A windfall of more than $8 billion last year allowed the state to plow more money into education and other popular programs, fostering bipartisan good will between Schwarzenegger and Democrats. A return to budget fights over state programs, Levy said, could “spill over to the era of cooperation.” It’s unclear what Schwarzenegger would do if Hill’s more pessimistic projections come true. Palmer, the governor’s finance official, declined to specify any spending cuts or revenue increases Schwarzenegger would consider. He said the governor is sticking by his January budget and its promise of a surplus until proven otherwise. [email protected] (916) 441-4603160Want local news?Sign up for the Localist and stay informed Something went wrong. Please try again.subscribeCongratulations! You’re all set! “The Legislature will face major challenges in crafting a budget for the coming year,” Hill said. Economists have said for months that a sluggish housing market has dampened economic growth over the past year, but last week state finance officials received more worrisome news: State revenues in January were nearly $1 billion lower than they had projected, thanks to lagging personal income tax collections, which are a substantial part of the state’s revenues. One explanation for the drop: that a “significant downturn in the economy” is under way, said H.D. Palmer, deputy director of the governor’s Finance Department. But he also said the dip could be a fluke – the result of high-income taxpayers lowering their estimated tax payments at the end of last year. The answer won’t be known until after tax season in late April. But some experts say that either way, the late-year tax decline, coming after three quarters of growth, could portend wrenching budget battles that Schwarzenegger has been fortunate to avert lately. “The only reason they avoided a fight last year is they had very strong revenue from Google and stock options” tax revenue, said Stephen Levy, director and senior economist of the Center for Continuing Study of the California Economy of Palo Alto. “There’s a much stronger chance that this will be a more contentious May and June,” he added, referring to the budget season in the Capitol. SACRAMENTO – After years of robust growth, California’s economy may be cooling – and that could put a crimp in Gov. Arnold Schwarzenegger’s hopes for an ambitious second term. State tax revenues have dipped in recent months, an independent budget expert said Wednesday in a report that challenges the governor’s rosier financial outlook. Assuming the state’s economy would continue to hum along, Schwarzenegger unveiled a budget in January that he said would create a $2.1 billion surplus. But the state’s nonpartisan legislative analyst, Elizabeth Hill, estimated Wednesday that revenue projections have slowed and his plan would actually leave the state with a $726 million shortfall in fiscal 2007-08.