to oppose the governor’s pension proposal. The following week, the governor withdrew four of his nominees who voted with the majority– Jim Gray, Gloria Hom, Mark Battey, and Miguel Pulido. But Smalley’s nomination remained, apparently because she voted to support the governor’s proposal.

For those who need a quick primer: the governor’s plan would turn the pension system for state employees into something more like the private sector’s 401(k) plan for employees hired after July 2007.

Today, Democrats said if the governor could use an appointee’s position on the pension plan as a litmus test, then they could, too. Senate President Pro Tem Don Perata said that Smalley’s vote in favor of the governor’s plan “put her at odds with her duty to protect teachers and the retirement funds on which they depend.”

The decision seems to be yet another sign that compromise on the governor’s self-proclaimed reform agenda is still a long ways away.

For those of you who think you could do a better job than the elected officials at mapping out the state’s broad budget priorities, here’s your chance.

A new organization called Next Ten today unveils its “California Budget Challenge”… which you can try yourself by clicking here. The group, which bills itself as independent and non-partisan, says the game gives individuals a chance to think about the state’s fiscal priorities on a macro scale over the next 10 years.

I gave a beta version of the challenge a try a few days ago. While it’s limited in some of the choices you can make (the broad options usually force you to choose specific amounts of increased or decreased spending, without having any middle-ground alternatives), it does show that budget balancing is tough. You can increase education spending, for example, but only if you make other large cuts or raise some taxes. And of course, the game doesn’t allow you to do what lawmakers have done the last few years: borrow your way out of the hole.

The governor’s budget advisers have decided to scrap plans for issuing a bond to settle a long-running lawsuit over flood damage.

At issue is a tentative court agreement for the state to pay $464 million to settle claims stemming from a levee break on the Yuba River in 1986. The break left water on some 7,000 acres near the communities of Olivehurst and Linda, and hundreds of homes and a shopping mall were flooded.

The idea to pay that settlement with a bond, first unveiled in January, would have been precedent setting. The Legislative Analyst’s Office (LAO) has said it knows of no previous attempt by the state to issue what’s known as a judgment bond.

An LAO analysis in February also raised a lot of questions about the proposal– wondering if the bond would require a vote of the people, and pondering the final cost to the state, considering a bond would likely be paid back over 30 years.

The first hint of the administration’s decision to dump its bond proposal can be found deep inside budget adjustment documents sent to the Legislature today.

The administration now wants to pay $11 million of the settlement out of the 2005-06 budget. And the biggest portion– $428 million– would be paid over 10 years, with interest, thanks to an offer by financial investment giant Merrill Lynch to front the cash now.

Bottom line: the new plan for settling the lawsuit is more conservative in how it’s structured, but would cost the cash-strapped state more in the short-term.