A new report says state tax revenues increased in the final three months of last year as the improving economy boosted income and sales taxes receipts.

Tax revenue increased 6.9 percent in the October-December quarter, according to the report from the Nelson A. Rockefeller Institute of Government, a research institute at the State University of New York. That's based on early data from 41 states. If revenues rise by that pace once all states have reported their data, it would be the fastest increase since the April-June quarter of 2006.

Still, revenues remain below pre-recession levels, while spending has risen to meet increasing demands for social services. That means states still face large budget gaps they will have to close through more spending cuts or tax hikes.

"States will continue to search for ways to climb out of a very deep hole," wrote Lucy Dadayan and Donald Boyd, the authors of the report.

It's also the fourth straight increase after revenue fell for five quarters in a row during and after the recession, the report said. Revenue plummeted 16.8 percent in the April-June quarter of 2009 and 11.5 percent in the July-September quarter of that year.

Income taxes, which provide about 36 percent of state revenue, on average, rose 10.7 percent in the final three months of 2010. Sales taxes, which account for 31 percent of revenue, rose 6 percent in the same period, the report said.

Thirty-four of the 41 early-reporting states have income taxes, and 30 of those states said income tax revenues rose. Only four reported declines. All 38 states with sales taxes that have reported data for the fourth quarter reported increases.

The report didn't include individual state data for the fourth quarter.

The Center on Budget and Policy Priorities, a think tank, estimated last month that 44 states are projecting deficits of $125 billion for the budget year that begins July 1.