(Updates with more detail on Schwarzenegger proposal)
By Michael Kahn
SACRAMENTO, Calif., Nov 17 (Reuters) - California Gov. Arnold Schwarzenegger on Monday rescinded a highly unpopular $4.3-billion car tax increase and said he would ask voters in March to approve a borrowing program to cover the state's budget shortfall.
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 tripling of the fees was a key part of Schwarzenegger's campaign. But the decision could increase California's 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 last week.
It could also deprive local governments of an important revenue source used to fund police, firefighting 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.
In the text of his call for a special legislative session, Schwarzenegger urged state lawmakers to put two measures before voters. One would authorize the deficit bond plan.
The second would be a constitutional amendment capping state spending, establishing a fiscal reserve fund and giving the governor and director of finance unspecified "extraordinary powers" in times of fiscal emergency.
Schwarzenegger was expected to detail those proposals at a news conference scheduled for Tuesday timed to coincide with the start of the special legislative session.
"None of this is going to be easy," said Kim Rueben, a public finance expert at the Public Policy Institute of California. "Given the size of the deficit he is going to have to make some hard decisions by making some cuts or raising some taxes."
The car tax hike, which took effect Oct. 1, would have put $4.3 billion a year into the state's coffers.
The fee hike, which is based on a vehicle's value, had 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.
Schwarzenegger's aides said that the bond measure he is proposing would be less than a widely reported $20 billion offering.
The aim of that borrowing program would be to fund next year's deficit and supplant other pending debt issues tied up by a court challenge over their legality.
Schwarzenegger, who said that California's business climate had become the worst in the nation, also suspended all proposed state regulations and called for a review of all new and amended regulations over the last five years.
The state's Legislative Analyst's Office forecast last week that 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 underscored 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.