Despite opposition from business and labor groups, Gov. Arnold Schwarzenegger embraced a blue-ribbon panel's recommendation Tuesday to flatten the state income tax, eliminate part of the sales tax and install a new form of consumption tax on most firms.

The plan would cut the highest state income tax rate to 7.5 percent on millionaires and 6.5 percent for single filers earning between $28,000 and $1 million in taxable income.

A new consumption tax, called a business net receipts tax, would capture revenues from firms that now escape taxation, such as service-based industries.

Schwarzenegger called a legislative special session Tuesday and wants lawmakers to approve the package this year. The GOP governor said he would sign the plan as is. But Democratic leaders made no promises on a timetable.

The complex tax package raises numerous questions:

Why is this necessary?

State leaders launched the panel because they believed the tax system was responsible for California's notorious budget problems.

The state experiences heavy revenue swings due largely to its growing reliance on income and capital gains taxes. Many panelists believed that a move away from those taxes would solve this problem, but others disagree and say the state's budget problems are better solved by a rainy-day fund.

How would this affect my state income taxes?

All filers who owe taxes would pay less, but those earning above $75,000 would benefit most. Because those earners pay the bulk of income taxes, they will see the most significant reductions.

According to the commission, millionaires would receive, on average, a $109,291 cut in their tax payments; those earning between $75,000 and $100,000 would see roughly a $905 drop.

What about deductions and credits?

The plan would allow itemized deductions only for mortgage interest, property taxes and charitable contributions. It would eliminate tax credits, including one for child care, while removing deductions for medical expenses.

Would I pay sales tax?

The plan calls for the elimination of the 5 percent portion of the state sales tax that currently pays for California's general fund budget (that rate is temporarily 6 percent through June 2011). Drivers would continue to pay the full tax at the gas pump. Consumers also would pay 2.25 percent in statewide sales taxes that would go toward local programs and repaying deficit bonds, as well as any additional local taxes.

What about property taxes?

The tax commission recommended no change.

Won't the state go broke?

The commission envisions that the new tax on businesses would capture more revenues from service industries that escape taxation, such as accountants, lawyers and auto mechanics. The panel also believes that out-of-state firms will pay more.

Critics dispute the extent to which the new tax will increase revenues.

Why do I care if more firms have to pay taxes?

The presumption is that firms would pass on the new tax burden to consumers through higher prices. Because companies could not deduct salaries or benefits, unions also fear employers would cut wages, benefits or jobs.

Conservatives assert that because companies face a lower tax rate - 4 percent compared to the current 8.84 percent corporation tax rate - they would be able to create more jobs. Critics suggest that the plan provides incentive to fire employees and hire independent contractors because contractors are deductible and in-house employees are not.

Commissioner Christopher Edley, dean of the UC Berkeley School of Law, said the Legislature might deal with this loophole by eliminating deductions for use of contractors who do not pay the new tax.

When would this begin?

The commission has recommended that it start in 2012 with a five-year phase-in period that allows for "tweaks" if economic models prove wrong.

The Legislature must approve the plan, however, and has made no promises. Business groups and labor unions, whose opinions weigh heavily, denounced the plan Tuesday.

Support on the commission tilted Republican. Nine out of 14 commissioners supported the final package, including six of seven Schwarzenegger appointees. Only three of seven Democratic appointees signed on.

Why are business groups opposed?

Their biggest concern seems to be that the new tax is untested and could become a regulatory hurdle that makes California less competitive than other states. Even if businesses dislike the current system, they prefer predictability and a known quantity.

Because businesses could not deduct benefits and pay for employees, some have called it a tax on employees. Service industries that rely heavily on labor rather than materials may face significant tax burdens.

Why are unions and many Democrats opposed?

As mentioned, labor groups fear that employers will cut wages and salaries to deal with the tax burden. Public employee unions dislike the commission's call for a spending cap and rainy-day fund.

It also remains unpalatable for Democrats to approve a plan that dramatically cuts income taxes on the upper-middle class and wealthy. Under the proposal, the top 3 percent receives half of the $15 billion cut in income taxes.

Any other problems?

UCLA tax law professor Kirk Stark and eight other tax experts suggest the plan could prove unconstitutional as it applies to out-of-state firms, including Internet retailers. Commissioners said Tuesday they believe those firms would provide roughly $6 billion in new revenues.

At the very least, the new tax would be challenged in court for years. Chairman Gerald Parsky said he believes the state would prevail, in part because the new tax is not a sales tax. But Stark warned that it is a "total crapshoot" and that the state could owe significant refunds if it loses at the U.S. Supreme Court.

Call Kevin Yamamura, Bee Capitol Bureau, (916) 326-5548.