Pushing up against a midnight deadline, state lawmakers are expected to choose today the tax and revenue-generating options they need to balance the budget.

The options to close a projected two-year $1.3 billion deficit includes bills that would suspend general excise tax exemptions on targeted business activities, divert money from a rental car surcharge, cap itemized deductions on higher-income taxpayers, cap hotel-room taxes that go to counties, repeal a state tax deduction for higher-income taxpayers, delay an increase in the standard deduction and personal exemption, and impose a pension tax on higher-income retirees.

House and Senate negotiators reached agreement last night on the final draft of the two-year state budget, which contains labor savings, spending cuts and state program adjustments that would be used with the new revenue to close the deficit.

Overall, however, the budget draft would increase state spending over this fiscal year to cover higher Medicaid, public-worker health care and debt service costs. But the budget is less than Gov. Neil Aber­crom­bie recommended.

The budget draft, which now goes to the full House and Senate for final votes, involves $11 billion in state spending in fiscal year 2012 and $10.9 billion in spending for fiscal year 2013. The general-fund portion of the budget, over which lawmakers and the governor have the most control, is about $5.4 billion in fiscal year 2012 and about $5.5 billion in fiscal year 2013.

"Well, we have a budget. And it’s not the budget that we would prefer, but it is a budget that attempts to preserve the most basic of services — core government services — in these trying times," said state Rep. Marcus Oshiro (D, Wahiawa), lead House budget negotiator.

Lawmakers have estimated labor savings of $88 million a year based on the new two-year contract reached between Aber­crom­bie and most units of the Hawaii Government Employees Association, which contains a 5 percent pay cut — equal to about one furlough day a month for state workers — and an even split on health care premium costs. The assumption is that Aber­crom­bie will negotiate similar deals with the Hawaii State Teachers Association and the United Public Workers.

Lawmakers chose not to use state general funds to finance scheduled pay raises for the University of Hawaii Professional Assembly as part of the faculty union’s six-year contract reached two years ago. Instead, lawmakers directed the University of Hawaii to cover the faculty raises from special funds.

Lawmakers also made about $120 million a year in state program cuts, but gave the Aber­crom­bie administration discretion over how to achieve about half of the cuts through efforts such as restructuring.

The budget draft slices $16.4 million a year from the state Department of Education’s school-based budgeting account, which includes the weighted student formula and school-related services.

Lawmakers also would strike $20 million from student transportation in fiscal year 2013, an incentive for the department to get a better handle on school bus costs in the year before the cut takes effect.

The budget includes a $25 million cut to Medicaid in fiscal year 2012 and a $50 million reduction in 2013 — which amounts to a $150 million decline due to the corresponding loss of federal matching money. The state Department of Human Services is expected to announce in early May how the cuts will be carried out.

Lawmakers also made adjustments to welfare spending, but department officials were relieved that the budget was not worse for social-service programs.

"This is a tough year, and the Legislature has a very difficult task of balancing projected deficits with the needs of the community," said Patricia Mc­Mana­man, director of the Department of Human Services.

"And I think the resounding answer today was that they stood behind and support those who are in need."

State Sen. David Ige (D, Aiea-Pearl City), lead Senate budget negotiator, said that while the focus has been on budget cuts, lawmakers also would restore spending on what they consider key programs.

Lawmakers devoted an additional $13.2 million to cover health care costs for migrants from the Marshall Islands, Micronesia and Palau. They invested $4 million in the Preschool Open Doors program.

Lawmakers would fund new positions at the state Department of Taxation to help with tax collections, and provide state money to lure federal matching funds for a Medicaid eligibility system.

House and Senate conferees also reached agreement last night on a capital improvement proj­ects budget of $1.8 billion in fiscal year 2012 and $1 billion in fiscal year 2013.

The construction budget includes $40 million in fiscal year 2013 for a new elementary school in growing Kapolei, $5.6 million in fiscal year 2012 for long-neglected water repairs at Mayor Wright Homes public housing, and $9.2 million in fiscal year 2012 and $7 million in fiscal year 2013 for improvements at Kuhio Park Terrace.

With the budget closed, lawmakers will spend the hours before the midnight procedural deadline to have bills ready for final votes next week in talks over the revenue-generating bills.

Ige said yesterday that the Senate would not agree to a pension tax. Senators instead want to lower the income threshold for the repeal of a state tax deduction, which would cover more taxpayers but would not specifically target retirees.

"All the other (tax) provisions really apply across the board," he told reporters. "A pension tax only applies to pensioners, and that’s the primary difference. We don’t want to single them out.

"We just believe that the tax on pensions should be a policy call rather than a budget-balancing call."

Oshiro said the House was not ready to concede on a pension tax on higher-income retirees. He said the option fits within the House’s philosophy of directing new tax increases at higher-income taxpayers.

But the pension tax involves only a relatively small amount of money — $17 million a year, down from the more than $100 million a year Aber­crom­bie originally wanted — and has been used as leverage in negotiations over the past few days mostly because of philosophical rather than financial reasons.

With the midnight deadline, and the end of session approaching Thursday, lawmakers are also making their last strategic moves.

State Sen. Malama Solo­mon (D, Hilo-Hono­kaa) gutted a bill yesterday relating to the Aloha Tower Development Corp. and added a proposal for a casino. A gaming commission would regulate the casino, and the state would impose a 15 percent wagering tax on monthly gross receipts.

Several House and Senate leaders said privately that they did not take the proposal seriously because lawmakers declined to advance casino gambling earlier this session.

State Sen. Donovan Dela Cruz (D, Kaena-Wahiawa-Pupu­kea) said the proposal could lead to a discussion before next session about the location and potential financial value of a casino. Hawaii and Utah are the only states that do not allow some form of gambling.

"You could be for or against gambling, but I think a lot more people are against raising any kind of taxes," he said.