Legislators are moving ahead with a plan to cut Indiana's corporate income tax rates by about 40 percent while holding off on a proposal for phasing out the state inheritance tax.

Decisions on both taxes are complicated by the state's tight money situation, with the Senate's top budget writer on Tuesday challenging business groups to suggest ways to replace the projected $140 million a year that the corporate tax cut could cost.

Supporters of the corporate tax cut told the Senate tax committee that Indiana's 8.5-percent tax rate is among the nation's highest and that it discourages businesses from moving to Indiana. They argued that cutting the rate to 5 percent would help the state's economy.

Tax committee Chairman Brandt Hershman, R-Lafayette, said work still was being done on a plan for covering the expected loss of tax revenue, but that he expected the panel to vote on it later this week.

Hershman's proposal includes an estimated $59.5 million annual revenue boost by starting to tax the interest on state and local bonds from outside Indiana and $7 million from the elimination of various tax credits.

Those still leave a projected $74 million gap in what is the state government's third-largest revenue source, behind sales and individual income taxes. The corporate income tax is projected to raise about $688 million of the state's $13.4 billion in revenue for the coming budget year.

Senate Appropriations Committee Chairman Luke Kenley, R-Noblesville, told business organizations during Tuesday's hearing that they "need to step up to the plate" with revenue suggestions if they want the tax cut.

"There is a significant dollar disparity here," Kenley said.

Many larger businesses are able to transfer profits to other states and lessen their Indiana taxes, but smaller companies aren't able to do that and end up paying relatively more, said Bill Waltz, a vice president of the Indiana Chamber of Commerce.

He said the tax rate also hurt efforts to attract businesses to the state.

"Companies looking to come into Indiana don't always look past that 8.5-percent rate," Waltz said. "On its face, it is the advertisement of Indiana's rate and it's not always a good thing."

Gov. Mitch Daniels is interested in the corporate tax cut as a way to attract new jobs and investment but wants to ensure it doesn't hurt the state's revenues, Daniels spokeswoman Jane Jankowski said.

The tax committee also heard from supporters of phasing out the inheritance tax over five years.

Bill sponsor Sen. Jim Banks, R-Columbia City, said the state's inheritance tax was a disincentive to keeping wealth in the state as some people move away to avoid having it fall on their estates.

The state now exempts inheritances up to $100,000 to children and grandchildren and has a top rate of 10 percent for portions of estates topping $1.5 million to them. More distant family members and non-relatives face higher rates.

State figures show the inheritance tax raises about $135 million a year.

Hershman, the tax committee chairman, said he supported the concept of eliminating the inheritance tax but declined to call for a vote on the bill because of its cost.

"Most people realize that our budget is already strained about as far as can be reasonably be expected," he said. "Absent a source of replacement revenue, we are going to have to move slowly on this."