Penn gov seeks natural gas tax to help plug deficit

PHILADELPHIA, Jan 26 (Reuters) -- Pennsylvania should plug a projected $500 million deficit in the new fiscal year by taxing natural gas extraction, ending discounts for businesses that pay taxes on time, and abolishing the tax-free status on smokeless tobacco, Governor Ed Rendell said on Tuesday.

Two weeks before presenting his fiscal 2011 budget, the Democratic governor warned business leaders that the state faces spending cuts that are even deeper than those in the current year's budget because of falling tax revenues.

"Next year we are going to have to have further cuts and they are going to be really painful," Rendell said.

Rendell, who is in his last year as governor, said the proposed "severance" tax on the current boom in natural gas drilling in the massive Marcellus Shale formation would raise $100 million to $120 million a year.

He said the recent $31 billion purchase of XTO Energy by Exxon Mobil (XOM.N) and the higher-than-expected price paid by other energy companies at a recent auction of state land for gas drilling indicated the industry is able to afford the planned tax.

Rendell said he felt "foolish" after dropping the proposed tax in the current year's budget talks, on the basis that the industry was in its infancy, and that the natural gas price was low.

He acknowledged concerns about water contamination from natural gas drilling but said the Marcellus has the potential to generate tens of thousands of jobs and is too valuable an opportunity to allow environmental worries to impede development.

"We can't let the occasional mishap stop what is an extraordinary boom for the Pennsylvania economy," he said during a question-and-answer session hosted by Philadelphia public radio station WHYY.

The proposed new taxes would raise revenues totaling $250 million, allowing the state to "eke" its way through the coming fiscal year, Rendell said.

But he repeated a warning that Pennsylvania faces deficits of $2 billion and $5 billion in the following two fiscal years after the expected expiration of federal stimulus money.

In view of the coming financial challenges, Rendell said lawmakers should reconsider a 0.5 percentage point rise in the personal income tax rate that he had proposed for fiscal 2010 but withdrew in the face of bipartisan opposition.

Rendell previously said he hoped to limit overall spending growth to 4 percent in 2011 from the $27.8 billion package that was agreed for the current year, and noted that there are some areas such as corrections over which the state has no control. (Editing by Leslie Adler)