Palin, who bills herself as a fiscal conservative, submitted her supplemental budget to lawmakers, calling for the budget reduction this year. Palin also sought approval from lawmakers to tap budget reserves after the spending deficit rose to $1.65 billion - up more than $1 billion from estimates just two months ago.

Alaska Gov. Sarah Palin gives the state of the state address to a joint session of the Senate and House in the Capitol in Juneau in this Jan. 22 photo. Palin on Feb. 3 gave lawmakers her supplemental budget, calling for spending cuts of $285 million in light of a nearly $1.7 billion deficit. AP Photo/Al Grillo

"Through savings targets we implemented at the beginning of the fiscal year and by efficiently managing our programs, we have been able to reduce the current budget and minimize supplemental funding," Palin said.

But legislators claim much of Palin's $268 million cuts this year aren't reductions at all.

A majority of that sum - $200 million - is actually unrealized tax credits for companies investing in oil and gas development in the state being returned to the treasury.

"That's not a savings. That's really a fact that we're not getting the exploration credits claimed that the administration anticipated were going to be claimed. So that's not a reduction," said House Finance Committee co-Chairman Mike Hawker, R-Anchorage, in a prepared statement.

Palin last year requested a total $400 million to cover the tax refunds in this fiscal year - a program first approved by lawmakers in 2006 and intended to spur oil and gas development.

Department of Revenue acting chief economist Cheryl Neinhuis said the credits are taking longer than expected to process and many won't be ready for payment until the next fiscal year, which begins in July.

Neinhuis said that doesn't mean that companies are cutting back on investments.

"If we keep seeing real low oil prices, we may see a curtailing of oil activity, but it's not reflected in that number at all," she said.

Hawker also noted the governor's budget contains a $15 million reduction in state Medicaid spending - money that wasn't going to be spent anyhow because it was based on an overestimate.

The supplemental budget also contains a broad but undefined $17.5 million cut to agencies.

Senate Finance Committee co-Chairman Lyman Hoffman, D-Bethel, said he wants more information on how those cuts should be spread out.

"An unallocated reduction doesn't give me an idea of where the (Palin administration's) priorities are. If we don't have them identified, it's hard to agree or disagree with those categories," Hoffman said.

Palin budget director Karen Rehfeld said the reductions were not specified so that department heads have the flexibility to manage their own cuts. She said agencies were put on alert last July they would have to prepare for budget reductions.

Rehfeld said unallocated cuts are unusual but so is a supplemental budget that actually reduces the governor's overall spending plan.

"The bottom line is we are reducing what we planned to spend in this year's budget, and when we do that it will reduce the amount we will have to draw ultimately in the end from reserves. That's the whole point," Rehfeld said.

Senate budget writers will get an overview from Rehfeld on Feb. 4.

The $268 million reduction will bring the state's estimated budget shortfall to $1.36 billion for this fiscal year.

Lawmakers will have to approve use of state reserves or make additional cuts to balance the budget, she said.

Senate and House finance leaders do not foresee major budget cuts this year but plan to use the state's savings to maintain the current spending levels. The state has about $7 billion in savings accounts.

"At this stage I don't think there will be major reductions in the operating budget but we will use the revenues that we set aside to level things out," Hoffman said. "The state operating budget should not be an up and down situation depending on what the price of oil is."

The state had estimated revenue at $7.5 billion in the spring of 2008, when oil prices were high. But they have dropped considerably, and the forecast was reduced to $5.5 billion last month.

In December, revenue officials forecast a shortfall of about $450 million and suggested an oil price rebound was coming. The shortfall, before Palin's proposed budget cuts, now looks to be about $1.65 billion.

The Department of Revenue usually releases its revenue forecasts in the spring and fall. It issued interim forecasts this year given the volatility in oil prices. The price of North Slope crude has swung from a high of more than $140 a barrel to just over $30 a barrel in the past fiscal year. Oil revenues provide almost 90 percent of the state's unrestricted revenue.

The supplemental budget was released Tuesday with a revised oil price forecast averaging $37.47 a barrel for the third quarter of this fiscal year and $43.76 in the fourth quarter.

And the situation could be much worse next year. Budget experts say next year's shortfall could be as much as $3 billion dollars if oil prices don't rally.