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Has California Finally Hit Bottom?

The Golden State has been forced into a sort of economic rehab after years of runaway spending.

Now, California's Legislative Analyst's Office says the state may be bottoming, and there is reason to hope.

Californians just passed Prop 30, raising taxes, but the LAO says the state will still have to close a $1.9 billion budget gap over the next two years. However, there could be a budget surplus beginning in 2014.

"We're not out of the woods," said Lt. Gov. Gavin Newsom, a Democrat. "There's a lot of desire, pent-up desire, to invest more in research and development and issues of education and the like, and so we're going to have to hold the line."

Newsom was speaking at the Milken California Summit in Beverly Hills, where the issue of the state's economy and notoriously poor business climate were front and center. (Read More: Job Opening in California—Chief Economist.)

Proposition 30 will raise the top state income tax rate to 13.3 percent for millionaires. "That's not a great way to encourage folks to come here and stay here," he said.

Add that to the potential repeal of the Bush tax cuts. "We're talking about a tax rate of over 50 percent," for top earners, said Scott Minerd, Guggenheim Partner's Chief Investment Officer.

Democrats now have a supermajority in Sacramento, meaning they could raise taxes without a single Republican vote. Newsom said that would be a mistake.

"Democrats now own this. We've got to lean back in," he said. "We've got to make a case to CEOs across the country that this is not the worst place to do business. It's not. But we have to demonstrate that."

Phoenix is the latest city making a play to lure California business to move out, promising 100 CEOs free flights to Arizona to tour the town. While it sounds like a gimmick, most at the Milken summit say the threat is real. (Read More: Top Destination States for Jobs.)

"You can't just take business and jobs for granted, you've got to have policies that foster economic growth," said Russ Goldsmith, CEO of Los Angeles-based City National . "When you're 49th in the country in terms of business climate, you've got to do something to make it better. Unfortunately the Governor doesn't seem to understand that."

Goldsmith believes, though, that the California economy is turning around. Income taxes jumped last month, a sign of improving employment. But he said his business clients are taking out lines of credit ... and then just sitting on them, waiting to see what happens in Washington. (Read More: States' Jobs Picture Improves: Behind the Numbers.)

"I don't know what my tax rate is going to be," he said they're telling themselves. "I don't know what my depreciation schedule is going to be. I don't know if the government is going to drive us into recession. ... I'm just going to wait."

Scott Minerd of Guggenhiem isn't pulling money out of California, despite its high cost structure. "It is still a leader in tech, it is still a leader in innovation."

But does he think the state will return to surpluses in two years as the LAO suggests? "No, and I don't think anybody who knows anything takes it very seriously,"

—By CNBC's Jane Wells
@janewells

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