OLYMPIA — Gov. Christine Gregoire yesterday proposed raising $203 million in taxes in a two-year budget that avoids major cuts in services and spends millions on raises for state workers and teachers, reducing school-class sizes and creating two new four-year colleges.

Gregoire proposed increasing the cigarette tax by 20 cents a pack and bringing back a revised form of the estate tax, which was knocked out by a state Supreme Court ruling last month. The money would be dedicated to Initiative 728, aimed at reducing class sizes.

Deep cuts, widely expected a few days ago, are largely missing in her $25.8 billion general-fund budget. Gregoire would close a projected $1.6 billion shortfall, in large part, with steps that don't cause immediate pain. For example, she would save $524 million by making changes to the state pension system and deferring payments to it. Gregoire proudly called it "a legacy budget" that moves the state forward.

"Getting by isn't good enough for Washington state," she said.

Yet, short of a boom in the state's economy, the budget would likely lead to another shortfall two years from now, causing more hand-wringing and angst over what programs to cut or taxes to increase.

"I have real concerns about sustainability," said Richard Davis, president of the business-backed Washington Research Council. "We're still going to be looking at [budget] shortfalls in the future."

House Appropriations Chairwoman Helen Sommers, D-Seattle, seemed most glad that Gregoire had released a proposal — any proposal. "We've been looking for a gov's budget," she said. "Too bad she had to wait so long."

Democrats in the House and Senate are expected to release their own proposed budgets within the next couple of weeks. There are only five weeks left in the session.

Rep. Gary Alexander, the ranking Republican on the House Appropriations Committee, said he was disappointed Gregoire didn't think more long-term. "She said she doesn't want to just get by, but to me it sort of is just getting by," he said.

Gregoire herself acknowledged the budget does not address the "structural" problem of the state expenses growing at a faster pace than tax revenues. "I inherited it," she said. "I can't solve it this legislative session."

Gregoire focused on living up to past commitments on education, health care and pay raises. Under her budget, state workers and teachers would get pay raises and benefits worth more than $600 million.

Gregoire also proposed dedicating money from the cigarette-tax increase and the estate tax to pay for the class-size initiative, I-728, which was approved by voters in 2000.

"I've asked for a commitment for us to stop debating about I-728 and class sizes, and let's buy it like the citizens asked us to do," Gregoire said.

The League of Education Voters, which grew out of the campaign committee that put I-728 on the ballot, had planned to attend a news conference to talk about the shortcomings of the governor's budget. Now, the group is supporting it, said Lisa Macfarlane, the league's president. "This is a real pro-education budget," she said.

Higher education would get a boost as well. Gregoire proposes increasing enrollments by 6,600 full-time students at state colleges and universities. She also calls for expanding two branch campuses into four-year institutions, one in Tacoma and one in Vancouver.

In human services, Gregoire would make up for the loss of $80 million in federal money to maintain community mental-health programs.

The budget is not without controversy.

Gregoire called her proposal a "no-new-taxes budget" because it doesn't contain general increases in sales, property or business-and-occupation taxes.

Still, any tax proposal is bound to create opposition.

Republican leaders have been saying since the Legislature convened in January that the budget should be balanced without a tax increase.

Last week's optimistic revenue forecast, which projects the state will take in $739 million more in tax revenue than expected, shows that the no-tax budget passed two years ago has helped fuel the economy, the Republicans say.

That makes this the wrong time to raise any taxes, said Rep. Ed Orcutt of Kalama, the ranking Republican on the House Finance Committee. "No matter what form they're in, tax increases take money out of the economy," Orcutt said in a statement.

The cigarette tax is projected to bring in $73.2 million during the next two years. It would continue to increase in the future, Gregoire said, up to 80 cents a pack more than the current tax to keep pace with I-728.

The new estate tax would raise $129.4 million. The state Supreme Court last month abolished an estate tax collected by the state, wiping out an estimated $431 million that lawmakers had been counting on. Gregoire's budget would bring back the tax in a different form.

Under the old system, estates valued at $900,000 or more would have been subject to taxes. Under Gregoire's new proposal, the threshold would be $2 million, and family farms would be exempted.

Other proposals in her budget likely to strike a nerve include calls for sentencing reform that would save money by reducing the amount of time certain low-risk offenders spend in prison. Similar efforts in the past by former Gov. Gary Locke created a storm of opposition in the Legislature.

JOHN FROSCHAUER / AP Gov. Christine Gregoire's budget, proposed yesterday, would increase the cigarette levy and bring back a revised form of the estate tax.

Sommers was troubled by the proposal to defer payments to the pension system. She's an expert in pensions and serves on the state Pension Funding Council. She says delaying contributions to retirement funds only solves short-term problems.

"In the end, you pay a lot more," she said.

Sen. Joe Zarelli of Ridgefield, the ranking Republican on the Ways and Means Committee, was positive about Gregoire's budget, saying he was glad she didn't propose raising more taxes.

He hopes Gregoire's proposal will put a damper on any plans to raise more than $200 million in taxes.

But Gregoire's proposal may just be the starting point, said Tony Lee, who lobbies for the Fremont Public Association for programs for children and low-income people.

He said it would be easier for lawmakers to raise $400 million in taxes as long as Gregoire is halfway there.

Andrew Garber: 360-943-9882 or agarber@seattletimes.com. Seattle Times reporters Linda Shaw and Nick Perry contributed to this story.