CHICAGO — Minnesota Gov. Tim Pawlenty this week sent lawmakers legislation that calls for business tax cuts and eliminates a $1.2 billion budget deficit through spending cuts and increased federal Medicaid funds not yet approved by Congress.

The spending reductions included in a supplemental budget package would have widespread effects.

Local governments would see cuts of $250 million in state government aid, $347 million in health and human services programs, $47 million in higher education, and $181 million in state agencies and programs.

Local governments responded to the news with warnings that they could not afford the drop in aid without deeply cutting services or steep tax increases.

The League of Minnesota Cities said local governmental units have already seen a drop of state aid of $258 million since late 2008.

The remainder of the red ink that developed in the state's $57 billion, two-year budget due mostly to declining revenues is eliminated through the use of nearly $400 million in increased Medicaid funding, but Congress has yet to approve the aid to states.

The cuts spare K-8 grade public education funds and military-related and veterans programs.

"The historic drop in the economy has caused an historic drop in state revenues," Pawlenty said in a statement. "Government has to live within its means by setting priorities and tightening its belt just like everyone else. While this budget maintains funding for priority areas, it contains dramatic spending reductions in many programs."

The Republican governor also outlined details of the jobs creation bill he floated during his state of the state address last week.

The six-part plan would reduce corporate and small business taxes by 20% and provide tax credits and other assistance for research, development and emerging businesses.

"In addition to balancing the budget without raising taxes, we need to improve our tax system if we are going to compete for jobs," Pawlenty said.

In other state news, the House late Monday passed a $1 billion capital budget, known as the biennial bonding bill.

The Senate passed a similarly sized package last week. Passage of a bill significantly higher than the governor's $685 million proposed plan and his proposed spending cuts set the stage for an acrimonious legislative session.

Democrats, who control the Legislature, prefer the bigger bonding bill as a means to create jobs, but Pawlenty believes the state can't afford it. Democrats also prefer a mix of cuts and revenue increases to balance the budget.

Minnesota's credit is under pressure because of the deficit and its reliance in the past on one-time revenues to erase red ink. Moody's Investors Service last week revised the outlook on the state's Aa1 general obligation rating to negative from stable.

The state is especially vulnerable to ongoing fiscal weakness due to its depletion of reserves and one-shot measures like bill payment delays, fund transfers, and federal stimulus funds to erase a $4.6 billion deficit going into the current budget cycle.

Minnesota carries top marks of AAA from Fitch Ratings and Standard & Poor's, though Fitch assigns a negative outlook.

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