The economic crisis that has halved 401(k) plans, sent stocks tumbling and undermined consumer confidence is also taking a toll on state governments.

Forty-five states, including Pennsylvania, are staring down budget shortfalls either this year or next. Midway through the current fiscal year, Pennsylvania has come up $814 million short of revenue estimates. Gov. Ed Rendell is projecting a $2.3 billion deficit before the fiscal year ends in June.

With next year looking even bleaker, the governor and legislative leaders have signaled steep budget cuts are on the way. That should worry Pennsylvanians.

Balancing the budget by cutting services will derail Pennsylvania's long-term goals and undermine efforts to transform our economy.

The recession has placed new demands on human service and safety-net programs while leaving the commonwealth with fewer resources. State tax revenue has dropped precipitously, as consumer sales have declined and corporate profits have plummeted. Meanwhile, hardship is on the rise. As businesses cut hours, more Pennsylvanians find themselves out of work, and families already struggling slip further backward.

The effects of the economic downturn will linger well beyond the official end of the recession. The U.S. unemployment rate is now at 7.2 percent, far higher than many economists expected just a few months ago. Pennsylvania's unemployment rate is now at 6.7 percent and could peak at more than 9 percent in 2011 if the national economy weakens further. State tax revenue took two years to rebound after the 2001 recession, which was shorter and milder than the recession of 2008.

The economy will recover at some point, jobs will return to Pennsylvania and state revenues will rebound. The state's policy goal, therefore, should be to get through this cyclical downturn without doing significant damage to public services or abandoning key commitments, such as the multiyear plan to adequately fund public education across the state's 501 school districts.

As the state deals with the deficit, it's important to recognize that Pennsylvania has a revenue problem, not a tax-and-spending problem.

Among the 50 states, Pennsylvania ranked 32nd in state taxes and 30th in state spending as a share of the economy in 2005. Taxes, by that measure, are lower in Pennsylvania than in several competitor states, such as North Carolina and Michigan. And Pennsylvania state taxes account for the same share of the economy today as they did in 1993 or 1977.

Pennsylvania actually should be spending more, not less, to jumpstart the ailing economy. But because the commonwealth, unlike the federal government, is required to balance its budget each year, its options are limited in providing counter-cyclical stimulus. Still, state policy makers have options to avoid drastic budget cuts.

Research by Nobel Prize-winning economist Joseph Stiglitz and Peter Orszag, President Barack Obama's budget director, demonstrates that cutbacks in state government programs are more harmful to the economy than raising taxes on upper-income households during an economic downturn. Why? Because state governments invest tax revenue back into local economies while a tax increase on the richest earners tends to reduce their rates of saving. Saving may be good for individuals but it doesn't help boost the economy.

The governor and legislators should take a page from Messrs. Stiglitz and Orszag and make the state's tax system less regressive by taxing dividends, net profits and other classes of unearned income at a higher rate than employment compensation and interest. The cost would fall mostly on wealthier Pennsylvanians but would have little effect on their lifestyles.

Other revenue options should be explored to ensure everyone is paying their fair share. That includes closing corporate tax loopholes that allow big retailers and other multistate corporations to avoid state taxes by hiding profits in low-tax states such as Delaware. Pennsylvania also should collect a tax on the extraction of natural resources, such as natural gas, just as mineral-rich states like Texas, West Virginia and Wyoming do. And Pennsylvania should join the ranks of every other state by putting an excise tax on smokeless tobacco.

Pennsylvania has no chance of balancing its budget without federal fiscal relief. It also will need to tap its rainy-day reserves and other sources.

But ultimately state policy makers will face a choice: preserve key investments that will drive resources back into the state economy or make harmful cuts that would exacerbate the recession and put more pressure on already-squeezed local taxpayers.

Let us hope our leaders choose to put us back on the road to economic prosperity.