* Revenues, spending inch up
* Demand for services remains high
* Governors want to rebuild reserves
By Lisa Lambert
WASHINGTON, Jan 15 (Reuters) - The natural gas boom has brought fortune to Wyoming over the last year and lifted its revenues beyond expectations, but in his state of the state address last week, Governor Matt Mead pressed legislators to cut spending by 6 percent.
Almost all U.S. states, including long-suffering California, are in a position unthinkable just a few years ago: their revenues are growing, and some are even running surpluses. But governors are hesitant to use their states' windfalls for spending sprees or massive tax cuts.
"We were the fourth-fastest growing state this past year," Mead said. "This is an opportunity we should take. In making cuts now, we will be prepared for what happens next - whatever that might be."
Like Mead, other governors are also concerned about the possibility of another economic downturn and that federal budget fights between the U.S. Congress and President Barack Obama will shrink crucial funding sources.
"Congress has failed to pass a budget in years. Uncertainty alone affects us," Mead said. "And if revenue fluctuations from the last few years teach us anything, it's that revenues fluctuate and we need to be ready."
Then there are spending demands beyond their control. Escalating healthcare, education and pension costs could consume any extra revenue.
As a whole, states expect revenues to creep up 3.9 percent this fiscal year. Spending will also likely increase, by just 2.2 percent, according to the National Governors Association and National Association of State Budget Officers.
Most states begin the next fiscal year on July 1 and legislatures will have to pass budgets in the coming months.
Only three states - Idaho, Maine and New Jersey - told a recent survey by the National Conference of State Legislatures that revenues are coming in less than expected this fiscal year. Revenues in states rich in natural resources, primarily natural gas, are particularly strong. Others, such as Virginia and Maryland, with large federal presences, are also on the mend.
Moreover, state tax revenues in total have grown for 11 straight quarters, according to the Rockefeller Institute of Government. Even Florida, which bore some of the housing downturn's worst effects, is projecting an $829 million surplus.
"We're not hearing the dire statements that we heard at the height of the downturn," said Bob Kurtter, a managing director at Moody's Investors Service. "We're not looking at these massive budget gaps. But we are hearing from governments that they have to hold the line on spending."
Revenues are "not growing fast enough to meet all the demands for spending," he said. "We expect states are still going to have budget battles."
The story Colorado Governor John Hickenlooper told during his state of the state speech last week is playing out across the country. Two years ago, Colorado experienced the largest revenue drop in its history and "had no choice but to cut funding for schools and other essential services.
"Today, with an improving economy, we have the beginnings of a reserve fund and we should protect it," Hickenlooper said. "We are restoring funding for education - not enough to make up for the $1 billion shortfall we experienced in the Great Recession - but our steps are in the right direction."
The 2007-09 recession caused states' revenue to plummet and because all except Vermont must balance their budgets, most made emergency spending cuts, raised taxes, borrowed and raided reserves. The U.S. government stepped in with a record transfer of federal funds to states through its stimulus plan, helping cover the costs of the biggest budget-busters: education and Medicaid health insurance for the poor.
"It's been a sustained revenue recovery, but the pace of growth has slowed in recent months and there's still a lot of uncertainty out there," said Robin Prunty, an analyst at Standard & Poor's Ratings Services.
States cut so deeply that demand is bursting in areas such as education, she said. Meanwhile, slow national economic growth has kept the number of people needing social services high.
"The focus continues to be on Medicaid," Fitch Ratings Managing Director Laura Porter said of state spending. "It's a hard program to control the rate of growth."
Connecticut is one state that had to pass emergency measures in December to help end a shortfall caused mostly by Medicaid.
"The general tone continues to be austere," Porter said. "I think you're in a situation where states are trying to rebuild their financial cushions."
In announcing California's projected surplus of $851 million, Governor Jerry Brown last week pledged to keep spending restrained. The state will also put $1 billion into its rainy day fund.
Virginia Governor Bob McDonnell asked legislators in his address last week to add $50 million to the state's rainy day fund, hoping to mitigate effects of the "unresolved drama" of federal deficit negotiations.
The U.S. government has delayed its scheduled automatic spending cuts until March, the same time it will hit its debt ceiling. States can receive a third of their revenues from the federal government, making them vulnerable to reductions.
Still, not all states are socking away their increased revenue. A handful are looking at tax breaks.
Creating jobs and boosting consumer spending "can be accomplished by returning a significant portion of our state's budget surplus to the taxpayers who made that surplus possible in the first place," Iowa Governor Terry Branstad said in his address on Tuesday.
Branstad focused on changing property taxes, seeking to "provide nearly $400 million in actual property tax relief" by putting money toward a homestead tax credit and further capping tax growth. He said the state could directly fund local governments, which traditionally rely on property tax revenues.
Texas Governor Rick Perry also is urging legislators to use any windfall from a 12.4 percent revenue increase for tax relief. But some lawmakers are cautioning against passing breaks until a court rules in a case on school funding.
Meanwhile, Louisiana Governor Bobby Jindal is seeking to end the state's income tax and corporate taxes.
Nebraska Governor Dave Heineman in his address on Tuesday proposed an overhaul in which the state would eliminate personal and corporate income taxes and cover the lost revenue by ending sales tax exemptions totaling $2.4 billion over fiscal 2014 and 2015.
Kansas slashed taxes last year and many in the state are awaiting Governor Sam Brownback's address Tuesday evening to hear if he suggests further cuts. Last week, a three-judge panel took the unusual step of directly criticizing the tax breaks when it ruled the state is unconstitutionally underfunding its schools.
New Jersey Governor Chris Christie had proposed an across-the-board state income tax cut to be implemented if revenue reached the high level of growth he predicted for fiscal 2013.
But the usually outspoken Christie was mum on the idea in his state of the state speech last week after the state legislature's budget officer estimated New Jersey could fall $705 million short in revenue this fiscal year.