* Income tax rate would rise, sales taxes would drop
* State lawmakers must still approve budget
* On the rise: spending on education, transportation, pensions, debt service
By Hilary Russ
Jan 23 (Reuters) - Massachusetts Governor Deval Patrick proposed on Wednesday a $34.8 billion state spending plan for fiscal 2014 that would raise income taxes by 1 percentage point to increase revenue for new education investments.
Patrick's plan would raise the income tax rate to 6.25 percent from 5.25 percent, double the personal exemption for taxpayers and strip the commonwealth's tax system of several itemized deductions.
The plan, which state lawmakers will be asked to approve, would also lower the sales tax rate to 4.5 percent from 6.25 percent, and would dedicate sales tax revenue to transportation projects that Patrick said were critical for the state's future.
He also repeated a call to tax soda and candy sales, which are currently exempt, and said the cigarette tax should rise by $1 to $3.51 per pack.
"I do not submit this proposal lightly," he said of his plan to hike income taxes. By focusing on education and transportation, Massachusetts will be able to grow its economy, he said during his budget presentation, which was streamed on the Internet.
Massachusetts, which has a population of 6.6 million, has a median household income of $65,981, well above the average in the nation of $52,762. Its unemployment rate stood at 6.7 percent in December, compared to 7.8 percent nationally.
The governor's total spending plan did not include the state's required pension contribution of $1.6 billion, an increase of about $78 million from fiscal 2013.
The state's pension funds were funded at a combined level of 71 percent, with a total unfunded liability of nearly $64 billion, as of fiscal 2012, the Pew Center on the States reported in June.
The commonwealth will also have to spend $62 million more on debt service payments next year, for a total of $2.4 billion.
Not included in the total budget number is more than $13 billion of additional revenue from the federal government and other sources.
The proposed tax changes makes the system fairer, said Noah Berger, president of the Massachusetts Budget and Policy Center, in a statement.
Rebalancing the state's tax regime to rely more on income taxes and less on sales taxes would make the system less regressive, the center has said.
Massachusetts, called "Taxachusetts" by some citizens who complain about high taxes, had been facing a projected budget gap of at least $1.28 billion in fiscal 2014, according to the center.
In a call with reporters, Massachusetts Finance Secretary Glen Shor said the budget was balanced.
The proposed budget uses new revenues while holding spending nearly flat in many areas, Shor and other officials said.
New revenues include the increased taxes, additional federal money for Medicaid, tougher enforcement of tax collections, expanded gambling venues, and an agreement with online retailer Amazon to begin collecting sales tax on goods sold in the commonwealth.
The state's use of one-time revenue sources would drop to $555 million next year from $919 million this year. And Patrick's proposal would leave the state with at least $1 billion in its reserve fund at the end of fiscal 2014, officials said.
Patrick's budget also calls for the commonwealth to borrow $400 million by issuing notes backed by the new, anticipated tax revenue that would be generated in fiscal years 2015 and 2016.
Overall, spending would rise by 6.9 percent over current levels, while base tax revenue - which doesn't include the new revenue sources - is projected to grow by about 4 percent.
Spending on education would rise to $6.8 billion from $6.2 billion under Patrick's proposed budget.
The governor also focused on transportation systems, saying the state should boost spending by $269 million.
That proposal would eliminate the structural operating deficit of the Massachusetts Bay Transportation Authority (MBTA), which operates the "T" mass transit system, and would allow officials to expand service, according to a budget document.
It would also be used to trim the MBTA's use of borrowing through bond sales to pay operating costs.