SACRAMENTO, Calif. (AP) -- Gov. Arnold Schwarzenegger and legislative leaders reported steady progress on California's $26.3 billion budget mess and raised the prospect of a resolution in the coming week.

Negotiators were scheduled to resume closed-door meetings Sunday at the Capitol following two days of talks. They were expected to continue discussing the governor's social service reform proposals, but still need to sort out public education funding, which is the largest component of general fund spending.

"I would say we're getting very close to a general framework, but there are still outlying questions," state Assembly Minority Leader Sam Blakeslee, a San Luis Obispo Republican, said after emerging from a closed-door meeting between lawmakers and Schwarzenegger on Saturday.

The possibility of a breakthrough in resolving California's mammoth budget shortfall comes a week after the state began issuing IOUs to thousands of vendors as a cash-saving move. State workers also have begun taking three days off a month without pay, cutting the salaries of more than 200,000 government employees by 14 percent.

Bank of America Corp. and other major banks said Friday was the last day they would honor the IOUs, which cannot be redeemed until Oct. 2. That left some state contractors who are being issued IOUs scrambling to find banks that will cash the warrants.

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California leaders approved a two-year budget package in February that increased sales, personal income and vehicle license taxes, but it was not enough to bring the state's spending plan back into balance.

Personal income taxes declined 34 percent during the first five months of the year, a slide that has accelerated as the recession continues to strangle California's economy. On Friday, the state controller's office reported California had spent $10.4 billion more than it collected in the fiscal year that ended June 30.

The current budget shortfall amounts to more than a quarter of California's general fund, its main account for paying operating expenses.

Without sufficient cash to cover all of its payment obligations, the state will have to defer payments to its pension funds and may issue IOUs instead of paychecks to state employees if a compromise isn't reached by late August.

"Certainly none of us wanted to see us get to the point of having IOUs. And now we're to a point where a number of banks are saying, 'We're not going to accept them,"' said state Assembly Speaker Karen Bass. "What more motivation is there?"

The latest talks center on the extent of budget cuts -- expected to range from $14 billion to $15 billion -- and what other steps might be taken to close the deficit.

In addition to cuts, Schwarzenegger and Republican lawmakers also want reforms to welfare, pension, health care and in-home supportive service programs. They say preventing waste and abuse will save the state money, which in turn can be used to prevent cuts elsewhere in the budget. The governor's office has estimated its reform proposals will save $1.7 billion this fiscal year alone.

Democrats have criticized the reform proposals as peripheral issues that do not have a direct effect on the immediate budget deficit. They also say Schwarzenegger has overstated the savings.

Bass, who walked out of negotiations earlier in the week, said Saturday that her concerns have been addressed and that there did not appear to be any insurmountable obstacles to reaching a deal. She described the talks as complicated.

"I think what has happened over the last 48 hours has been the most productive in the last several weeks," the Los Angeles Democrat said. "We are just not finished."

Blakeslee said they would spend part of Sunday reviewing reports on some of the governor's reform proposals. Lawmakers said they also have yet to decide how much education funding can be cut.

"These are very difficult cuts, and we're trying to identify how to implement those cuts in a manner that impact people as little as possible," Blakeslee said.