CHICAGO - Minnesota Gov. Tim Pawlenty yesterday proposed cutting the state's business tax as part of an economic development and job growth package that includes tax credits and a sales tax exemption for businesses.

The Republican governor laid out the proposal, dubbed the Minnesota Jobs Recovery Act, in his state of the state address.

Under the plan, the business tax rate would fall to 4.8% from 9.8% over the next six years and businesses that invest in regional funds that support emerging or local businesses, or reinvest in their own businesses, would be eligible for $50 million in tax credits.

Companies with qualifying investments in small businesses would receive a capital gains exemption and equipment purchases would be exempt from state sales taxes.

While the package would cut into general fund tax revenues at a time when the state is facing a $4.85 billion deficit over the next two years, Pawlenty portrayed it as necessary to stimulate the economy.

"I know these tax cuts and incentives may seem aggressive in the context of our budget challenges," Pawlenty said. "But we simply have to take dramatic measures to improve our job climate and kick-start job growth in Minnesota."

To address the deficit, Pawlenty said he would propose significant spending cuts in the two-year budget he will unveil at the end of the month, but public safety and programs for military families will be excluded from the chopping block.

He said the state must stem skyrocketing growth in human services spending, but he did not elaborate on how to accomplish that goal. The governor reiterated his opposition to tax increases and warned of possible layoffs, but said a two-year freeze on government employee raises could curtail some job cuts.

Pawlenty struck a more diplomatic tone than last year when he warned lawmakers he was ready to use his veto pen. Democratic majorities in the House and Senate have increased, with the party now holding a veto-proof majority in the Senate.

"Today, we're not Democrats, we're not Republicans, we're Minnesotans," he said. "We're all here because we love and care about Minnesota."

The ultimate budget agreement reached by the governor and lawmakers stands to affect the state's credit.

Ahead of its sale earlier this week of $400 million of general obligation bonds, Fitch Ratings revised its outlook to negative from stable on the state's AAA rating while Moody's Investors Service revised its outlook to stable from positive on its Aa1 rating. Standard & Poor's affirmed the state's $4.3 billion of GOs at AAA with a stable outlook.

Fitch attributed its negative outlook to the magnitude of the state's "budgetary challenges in an environment of a large fiscal 2009 operating imbalance and depletion of reserves, and likely further negative forecast revisions."

Moody's analysts agreed, but also fear a return to the legislative gridlock seen in 2005 that resulted in a partial government shutdown and the use of non-recurring revenues to close a budget gap.

The state's November revenue forecast warned of a $5.2 billion deficit.

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