SACRAMENTO — The Legislature's nonpartisan fiscal analyst Monday warned lawmakers that Gov. Arnold Schwarzenegger's proposal to sell off future lottery revenues could result in a reduction over time in the amount of money schools receive from lottery sales.

The governor's proposal, which would raise $15 billion upfront over three years by selling bonds backed by future increases in lottery sales, estimates the state would be able to pay off bondholders and still have enough left each year to pay schools the $1.2 billion in lottery funds they now receive.

That estimate is based on the assumption that lottery sales in California, which on a per-capita basis are now less than half the national average, will climb to the national average over the next five to 10 years. If sales did not increase to that degree, Elizabeth Hill said, schools would be shortchanged.

"Payments to education would be in second order to the bondholders," she said. "Bondholders are going to be paid first."

Hill estimated that schools could be shortchanged as much as $5 billion over the next 12 years.

"We certainly have a concern with the magnitude of the governor's lottery proposal," she said.

Administration officials defended their estimates, which are based on various projections made by financial firms.

"It's a question of whether you think California can be average," said Fred Klass, chief operating officer in the Department of Finance.

If future revenue increases were insufficient to pay off bondholders and provide $1.2 billion to schools, Schwarzenegger has said he would seek to make up the shortfall from other state revenues.

In presenting lawmakers with an alternative budget, Hill suggested keeping the lottery idea but structuring it on the assumption that sales will increase to only 80 percent of the national average.

Hill's proposal would generate far less upfront revenue — $5.6 billion over two years instead of $15 billion over three years — but she said it would have the benefit of virtually guaranteeing that schools would continue to receive their current level of lottery funding.

Both proposals would be dependent upon voters in November approving a ballot measure to allow the lottery to modernize its operations and shed some of the restrictions that have contributed to its lackluster sales performance.

Finance Department spokesman H.D. Palmer said Hill's analysis of the proposal is encouraging because she backed the idea of modernizing the lottery and securitizing the revenue increases that would flow as a result. "The LAO has now embraced the concept of using the lottery as part of our overall budget solution," he said.

In analyzing Schwarzenegger's revised budget proposal, Hill made clear that aggressive steps will be necessary to close the state's $15 billion budget shortfall.

She proposed eliminating or reducing $3.3 billion worth of existing tax credits, including the one parents can take for dependent children.

"None of the choices are easy," Hill said. "We need to level with the public that the state of California has a very major budget problem that will require sacrifices on the part of all Californians."

Hill has been sharply critical of Schwarzenegger's proposed across-the-board spending reductions. That approach prompted her in January to take the unusual step of putting forth her own proposal, one she says would allow lawmakers to protect the core services the state provides and to set priorities among state programs.

She noted that since January there has been "a dramatic decrease in revenues" as well as unanticipated spending increases that have combined to worsen the budget shortfall by $8 billion.

Hill said Schwarzenegger's proposal, even if lawmakers were to adopt it in full and all of its projections came true, would result in "multimillion-dollar budget shortfalls in 2010, 2011 and beyond.

In contrast, Hill said her proposal, which includes revenue increases, would yield balanced budgets in each of the next five years, based on current economic projections.