The state Senate approved its version of the budget yesterday and grudgingly agreed to suspend general excise tax exemptions on several business activities to help make it balance.

Senators acknowledged that their budget draft does not pencil out because much of it was written before the latest projection by the state Council on Revenues and contains higher labor savings than Gov. Neil Abercrombie anticipates.

The Senate draft calls for $11 billion in state spending for fiscal year 2012 — slightly more than the House draft — and $10.8 billion in spending for fiscal year 2013, which is less than the House. The Senate draft is more than $650 million lower over two years than what Abercrombie requested, but about half of that amount is based on the presumption of labor savings of 8 percent to 10 percent, equal to the existing two furlough days a month for state workers.

Abercrombie and the Hawaii Government Employees Association, the state’s largest public-sector labor union, have tentatively agreed to a two-year contract with a 5 percent pay cut, equal to one furlough day a month. The state will likely negotiate similar deals with the Hawaii State Teachers Association and the United Public Workers.

Senate and House negotiators will now meet in conference committee over the next few weeks to prepare a final budget draft to send back to Abercrombie.

“We’ll take the budget into conference, and we’ll probably have to do a combination of things, including looking for further budget cuts,” state Senate President Shan Tsutsui (D, Wailuku-Kahului) said.

The Senate, after discarding a general excise tax increase as an option last week, reluctantly agreed in an 18-7 vote to temporarily suspend GET exemptions on several business activities. Six senators voted for the bill with reservations, however, a signal of lukewarm support going into conference.

Suspending GET exemptions — on contractors, airlines, businesses that sublease and others — would generate about $200 million a year to help close the state’s projected two-year, $1.3 billion deficit.

The GET exemption bill is now the primary source of new revenue to blend with spending cuts to balance the budget.

Several senators said they worry that the budget debate has dwelled too much on the short-term problem of closing the deficit and not enough on strategies to prepare the state for economic recovery.

“The way out of this dilemma is we have to start to restructure our programs. We have to look at stimulating the economy. We need the revitalization of Oahu and the urban core. We have to streamline permitting,” said Sen. Malama Solomon (D, Hilo-Honokaa).

Sen. Ronald Kouchi (D, Kauai-Niihau) said the Abercrombie administration’s decision to tap the state’s hurricane relief fund and rainy day fund just to get through the fiscal year that ends in June will leave the state without much in reserve for the next two years.

Senate Minority Leader Sam Slom (R, Diamond Head-Hawaii Kai) said the budget draft would still increase state spending over this fiscal year. He said senators appear reluctant to make fundamental changes to the state’s financial course. “Sometimes you have to stand up and say no. That’s the mark of true leadership,” he said.

The Senate and the House voted yesterday on dozens of bills to meet tomorrow’s procedural deadline to exchange bills between the chambers. The bills that are still alive will now move into conference committee for final negotiations before the Legislature adjourns in early May.

Senators opted to remove a pension tax on higher-income taxpayers from a larger tax bill, citing a letter from the state attorney general’s office that warned of potential legal challenges from retired public workers who might claim a pension tax unconstitutionally erodes their accrued benefits.

But the House — in a close 28-23 vote — preserved a pension tax, which sends the measure into conference.

Many House dissidents, minority Republicans and freshmen lawmakers voted against the pension tax. Some House lawmakers asked why they should risk political exposure from voting on the unpopular idea again given the cold feet in the Senate.

House leaders said a pension tax — which would raise about $17 million a year, a fraction of what Abercrombie initially proposed — is among about two dozen revenue-generating options still available to reduce the deficit.

Lawmakers also plan to limit itemized deductions and repeal a state income tax deduction on higher-income taxpayers, delay an increase in the standard deduction and cap hotel-room tax revenue that goes to the counties.

Lawmakers would also increase the liquor tax and extend a surcharge on rental cars. A portion of the rental car surcharge would be diverted into the general fund.

The House and Senate passed competing proposals to recoup uncollected state taxes on mail-order catalog and Internet sales.

House Speaker Calvin Say (D, St. Louis Heights-Wilhelmina Rise-Palolo Valley) said the deficit reduction plan relies mostly on suspending the GET exemptions. “All of those entities that are fighting us in the repeal of the exemptions for two years are special interests,” he said.

House Minority Leader Gene Ward (R, Kalama Valley-Hawaii Kai) questioned whether families and businesses can afford the changes. He still fears Democrats will turn to a GET increase as an option in conference committee. “We’ve got to hold strong, and we’ve got to balance the budget without doing that. Otherwise we’re going to really stall the economy, which is already sputtering,” he said.