U.S. state governments are recovering from the recession as tax collections increase, allowing them to spend more on schools and transportation, according to a report.

State revenue is projected to rise 3.9 percent during this budget year over last to surpass the peak hit before the full effects of the 18-month recession that began in December 2007, according to the report, released Thursday by the National Governors Association and the National Association of State Budget Officers. Planned state government spending will climb 2.2 percent over last year, the Washington-based groups said.

“There are some positive developments and the trend line is going in the right direction, but the challenges are still significant for states,” Scott Pattison, the executive director of the state budget group, said in an interview. “There’s not enough money going around, and we’re not going to see them replace all the cuts they’ve made.”

The financial improvement is lifting a restraint on the economy that lingered after the recession and prompted states to eliminate jobs, raise taxes and cut spending to close deficits.

State revenue is projected to increase this year to $692.8 billion, while planned spending will rise to $681 billion, in the third consecutive annual gain, according to the report.

Almost half of state budgets are smaller than four years ago, an indication of how deep public spending was cut following the longest economic downturn since the Great Depression.

Economic Drag

With their budget outlook improving, state and local governments exerted the smallest drag on economic growth in three years in the three months through September, according to Commerce Department data. State payrolls have grown this year. And concern over government finances has diminished among investors in the $3.7 trillion municipal bond market, where the securities have rallied amid speculation that their tax- exemption will be more valuable should tax rates rise.

States are struggling with rising employee health-care costs and with rising expenses for Medicaid, the joint federal- state health program for the poor, said Dan Crippen, executive director of the National Governors Association.

Pressure to curb the budget deficit in Washington also poses risks for states, which might lose money or be hurt by tax changes, such as proposed curbs on the breaks given to municipal-bond buyers. President Barack Obama and Congress are negotiating over how to avert more than $600 billion in automatic spending cuts and tax increases scheduled to start in January.

‘Fewer Resources’

“Whatever happens will inherently mean fewer resources going to states from Washington,” Crippen said in an interview.

In states, the difference between their revenue and what they have committed to spend has narrowed as tax collections grow along with the economy.

Just eight states are forecasting deficits for the next fiscal year, down from 33 in 2011, according to the report. States are also adding to their reserve funds, an indicator of fiscal health watched by bond-rating companies. States raised the funds to about $61 billion this year, from $33 billion in 2010.

States aren’t benefiting evenly from the recovery. Twenty- one still expect revenue to be lower this year than in 2008. In eight states, including Texas, Illinois, and Alabama, spending is set to drop this year.

Overall, officials increased funding for public schools by $4.9 billion during the current budget year, led by California and Florida, and more states increased aid to local governments, according to the report. Colleges and universities continue to face pressure as state funding dropped by $1 billion this year. Spending on transportation projects rose by $254 million because of increases in New York, Oklahoma and Georgia.