The New York State Financial Control Board yesterday issued a stern warning to New York City officials as a budget dispute between the mayor and the city council entered court.

On Wednesday, the council asked the New York State Supreme Court in Manhattan to block Mayor Rudolph Giuliani's plan to close the fiscal 1995 budget gap in favor of the council's own plan.

Both the council's gap-closing plan and Giuliani's would cut $1.1 billion out of the city's $31.6 billion budget. The difference comes in where the cuts would fall: The council wants the mayor to restore money to several programs and instead make the cuts in areas that Giuliani protected with his October modification to the city's fiscal 1995 budget.

Fiscal watchdogs, like the control board, say they are concerned that the court challenge may set a dangerous precedent, causing governmental gridlock and preventing the city from making a unified effort to address its massive structural budget deficit.

In a report covering Giuliani's proposals to plug newly projected gaps in the city's fiscal 1995 budget, the control board said, "It is imperative that the city council and the mayor work together to ensure that the actions taken are recurring."

The control board, a state-mandated fiscal watchdog, said the city faces a $2 billion budget gap in fiscal 1996, which begins July 1 of next year, and multibillion budget gaps in fiscal 1997 and 1998.

In its report, the control board also said that the city's budget gap for fiscal 1995 could grow to be as much as $513 million higher than the mayor has so far disclosed, echoing projections made by the state and city comptrollers' offices.

"A cooperative effort is necessary if the city is to solve its structural budget problems and bring stability to the delivery of services to its residents," the control board said.

Richard Larkin, a managing director at Standard & Poor's Corp., also said the hostility between the mayor and the council could have severe fiscal consequences if it results in gridlock.

Standard & Poor's rates city debt Aminus with a negative outlook, and municipal market experts are keeping a close watch on the rating agency's assessment of city debt.

The council and the mayor are at odds over about $100 million of spending. That's an amount that, by itself, does not cause raters to lose much sleep, given the size of the city's budget and its ability to generate revenues from a number of sources.

But Larkin said credit problems will develop if the dispute prevents the city from passing gap-closing plans and a credible fiscal 1996 budget. In January, Giuliani is expected to announce his preliminary budget for fiscal 1996.

"If this thing is still going on, and whatever has to be done in next month's financial plan is in jeopardy, you'll be hearing from me," Larkin said. "I told that to the mayor's side, and I told that to the council's side."

The battle began earlier this month, when the council rejected Giuliani's gap-closing plan in a nearunanimous vote and threatened legal action if the mayor failed to implement its plans.

Giuliani, in turn, called the council's proposals illegal, and said he would implement his plan regardless of what the council says.

Giuliani's budget director, Abraham Lackman, said the council's budget plan adds nearly $100 million to the city's budget, and that the city must look for ways to cut spending. "The city council is asking us to spend more money," Lackman said.

Lackman said the council's proposal is particularly troubling, given the recent budget reports issued by the control board, the state comptroller, and the city comptroller.

In a news release, council speaker Peter F. Vallone said it is Giuliani who is violating the law, specifically the city charter, which gives the council the authority to revise the mayor's budget. Council budget officials also say its gap-closing proposal in no way increases spending.

"No one, including the mayor, is above the law," Vallone said in the release. "Once the council has enacted legislation, it is binding unless and until a court of competent jurisdiction orders otherwise."

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