Department of Personnel Administration director Debbie Endsley wrote in a memo to agency managers that the administration will instruct the state controller to reduce wages to $7.25 per hour for the July pay period if there is no budget agreement.
She also warned that furloughs, which were scheduled to end last week, could be extended.
"The Governor retains the right and authority to order furloughs if necessary to address a fiscal and cash crisis," Endsley wrote. "As for the prospect of state workers receiving minimum wage in lieu of full wages, it will depend on when the Legislature and the Governor reach a budget agreement."
The threat was intended to prod legislative leaders on a budget deal and to speed up labor talks with state workers' unions.
California faces a $19.1 billion budget deficit for the fiscal year that starts July 1 but state lawmakers and the governor are no where near a deal. Democrats in the Senate and Assembly have different plans calling for increased revenues while Republicans have backed Schwarzenegger's proposal for deep cuts to schools and social services.
State workers have been furloughed a total of 46 days since Schwarzenegger issued the order in February 2009.
Last week, Schwarzenegger struck a tentative deal with four unions that represent 23,000 of the 170,000 state work force. Those unions would not be subject to new furloughs or minimum wage payments if the contracts are ratified, Endsley wrote.
Despite the administration's threat, the legal battle over minimum wage remains unresolved.
A Sacramento County Superior Court judge ruled last year that Schwarzenegger could cut state employees' pay to the federal minimum wage during a budget impasse. Controller John Chiang, who defied the governor's order, is appealing that ruling.