That shortfall, combined with a steep drop in revenue from the tax on home sales and decreases in sales tax and income tax collections, created the $641 million budget gap for 2008, he told lawmakers.

“The economy of Virginia remains sound, but the housing market will take a few years to rebound,” Kaine said.

To save money, Kaine has directed Cabinet secretaries to develop plans to cut 5 percent of the spending for their agencies. Unfilled jobs will remain vacant unless the need is considered critical. The governor also hinted he may ask legislators to approve tapping into Virginia’s Rainy Day Fund.

Kaine will update lawmakers on the cost-cutting efforts in December, when he will also propose a two-year spending plan covering 2009 and 2010.

Though Kaine said the money-saving measures will have to be continued in future fiscal years, he also acknowledged spending will increase in some areas.

For example, state spending on public education will likely go up by at least $1.1 billion, Kaine said.

And that does not include the governor’s high-priority plans to expand pre-kindergarten programs or any efforts to improve mental health treatment in response to the Virginia Tech shootings.

“Preliminary analysis of the tragedy on April 16 shows that we need to strengthen emergency services and ensure that treatment is available and reliable in the community,” Kaine said. “And we need to focus on preventing future tragedies by strengthening our children’s mental health system.”

The situation is not as dire as the predicament encountered by former Gov. Mark Warner, who faced a $6 billion deficit. Overall, Virginia’s revenue collections are still expected to increase in fiscal 2008, but not enough to balance the two-year, $74 billion budget that was approved in 2006.

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