The economic outlook for California retailers and manufacturers is taking a steep dive.

The latest blow came when Gov. Arnold Schwarzenegger declared a fiscal emergency on Monday, predicting that the state would go broke by February or March unless the legislature approves higher taxes, including a 1.5 percent increase in the sales levy to 8.75 percent for three years, and makes deep cuts in public services to reduce spending. The governor’s declaration mandates that lawmakers break their political gridlock and act within 45 days to close an expected $11.2 billion shortfall — or face a potential standstill in state government. The deficit could balloon to $28 billion by mid-2010.

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