Mr Schwarzenegger has pledged to veto any tax increases
California Governor Arnold Schwarzenegger has declared a fiscal emergency in his state, as officials prepare to issue billions of dollars of IOUs to the state's creditors.
California is estimated to be the world eighth-largest economy, and the fiscal crisis will have ripple effects through the US.
It is not the first time that the Golden State has faced budget problems, but this time the global economic crisis has exacerbated the state's dire fiscal situation.
How big is California's deficit?
The state is running a deficit of some $24.3bn (£14.5bn). That represents around a quarter of the state's general fund - the account it uses to pay its daily expenses.
And the shortfall could increase by up to $6.5bn by September 2009, because the state government failed to approve a budget by the 1 July deadline.
How did California get to this position?
Back in 1978, California voters approved a ballot proposition which amended the state's constitution. The amendment capped property taxes state-wide at 1% of property value.
The amendment also required a two-thirds majority in both houses of the state legislature to pass any future tax increases, including income taxes.
The measure was incredibly popular, but - ever since - it has meant that the state's government has had to rely on income and capital gains taxes for its revenue, which are far less stable sources of income than property taxes.
Over the years, spending commitments have increased, without any corresponding increase in revenue.
As the US - and the rest of the world - plunged into recession over the last 18 months, California's revenue stream began to dry up. Its jobless rate is one of the highest in the country - personal income tax revenue coming to the state plummeted by 34% for the first five months of the year.
So the state has found itself unable to fulfil its spending commitments.
What proposals have been made to alleviate the crisis?
Back in February, state lawmakers - with agreement of Governor Schwarzenegger - approved a budget package that included spending cuts and tax increases. It was hoped that the plan would plug the deficit until summer 2010.
But the economic situation was worse than lawmakers expected, and further measures were needed to shore up the state's finances.
Mr Schwarzenegger has proposed cutting $16bn from state programmes, borrowing $2bn from local governments and diverting $6bn from other government funds.
But California Democrats, objecting to the scale of the governor's proposed spending cuts, have countered with a plan to cut $11bn, and raise $2.5bn through increased taxes on tobacco products and oil drilling.
Their plan was blocked in the state senate however, and would have been vetoed by Mr Schwarzenegger even if it had passed. he has pledged to block any budget plans that involve tax increases.
The failure to pass a budget plan by 1 July led to Mr Schwarzenegger declaring a "fiscal emergency".
What will the governor's "fiscal emergency" involve?
Under Mr Schwarzenegger's plan, California's state offices will be closed three days a month.
This takes state employees' total effective pay cut this year to 14%.
The governor says he "will not rest" until the budget crisis is resolved.
How can California avoid this situation in the future?
A special commission will report to the governor and the state legislature by the end of July on ways to restructure the California's tax system to avoid violent fluctuations in the state's revenue stream in the future.
But there is little prospect of any changes to the rules governing taxes and budgeting that are set in stone in the state's constitution.