"We're all going to get through this, and California is going to come through it just fine," Senate leader Darrell Steinberg, D-Sacramento, said before entering a closed-door meeting between Gov. Arnold Schwarzenegger and the three other legislative leaders.
Sunday's talks were expected to last several hours.
That Republicans, Democrats and Schwarzenegger were back on speaking terms and making apparent headway was a welcome sign after two weeks of acrimony and partisan infighting that temporarily derailed budget negotiations. During a low point last week, the office of the Assembly speaker, a Democrat, accused the governor's office of disrespecting female lawmakers.
Over the weekend, lawmakers focused on reform proposals advanced by Schwarzenegger, who wants to weed out waste and abuse in welfare, in-home support and health care programs. His office says such reforms could save taxpayers an estimated $1.7 billion this fiscal year, money that could be used to make up for cuts in other programs.
The governor also has sought pension changes for new state government employees.
Funding for K-12 schools is a main sticking point. Senate Minority Leader Dennis Hollingsworth, R-Temecula, said closing the deficit would have to involve school spending because it accounts for at least half of California's annual budget.
The lawmakers were debating whether to suspend Proposition 98, a constitutional amendment passed by voters in 1988 that guarantees a minimum level of funding for schools each year. The funding also is supposed to rise each year based on the previous budget.
Democrats are trying to preserve as much K-12 funding as possible.
Earlier this year, lawmakers cut education spending by $8.6 billion over two years. Many districts are planning to lay off teachers and increase class sizes.
Lisa Bradley, a kindergarten teacher from the Marin County community of Terra Linda, said public schools cannot suffer further cuts. A teacher for three decades, Bradley said she has never seen as much turmoil in public education as she has this year.
"We're the eighth biggest economy in the world, and I don't know how this happened," she said of California's fiscal crisis, after stopping to talk to a reporter while touring the Capitol. "If they take our money from Prop. 98, then we'll lose our support staff, we'll lose our instructional assistants."
The efforts to close California's budget shortfall for the fiscal year that began July 1 are going on against the backdrop of a deep recession that has led to an unprecedented drop in tax revenue.
Personal income tax, a cornerstone of how state government funds its operations, dropped 34 percent during the first five months of the year. The latest reports from the state controller's office show that the slide has continued into the summer, widening the gap between California's spending obligations and its tax income.
Lawmakers are trying to figure out how to close it. A budget for the current fiscal year already is in place, approved during a rare midyear budget session in February.
The depth of the recession sent the budget into the red within weeks.
The $26 billion deficit represents more than one-quarter of California's general fund spending. For perspective, eliminating all spending on state prisons and higher education wouldn't come close to eliminating that shortfall.
The governor and lawmakers are settling on a package that takes a number of steps to close the deficit, including cuts worth $14 billion to $15 billion, borrowing from internal funds and accelerating some tax collections.
Earlier, Schwarzenegger proposed eliminating health care for 930,000 low-income children, ending the state's welfare-to-work program and closing 220 state parks. Negotiators are trying to preserve at least parts of those services.
The governor and Republican lawmakers have refused to raise taxes further after the February budget package hiked the sales tax, personal income tax and vehicle license fees.
Meanwhile, the state is trying to preserve cash and has begun issuing IOUs instead of payments to thousands of state contractors and suppliers. The controller said his office can continue that practice through late August, but lack of a balanced budget after that will jeopardize contributions to the state pension funds and paychecks to state workers.
IOUs instead of paychecks will further darken the mood of government employees, who already have been ordered to take three days off a month without pay.