Although $10 billion in stimulus funds for education has been granted to the state, those funds come with a caveat, as outlined by the U.S. Department of Education:

As part of the state’s application, each governor must include an assurance that the state will maintain the same level of support for elementary, secondary, and postsecondary education in FY 2009 through FY 2011 as it did in FY 2006.

This is to ensure that states use stimulus dollars to fund innovation and improvement in schools, rather than merely to plug budget holes. If California fails to ensure that its schools will receive the same amount of money from the state general fund as they did in 2006, the state will no longer qualify for stimulus funds for education.

But Schwarzenegger’s proposal leaves education funds unaccounted for until the state borrows money from local governments.  According to the Chronicle:

The flaw in Schwarzenegger’s proposal centers on his plan to borrow $2 billion from local governments, which would then be used to pay for education. That move would free up $2 billion in the state’s general fund, which carries the $26.3 billion shortfall.

As a result, the Chronicle reports, California would not meet the Department of Education’s condition that the state maintains its 2006 level of support for education. The money borrowed from local governments would replenish funds to 2006 levels, but the stimulus provision requires that state funding remain consistent.

Although California has received much of the $10 billion in stimulus funds it was allocated for education, Schwarzenegger’s maneuver could end up jeopardizing the rest of the money, and the initial grants may need to be repaid to the government. Secretary of Education Arne Duncan has warned both Tennessee and Pennsylvania lawmakers against similar proposals, but neither state suffers from as dire a budgetary crisis as California. With an unbalanced budget looking him down the nose nine days after California’s new fiscal year began, Schwarzenegger will need to find a sufficient compromise soon — one that isn’t as potentially crippling as his current proposal.

Many states face fundamental legal barriers to accepting such loans. The constitutions of a number of states explicitly bar the state from borrowing funds to cover operating expenses. Other state constitutions or statutes strictly limit the amount of debt that the state may incur, and in some states, such loans would exceed the limit. In addition, most states have balanced-budget requirements that may bar them from accepting operating-budget loans. As a result, most states likely would not be able to accept federal loans.

Some help that would be.

Combined, these factors force states to cut services to their neediest residents during a time when the need is greatest. The perversity of that equation hasn’t been lost on Paul Krugman, the Nobel Prize-winning economist, who uses his column in The New York Times today to push for a Medicaid program funded solely by the federal government, which can borrow money in a recession to meet the budget challenges when more and more people become Medicaid-eligible. From the column:

[S]hredding the social safety net at a moment when many more Americans need help isn’t just cruel. It adds to the sense of insecurity that is one important factor driving the economy down. [...]

As a nation, we don’t believe that our fellow citizens should go without essential health care. Why, then, does a large share of funding for Medicaid come from state governments, which are forced to cut the program precisely when it’s needed most?

This is hardly a change of heart for Krugman, who has long-advocated for the creation of a nationalized health care system. But reforms of such magnitude don’t happen in times of non-crisis (Just ask the Clintons). Whether the current recession will force Washington policymakers to consider some reworking of Medicaid’s funding mechanism has yet to be seen. But you can bet that roughly 50 state governors would be behind such a change.

Twenty-one states and the District of Columbia now face budget shortfalls totaling $8.9 billion this fiscal year, according to an analysis released this month by the Center on Budget and Policy Priorities, a liberal policy watchdog.

The financial crisis has been particularly tough on states, for at least two reasons.

First, consumers are spending less, and that means sales-tax revenues are falling at the same time that demand for social services like unemployment benefits, food aid and Medicaid is rising.

Second, unlike the federal government, states (generally) are required by law to balance their annual budgets.

And here’s a hint: It’s not the wealthy folks who usually feel the pain of the squeeze.

This fiscal year, 22 states have already made or proposed cuts to programs benefiting some of their most vulnerable residents, CBPP found. Some examples, according to another CBPP report:

• 14 states have cut programs providing health-care services to low-income residents. Rhode Island, for example, eliminated care for an estimated 1,000 low-income parents.

• 11 states have cut medical care for the elderly and disabled. Ohio, for example, has closed two mental health facilities.

• 17 states have cut funding to public colleges and universities. Community and technical college students in Kentucky, for example, have seen average tuition hikes of 5.2 percent as a result of education cuts there.

• 13 states have cut funding to public elementary, middle and high schools. Aid to local school districts in Florida, for example, has been cut by roughly $130 per student.

Unlike some banks, of course, the folks affected by these cuts are not too big to fail.