It is the first time in 17 years that the state's government will have to utilise such a measure.
California's latest budget struggle comes after the state's worst drop in revenues from personal income taxes since the Great Depression.
The US' most-populous state has been hit hard by the national recession, with unemployment and foreclosures of homes rising.
Differences over strategy
Republicans in congress have differed over which methods should be employed to tackle California's $24.3bn budget shortfall.
Republican legislators and Arnold Schwarzenegger, the state governor, who is also a Republican, have ruled out tax increases to reduce the deficit, calling instead for dramatic spending cuts.
However, Democrats are opposed to the extent of the cuts proposed by the governor, saying that the provision of welfare to the poor would be seriously affected.
Legislators in the state senate on Tuesday argued over how to tackle the budget crisis as the start of the new fiscal year neared.
"There is no excuse to hold this whole state hostage," Darrell Steinberg, state senate president pro tem, told Republicans during a floor debate.
Dennis Hollingsworth, state senate Republican leader, argued that major cuts are needed, or "entire programs that will have to be lopped off".
California has faced a sharp decline in revenue, meaning that the state could run out of money to pay all its debts unless its books are balanced quickly.