The spending plan for the fiscal year that begins in July is austere, a byproduct of a slowing state economy.

Tax revenue has been falling far short of what California needs to keep pace with spending obligations, leading to a $15.2 billion shortfall.

"As everyone knows, we are facing an extremely tough budget year," Schwarzenegger said during a news conference at the Capitol. "Our crisis is real, and it is very serious."

KCBS' Doug Sovern reports

The centerpiece of Schwarzenegger's budget relies on a plan to make the state lottery more lucrative and thus more attractive to potential investors.

The governor hopes to raise $15 billion over the next three years by selling bonds based on anticipated lottery revenue. He will use about $5.1 billion of that in the 2008-09 fiscal year to help erase the state's deficit.

The other $10 billion would remain in a reserve fund the governor wants to create to help the state get through rough financial times in the future.

Schwarzenegger said creating a reserve fund is crucial if California is to avoid severe financial problems in the future. He said California's tax system means revenue can fluctuate wildly from year to year, while the budgeting and initiative process have created a system in which spending rises every year.

The governor, sounding frustrated at having to deal with yet another budget deficit, said that instability needs to be resolved.

"So now we are back again, and I want to say to the people of California and to the Legislature, how many more years, how many more decades, should we go through this crisis?" he said.

Even without more far-reaching structural budget reform, Schwarzenegger said putting $10 billion from a lottery bond into reserves will help future governors cope with budget deficits.

The revenue proposal _ which administration officials refer to as "securitizing" the lottery _ would require voter approval on the November ballot because the lottery was established through the initiative process.

If it fails, the governor will ask the Legislature to approve a temporary 1 cent increase in the state sales tax to pay for the reserve fund. It would last no more than three years.

Schwarzenegger's fellow Republicans said they disagree with his plan because it links the lottery and sales tax proposals. They have taken a pledge to oppose any tax increase.

"The idea that we use the lottery to pay down debt is a good one," said Assembly Minority Leader Mike Villines, R-Clovis. "Tying it to borrowing is, I think, a mistake, and tying it to a tax is a mistake."

Sen. George Runner, R-Lancaster, said Schwarzenegger had reversed his long-standing pledge against a tax increase.

"The fact is you're tying to secure future dollars on a scheme that has yet to be proved and ... if it doesn't work, triggering a tax increase," he said.

The Democratic leaders of both houses also were critical.

Assembly Speaker Karen Bass, D-Los Angeles, praised Schwarzenegger for trying to find new ways to raise money and not reducing the deficit solely through cuts. But she decried a proposed $2.9 billion reduction to health care and social service programs, and an $824 million cut to public transit.

State Sen. President Pro Tem Don Perata compared Schwarzenegger's plan to sell lottery bonds based on future revenue to the kind of ill-advised lending that led to the housing crisis.

"The lottery proposal he unveiled today seems to me as the worst kind of market speculation," he told reporters.

Perata, D-Oakland, also said basing the state's fiscal health on increased gambling revenue was a bad idea that glossed over the state's persistent imbalance between revenue and spending. He has said California must look at reforming its tax system.

"With this budget, it is kind of 'Hey, California, you can have it all and now gaming interests and gaming revenues will pay for it _ the schools, the health care system, public safety,"' Perata said. "It's not unlike Countrywide (Financial Corp.) telling people you can have this house for no money down and interest-only payments."

Schwarzenegger's plan to sell bonds based on lottery revenue is part of a trend among some states that are considering ways to tap their lotteries to help pay for ongoing operations.

Pam Taylor, spokeswoman for the National Association of State Treasurers, said she knew of no other state that has moved to securitize its lottery as California is proposing.

Several states are examining privatization or borrowing plans, said David Gale, executive director of the North American Association of State and Provincial Lotteries in Geneva, Ohio.

Among them are Florida, Illinois, Indiana, Texas and Vermont, which have expressed interest in cashing in on some of the value in their lotteries. Typically that has meant selling all or a portion to private investors.

Illinois is considering allowing private management of its lottery in exchange for $10 billion up front and retaining 20 percent of lottery proceeds, which would help continue current lottery funding to education.

Bob Greenlee, deputy chief of staff for Illinois Gov. Rod Blagojevich, said Schwarzenegger's proposal could work.

"It's certainly something that makes sense, so long as you can find somebody willing to buy the bonds," he said.

Schwarzenegger's budget proposal backs away from a politically unpopular plan to suspend the state's minimum school funding guarantee. Instead, he will boost education funding by about $1.8 billion in the 2008-09 fiscal year when compared with current year spending.

Schools still would lose about $4 billion in anticipated revenue because Schwarzenegger's plan would not include program cost-of-living increases.

Adding the anticipated $5.1 billion in lottery bond revenue and saving the $4 billion in education spending leaves the administration with some $6 billion in cuts needed to balance the budget.

Schwarzenegger also will propose a surcharge on homeowners insurance policies that would raise $69 million a year for the state's emergency services.

The governor's updated budget plan also reverses some other politically unpopular proposals he made in the spending plan he released in January.

He is dropping plans to release 22,000 low-risk prison inmates early, close 48 state parks and reduce lifeguards at 16 state beaches. He will propose boosting fees $1 to $2 at some of the most popular state parks.

In addition to closing the $15.2 billion deficit, the governor wants lawmakers to set aside a $2 billion reserve fund for the 2008-09 fiscal year, which starts July 1.

The $144.3 billion spending plan includes a $101.8 billion general fund, which pays for ongoing state operations. The 2008-09 general fund is 1.6 percent lower than last year's.

The larger budget figure includes special obligation funds and money to repay bonds the state has sold in past years.