Gov. Gray Davis issued a new budget plan yesterday that would use a $10.7 billion bond to ease spending cuts and lower tax increases, in a bid for legislative support amid worry that delay could cause deeper fiscal trouble.

The milder cuts were welcomed by schools, health groups, local government and others – but an $8 billion increase in the taxes on cars, purchases, cigarettes and the people in upper-income brackets was swiftly rejected by Republicans.

The governor said he had listened to legislators in both parties while redrawing the budget he proposed in January for the new fiscal year, which will begin July 1.

"I've taken the best ideas from these meetings and put together a plan which I believe will lead us to a timely, responsible budget," Davis said.

He reported that a record budget gap has increased by $3 billion to $38 billion, which is more than half of the proposed $70.4 billion general fund that pays for most programs.

The governor abandoned his proposal to erase the budget gap in one year. The new plan, based on a one-time infusion of bond money, would cause a $7.9 billion budget gap to reopen the following year.

Davis said his plan requires three things: passage "on time" before the new fiscal year begins, a plan to pay off the $10.7 billion bond, and action this summer to close future budget gaps.

Budget deadlocks are routine as both parties cling to their ideological positions, testing the resolve of the other side. A budget was not passed last year until early September, when the Legislature adjourns for the year.

The governor's finance director, Steve Peace, a former Democratic legislator from El Cajon, warned that the state is reaching the limit of its borrowing capacity and risks deeper trouble if the new budget is delayed.

"We do not have a choice to be late with the budget," Peace said. "So we compromised with the Legislature's desire to have a multiple-year solution."

In a move that maintains cash flow but does nothing to close the budget gap, the state plans to get a short-term $11 billion loan next month, most of which will be used to pay off a $12.5 billion loan obtained last fall.

State Controller Steve Westly has warned that without a new budget, the state will be unable to borrow more after July 1 and will run short of cash in 30 to 60 days, forcing the use of "IOUs" to pay some of its bills.

In a two-month budget deadlock in 1992, the state issued more than $3 billion worth of IOUs. Peace said major banks, facing their own tight fiscal limits, have suggested they will not be able to cash state IOUs this year.

Beyond the cash-flow problem, Peace said that a budget delay also might jeopardize the $10.7 billion bond, the centerpiece of the governor's new plan.

He said lenders want to see action this summer that would begin to close future budget gaps, protecting their investment as the bonds are paid off over five or more years.

Peace said the bond would not be sold until this fall or later, long after the Legislature adjourns Sept. 12. If there is no move to close future budget gaps, he said, the bond could be downgraded or even unmarketable.

"We might suddenly find ourselves with a much differently rated instrument or no ability to go at all," Peace said.

California's bond rating ranks at the bottom among states. Peace said the interest rate on California bonds has traditionally been two-tenths of 1 percent below average, but is now about one-half of 1 percent above average.

The unprecedented $10.7 billion deficit-reduction bond would be paid for by a half-cent increase in the sales tax, which varies among counties and is currently 73/4 cents for each $1 of a purchase in San Diego County.

The plan is to increase the sales tax in October, yielding $2.4 billion a year in new revenue for the state. How to pay for the bond has become one of the major budget disputes.

The Davis administration says the bond payment, for a number of legal reasons, must come from a tax increase. An Assembly Republican plan would pay off the bond with a half-cent of the existing sales tax.

"Republicans will not vote for a budget that increases taxes on hard-working families of California," said Assembly GOP Leader Dave Cox of Fair Oaks. "It's an issue we will not compromise."

The governor's original plan called for an $8.3 billion tax increase to pay for health and social services that would be shifted from the state to local government.

His new plan reduces the programs that would be shifted and pays for them with a smaller, $1.8 billion tax increase: increasing the tobacco tax by 40 cents per pack in two years and higher income taxes for people in upper-income brackets.

Davis' new plan also assumes that a $4 billion increase in the vehicle license fee will be automatically triggered by July 1. A two-thirds reduction in the tax phased in since 1998 would be repealed.

Peace said the tax on the average vehicle, now $76 a year, would increase to $234. But the view that the tax cut was designed to be repealed when the state needs money is expected to be challenged in court.

The governor's new proposal to reduce the amount of his proposed tax increase that must be approved by the Legislature was not warmly welcomed by Assembly Speaker Herb Wesson, D-Culver City.

The speaker said he probably would support a larger tax package to avoid making more cuts in schools and other programs that provide essential services to Californians.

"I've gotten to the point now where I truly believe we have a moral obligation," Wesson said. "I cannot cut any more."

Wesson said the Assembly Republican plan to balance the budget without a tax increase would result in a $13 billion budget gap in the following fiscal year. He cited an estimate by the nonpartisan Legislative Analyst.

In two rounds of midyear cuts, said Peace, the Legislature already has trimmed about $7 billion from the $38 billion budget gap. He said the action tentatively trimmed an additional $7 billion in the new fiscal year.

The governor's new plan to issue a deficit-reduction bond softens the cuts he originally proposed for next year. The plan cuts about $700 million less from kindergarten-through-high school funding.

Davis said his goal is to avoid teacher layoffs, continue the class-size reduction program, and preserve the test-based accountability programs he launched in his first year in office.

"There is nothing more important to me than education," Davis said. "It is literally a path to a better life for everyone."

Kevin Gordon of the California Association of School Business Officials said the new proposal would reduce the school cuts next year to $2.1 billion. He said $2.4 billion has been cut this fiscal year.

"The actions he has taken in this budget, no question about it, will result in far fewer teacher layoffs," Gordon said.

The governor also dropped his original plan to cut $305 million from community colleges, which triggered protests at many campuses and a march on the Capitol earlier this year.

In addition, the new plan would reduce the proposed increase in community college student fees. Instead of increasing from $11 per unit to $24 per unit, the new fee would be $18 per unit.

"Gov. Gray Davis deserves credit for taking significant steps to reduce the magnitude of the disproportionate reductions that he proposed for community colleges in January," said Community College Chancellor Thomas Nussbaum.

The governor made no major changes in his proposal for the University of California and California State University systems. Student fees at UC and CSU may be increased by 35 percent next fall.

Although relieved by the governor's revised budget, UC regents and CSU trustees warned that more cuts are possible. UC already faces double-digit percentage cuts to research, administration, student services and libraries.