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UPDATE 2-Calif. Gov. Schwarzenegger rescinds car tax hike

(Adds car tax rescinded, details)

By Michael Kahn

SACRAMENTO, Calif. (Reuters) - California Gov. Arnold Schwarzenegger Monday rescinded a $4.3-billion increase in the state's highly unpopular car tax, fulfilling a campaign promise as his first official act.

The Republican, who defeated former Democratic Gov. Gray Davis in an October recall election, also said he would convene a special session aimed at dealing with California's yawning budget shortfall and soaring workers compensation costs.

"During the campaign I promised on day one to repeal the car tax increase," Schwarzenegger said after his inauguration. "Today, I am making good on that promise."

Reversing the increase was a key part of the political novice's campaign. But the decision could swell California's huge budget deficit by another $7.4 billion next year, bringing the total to $17.8 billion, the state's nonpartisan Legislative Analyst's Office said in a report last week.

It could also deprive local governments of an important revenue source used to fund police, fire and health programs. Schwarzenegger has said he would not reverse the car tax at the expense of local governments but so far has not detailed how he would avoid doing so.

The fee hike would have boosted the cost of registering the average car worth $10,154 to $204 per year, up from $66, according to a report in May from the California Budget Project. The license fees were based on a vehicle's value.

"Local governments provide essential services like police and fire protection," Schwarzenegger said. "To ensure that those services continue, I have called the legislature back into session to address this important need."

The actor-turned-politician will also have to convince a divided legislature controlled by Democrats that he can repeal the tax increase while dealing with California's crippling budget problems.

The unpopular car tax, which took effect on Oct. 1, would have put $4.3 billion a year into the state's coffers. Under state law, California's department of finance director has the authority to both trigger and reduce increases in the tax.

Schwarzenegger and aides have also been studying a range of proposals to bring the state's books into balance, including asking voters to approve a record-breaking bond of some $20 billion that would fund next year's deficit and roll in two other pending bond issues tied up by a court challenge.

The Legislative Analyst's Office report said California will end the current fiscal year in June 2004 with a deficit of $2.6 billion, rather than a reserve of about the same size, as earlier expected.

Without any tax or spending changes, the deficit for the next budget year would be $10.2 billion, a "modestly worse" outlook than a year earlier despite gains in the stock market and the economy, the report said.

Wall Street credit analysts have said the report underscores the tough choices state legislators face in a special session expected to be dominated by the budget crisis and Schwarzenegger's declared intent to break California from its "tax-and-spend" ways.