Treading into politically sensitive territory, state Senate Democrats are asking the public to choose between raising the general excise tax or temporarily suspending a tax exemption on certain business activities to help balance the budget.

Gov. Neil Abercrombie and state House leaders have sought to take a GET increase off the table, warning that a broad-based tax increase could damage the state’s economic recovery, and have tried to guide the Senate toward suspending exemptions.

But Senate Democrats have insisted that a general excise tax increase be part of the debate, arguing that lifting GET exemptions might be worse for business.

“While we certainly understand that the governor has strong reservations on the general excise tax, I think there are some members of the Senate who still feel that the greater impact on the economy and on our residents will not be a general excise tax with some exemptions and rebates, but rather eliminating the exemptions from some of the businesses that do business here,” said state Senate President Shan Tsutsui (D, Wailuku-Kahului).

“So because there is a lot of uncertainty as to which measure may impact our residents more, the idea is to hear it together and then move something to conference.”

Tomorrow morning the Senate Ways and Means Committee will hear a bill — HB 793 — that includes both a GET increase and the suspension of exemptions.

The two options involve the largest potential sources of new revenue to close a projected two-year budget deficit estimated at about $1.3 billion.

The bill would raise the general excise tax — the state’s largest source of revenue — by 1 percentage point for two years, roughly a 25 percent increase.

The rate would go to 5.5 percent from 4.5 percent on Oahu — where there is a 0.5 percent surcharge for rail transit — and to 5 percent from 4 percent on the neighbor islands.

The tax increase could generate between $500 million and $600 million a year. But senators — concerned about the impact of the regressive tax on the poor — would double the standard deduction, double the income tax credit for low-income renters, double the refundable food credit and increase the capital goods tax credit.

The tax credits would reduce the amount of the GET increase available to balance the budget by about $100 million.

The bill would also suspend general excise tax exemptions on certain business activities and impose a 4 percent GET on those activities for a few years. According to the state Department of Taxation, the move would generate $161.7 million in fiscal year 2012 and $185.1 million in fiscal year 2013.

House leaders have proposed to gradually apply the GET on the business activities targeted, but the Abercrombie administration put the GET rate at 4 percent.

Business interests are mobilizing against both tax options, although the GET increase will likely produce the strongest opposition.

Some labor unions and social service providers have favored a GET hike as the most sweeping solution to the budget deficit, relieving some of the pressure for labor savings and further cuts to state programs. Some also note that visitors shoulder more than a third of the GET burden.

A few senators have privately questioned why the Senate has forced a politically sensitive GET debate when both Abercrombie and the House appear adamant. The tax has not been raised statewide since 1965, and, because of its broad application and regressive nature, a potential increase causes public outcry every time it comes up as an option.

“We’re going to see what the public says and get some comments and whatever suggestions we can and try to make the decision,” said Sen. David Ige (D, Aiea-Pearl City), chairman of the Senate Ways and Means Committee. “We haven’t decided at this point.”

Ige had said previously that suspending GET exemptions was not part of the Senate’s budget plans. Last month the Senate Economic Development and Technology Committee held a GET exemption bill.

The House Finance Committee, as a precaution in case the Senate again attempts to kill the GET exemption idea, is preparing to add the provision to a Senate bill so it will advance to conference committee later this month.

Sen. Pohai Ryan, who serves on the Senate Ways and Means Committee, said she would back raising the GET but only as a last resort. Ryan (D, Lanikai-Waimanalo) called suspending GET exemptions tough “because we have to support businesses to create work.”

Sen. Donovan Dela Cruz (D, Kaena-Wahiawa-Pupukea), who also serves on the committee, said he would prefer the approach taken by Abercrombie and the House. But he has also called for a wider discussion about job creation to stimulate economic recovery.

“We need big-picture ideas,” he said. “What industries are we going to grow? How are we going to grow them so we can get more jobs in Hawaii?”

Sen. Sam Slom (R, Diamond Head-Hawaii Kai), who serves on the committee, said senators should reject both GET options.

“What we have to do is significantly cut this government,” he said. “It’s not a question of where we’re going to find additional revenue.

“We’ve got to put a rein on the way that government is operating right now. Period.”