U.S. states inch closer to pre-recession prosperity By Lisa Lambert WASHINGTON (Reuters) - U.S. states are coming close to the end of a three-year trek back to the financial prosperity they enjoyed before the recession, according to a survey released on Friday that found the recovery is slow and uneven. The National Association of State Budget Officers and National Governors Association found that total state spending will likely rise 2.2 percent this fiscal year from last, while general fund revenues grow 3.9 percent to $692.8 billion. Meanwhile, states' primary tax sources will likely rise in fiscal 2013, with personal income tax collections projected to increase 5.5 percent and sales tax collections 2.8 percent. For most states, fiscal 2013 began on July 1. "The direction is encouraging, but it's still very slow growth," said NGA Executive Director Dan Crippen. We would despair if it were going down, but we aren't dancing in the streets because it's going up modestly. Average revenue growth over the past 35 years of the survey has been 5.6 percent, and fiscal 2012's increase in revenue was 3.4 percent. States have more money for education and healthcare but are still struggling to find funds for other areas they slashed when the 2007-09 recession caused revenues to plummet and demand for services to rise, according to the report. More than half of the states have boosted spending for education and Medicaid, the healthcare program for the poor, this fiscal year, and nearly all, 42, have higher spending levels than in fiscal 2012. In the same light, fewer states had to close budget gaps this fiscal year than in the last two, and those shortfalls were also smaller than ones they eliminated in fiscal 2011 and 2012. Total general fund revenues in fiscal 2013 will surpass the pre-recession peaks reached in fiscal 2008, and many states' spending will also be higher than in that fiscal year. Still, the report noted 21 of the 50 states say revenues will not return to their pre-recession highs this fiscal year, and 24 say spending remains below fiscal 2008 levels. States are just about getting back to pre-recession levels. But what I'm intrigued by is that they're still not just there yet," said NASBO Executive Director Scott Pattison. When adjusted for inflation, revenue is 5.5 percent below fiscal 2008 and spending lags by 8 percent, he said. There is also a list of caveats accompanying the news of improvement. Costs for healthcare have been rising for years, threatening to swamp budgets. While healthcare spending is increasing, it does not always create new economic activity, and in some cases it is pulling money from other areas. Also, some states are putting more dollars toward education because struggling school districts cannot cover costs with their still-depressed property tax revenues. A third of states expect to cut their workforces in fiscal 2013, after 33 states laid off employees in fiscal 2012. Public sector job losses were so steep over the last year that they threatened the already sluggish national economic recovery. Governors do not believe their states' finances could handle the shock of another recession. "It would be a disaster for them if the economy went back to recession," said Crippen. They've had this experience of just barely climbing out of the hole. Currently, President Barack Obama and the U.S. Congress are negotiating a budget deal to sidestep a combination of spending cuts and tax increases set for the beginning of the year that has been dubbed the "fiscal cliff." Many economists warn that without a deal, the country will plunge back into recession. Pattison said states "are not going to be able to make up for all their prior cuts, and they're not going to be able to make up for federal cuts." Federal funds currently represent 31.2 percent of the money states spend, with general funds raised mostly from taxes making up 39.8 percent. The 2009 stimulus plan, which included the largest transfer of federal funds to states in U.S. history, pushed up the federal share and that proportion will likely shrink in coming years. The survey noted that in fiscal 2008, federal funds provided slightly more than a quarter of state spending. Even if the federal government finds a way to halt its spending cuts, often called sequestration, congress' focus on deficit reduction means other cuts will be made in coming months, Crippen said. Medicaid was put out of reach of sequestration, but could be part of future deals, he added. Meanwhile, tax reforms under consideration include capping the amount of money people can exempt from their taxes for the interest paid on bonds sold by states and local governments. Eliminating the exemption would drive up states' borrowing costs, he said. Reporting by Lisa Lambert; Editing by Dan Grebler