Schwarzenegger also issued an executive order calling lawmakers back into session to deal with the budget for the third time in two months. On Thursday he announced he would veto an $18 billion Democratic deficit-cutting package that he said didn't do enough to address the financial crisis.

SACRAMENTO, Calif. — Gov. Arnold Schwarzenegger on Friday ordered a state hiring freeze and payroll cuts to conserve cash as California struggles to deal with a $42 billion budget deficit.

The governor issued an executive order that requires state agencies to reduce payroll by 10 percent, which could lead to massive layoffs. He also ordered the state's 235,000 employees to take two days off a month without pay, starting Feb. 1.

Schwarzenegger also issued an executive order calling lawmakers back into session to deal with the budget for the third time in two months. On Thursday he announced he would veto an $18 billion Democratic deficit-cutting package that he said didn't do enough to address the financial crisis.

In a letter to state workers, Schwarzenegger said California must take emergency steps that will require sacrifices from everyone.

"It is imperative that state government look inside itself and be part of the solution," the governor wrote. "We simply have no other choice."

Labor officials said they were considering filing a lawsuit to prevent job losses.

"We definitely think we have grounds for filing an unfair labor charge," said Jim Herron Zamora, a spokesman for the Service Employees International Union, Local 1000, the largest state employee union. "Our contract doesn't allow him to do this."

Officials warn that the state will run out of cash in February unless Schwarzenegger and lawmakers can reach a deal to close the budget gap with spending cuts, revenue increases or a combination of both.

Schwarzenegger ordered all state employees to take two days off a month without pay or take a similar salary cut to achieve $1.3 billion in savings through the next fiscal year.

On top of that, the governor directed agencies that get their money from the state's largest budget account, the general fund, to achieve a 10 percent payroll savings. Officials said that could lead to an undetermined number of layoffs.

Department of Personnel Administration spokeswoman Lynelle Jolley said any workers who lose their jobs as a result of the order could seek employment at other state departments that use special state funds.

"We're hoping we can do this with the least number of layoffs possible but the goal is to address this imminent cash crisis," Jolley said.

Lawmakers adjourned for the holidays Thursday after Democrats pushed through a package of spending cuts and tax increases using a creative maneuver to bypass Republican opposition.

Schwarzenegger's decision to veto the package left Democratic leaders scrambling to save their plan. They argued that it met some of his demands for speeding up public works projects and selling surplus state property.

Assembly Speaker Karen Bass, D-Los Angeles, said it was "mind-boggling" that the governor would throw away a package that begins tackling the state's fiscal problems because it didn't contain exactly what he wanted.

"It's like a child telling Santa if you don't bring every single item on the list, then stay out of my chimney," Bass said. "I am hoping that the governor over these next few days will really reconsider saying he will veto the budget."

Bass and Senate President Pro Tem Darrell Steinberg, D-Sacramento, said they would remain at the Capitol to negotiate with the governor or his staff, but would not call the other 118 lawmakers back until a deal could be reached.

Under the governor's special session declaration, lawmakers have 45 days to send the governor bills that address the budget crisis. If they fail to do so, the Legislature may not act on other bills.

The governor had sought what he said was assistance for homeowners facing foreclosure, broad authority to relax environmental regulation on public works projects and more toll roads. Democrats allowed only partial waivers for a limited number of road projects and for certain state properties up for sale.

Additionally, Schwarzenegger requested deeper cuts than Democrats were willing to offer, such as reductions in welfare and senior assistance programs, greater flexibility to reduce school spending, and the elimination of two of 14 state employee holidays.

Environmental advocates also questioned why the governor would toss aside the only deficit-cutting legislation to reach his desk since he declared a fiscal emergency on Nov. 5. Paul Mason, deputy director of the Sierra Club in California, suggested that by demanding environmental exemptions, the governor was betraying his public image as a crusader against global warming.

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Associated Press Writers Samantha Young and Steve Lawrence contributed to this report from Sacramento and Garance Burke contributed from Fresno.