AUSTIN – Nearly 40,000 small businesses would see their state franchise taxes go away for at least the next two years – an average annual savings of $2,200 – under legislation Gov. Rick Perry approved Tuesday.

The tax cut that the Legislature passed last month exempts businesses with gross receipts of $300,000 to $1 million, yielding a total reduction for the state of $85 million next year and $87 million in 2011.

That represents less than 2 percent of the revenue collected under the state's business franchise tax.

About 40,000 small businesses "will be able to hang onto more of their dollars and plow them back into their businesses in the form of new hires and new equipment," Perry said.

A Republican running for re-election, Perry signaled that his support for the tax change may be an issue he seeks to capitalize on in next year's campaign.

"There aren't many states that could extend a tax cut to small businesses in these tough economic times," he said. And in an apparent jab at his potential rival for governor, Sen. Kay Bailey Hutchison, Perry said: "I wish they'd do a tax cut like this in Washington."

All of the affected businesses will be exempt for the next two years, but the tax will resume in 2012 for those with gross receipts over $600,000 – unless the Legislature opts to extend the tax break when it meets again in 2011. The exemption is permanent for businesses under $600,000.

Businesses below $300,000 have been exempt since the business tax lawmakers enacted it in 2006 as part of a plan to fix the state's funding system for public schools.

Sen. Dan Patrick, R-Houston, the bill's sponsor, said it "represents a significant tax reduction on small businesses, and I'm glad these companies now have greater opportunity to hire workers instead of paying the government."

Patrick and the House sponsor, Rep. Rene Oliveira, D-Brownsville, joined Perry at a bill signing ceremony in Houston.

Backers said nearly 266,000 businesses would be free of the tax for at least the next two years – including those already exempt – saving money not only from the tax cut but also from their accounting costs to prepare and file tax returns with the state.

All businesses except sole proprietorships are supposed to file tax returns and more than half a million did last year, according to the state comptroller. Only 133,000 were required to pay because of the exemptions for businesses with gross receipts under $300,000 or that had a total tax liability of less than $1,000.

The new law gives a tax break to 40,000 small businesses. To make up for that, the Legislature:

Increased the state tax on smokeless tobacco, basing the tax on weight rather than price and generating additional revenue of $105 million over two years.

Of that amount, $83 million will be used to pay for the business tax cut and $22 million will be used to encourage new doctors to practice in rural areas.

The rest of the tax cut will be funded with general revenue.