In a projection that promises to substantially reshape next year’s policy and political debate here at the Capitol, Legislative Analyst Elizabeth Hill now says the state’s finances will be in the black for 2006-7, and not the red.

[You can read her fiscal report here]

Even so, Hill projects that the state will still spend $4 billion more than it takes in next year. So how, you ask, does that not add up to a deficit?

In a nutshell: an unexpected surplus of cash from past budget years.

Hill’s analysis says that revenues are up dramatically since the LAO’s report this past summer. Higher personal and corporate income taxes– many of which are counted as part of the fiscal year in which they were earned– will brighten the revenue side of the state’s ledger by some $3.9 billion.

The LAO analysis also projects reduced spending this year, largely due to the politically controversial decision to keep school funding lower than required under Proposition 98.

So when you add the “surplus of cash from years past” to the “lower than expected spending” this year… the deficit is apparently erased. Hill’s reports concludes that the state budget can be balanced in the 2006-7 fiscal year “without any new program reductions or added revenues.”

Before anyone starts handing out cigars at the Capitol, Hill says the good news isn’t likely to last. Deficits are expected to return over the next few years, due to the budget’s structural imbalance between revenues and expenditures.

So what will all of this mean, if it comes true, for the year ahead? Will efforts to reform the budget process lose steam as a result? Or will this allow Governor Schwarzenegger and legislative leaders some breathing room to search for compromise on other issues? Granted, the new projections are just that… projections. But they are likely to spark some different atmospherics once lawmakers return in about 6 weeks time.