Following is the full text of Gov. Gray Davis' annual State of the State Address, delivered on January 8.

Thank you, Lieutenant Governor Bustamante. Speaker Hertzberg, President Pro Tempore Burton, Speaker-designate Wesson, distinguished Members of the Legislature, Chief Justice Ron George and honorable Justices of the Supreme Court, including our newest justice, Carlos Moreno. Please join me in welcoming Justice Moreno to our highest court.

My fellow Constitutional Officers, esteemed Cabinet Secretaries, friends and fellow Californians.

Please join me in welcoming the two most important women in my life - the love of my life, the First Lady of California, Sharon Davis, and the first lady of the Davis family, my mother, Doris Morell.

The horrific events of September 11th shocked us all - and changed our world forever. All four hijacked planes were bound for California. On that darkest day, more than 100 fellow Californians paid the ultimate price for our freedom, as much as any solider who ever fought in any war. Tonight, we dedicate ourselves to building a future worthy of their sacrifice.

We're honored to have with us tonight Inez Paskins, whose husband Jerry perished in the World Trade Center. And Tom and Melanie Frost, who lost their daughter Lisa on United Flight 175. God bless each one of you.

On September 11th, the world also saw our greatest strength in the courage of the passengers who made United Flight 93 a final stand against terror. I am honored to have with us the loved ones of two of those Northern California passengers. Please join me in welcoming Alice Hoglan, the mother of Mark Bingham. And Kim, Sonali and Chris Beaven, the family of Alan Beaven. Also with us tonight is Chief Rick Martinez of the Sacramento County Fire Department. Rick personifies the spirit of sacrifice as a leader of the urban search and rescue teams in New York City. They spent every waking hour in a dangerous valley of death in the hope of finding life. We thank you, Chief, and all six search and rescue teams from California who went to Ground Zero.

In the aftermath of these unspeakable attacks, we moved rapidly to protect Californians. I directed the California Highway Patrol to provide additional protection for our highways, dams and water supply. I activated the California National Guard to protect our airports and bridges. We increased security for our power plants and food supply. We enhanced the state of readiness of our public health system. In fact, no state has done more than California to protect its citizens and vital assets since the terrorist attacks. Now, many states are emulating our example.

Our ability to respond so rapidly was enhanced by actions we took back in 1999. That spring, I established the State Committee on Terrorism and the State Threat Assessment Committee. They gave us a head start in marshaling our forces for this war against terrorism. After September 11th, I established the state Anti-Terrorism Information Center in the Attorney General's office and the Joint Information Center in my Office of Emergency Services. These actions have made California a model of preparedness. In addition, I hired one of the country's most experienced anti-terrorist experts as my security adviser. He's a 10-year veteran of the California Highway Patrol and a 23-year veteran of the FBI. Please welcome George Vinson.

The horror of September 11th is seared in our hearts and minds forever. But so, too, is the spirit of courage, sacrifice and patriotism to which this tragedy gave new life. Tonight, we honor the valiant men and women of our Armed Forces. These guardians of justice and freedom are meeting the threat of terror with strength, bravery and resolve. History shows that freedom exacts a high price. Many times, it requires the supreme personal sacrifice. Last month, California lost a hero of our own, an elite Special Forces soldier - Army Staff Sergeant Brian Cody Prosser. Cody gave his life for his country - and for our freedom. It's my heartfelt honor to introduce Cody's mother and stepfather - Ingrid and Al Solhaug.

While we honor and support our fighting men and women overseas, we also pay tribute to those keeping us safe here at home. The men and women of law enforcement and the California National Guard have put themselves in harm's way to protect our very way of life. For that, we owe them our deepest gratitude. Please join me in honoring those Guard members here tonight.

My friends, the citizen-soldiers of the National Guard should not have to pay for the privilege of protecting us against terrorism. Many of the reserves called to duty left better-paying jobs behind. During these extraordinary times, the State should pay the difference between military and civilian pay for State employees who've been called up to duty. Many private companies already make this commitment. I urge every other employer who can, to make their Guard employees whole.

Since September 11th, we acted swiftly to protect our airports, bridges, highways and dams, to secure our water supplies and electricity grid and to prepare our health facilities. But there is more we can and must do.

First, we're working with the Bush Administration to create a tiered system of public warnings when terrorist threats occur. Second, we're asking the federal government to allow Highway Patrol officers to provide additional "sky-marshal" protection on in-state flights they're already taking in the course of their duties. Third, we'll ensure that law enforcement officials - with the authority of the court - can monitor communications by suspected terrorists and allow "roving" wiretaps on suspects. Fourth, we'll tighten controls over the transportation of toxic and hazardous materials. In addition, I will ask the Attorney General to review new federal Anti-terrorism legislation to ensure that California law is consistent with - and at least as tough - as national law. Attorney General Lockyer, I commend and applaud you for your vigilance and cooperation during these difficult times.

The events of September 11th also struck a major blow to our nation's economy. California, like most other states, is now faced with daunting challenges. After three years of unprecedented economic expansion in this State, the coming year will require some difficult choices. But even with the budget cuts that will be necessary, California will still be much stronger than it was when I took office.

The Golden State's underlying economy remains more diverse and entrepreneurial than ever. When the economy does rebound - as we know it will - California will be better prepared to come roaring back because of the smart investments and dramatic progress we've made together over the past three years.

My friends, California has challenges ahead - but also a bright future. I am proud to report to you tonight that - together - we've made good on the promise to lead California in a new direction, guided by lasting values. Just look at what we've accomplished together:

Although unemployment has risen after September 11th, California has created 900,000 new jobs in the last three years - more than any other state in America.

When I took office in 1999, California was the world's seventh largest economy. Today - because of the extraordinary ingenuity and industry of Californians - we are the fifth-largest economy on the planet, surpassing both France and Italy. Within 28 days of taking office, I traveled to Mexico to demonstrate the respect our only international neighbor deserves. Our trade with Mexico has increased three years in a row - and Mexico is now our largest trading partner. As a result, we've added 66,000 new jobs in California.

In education, we've made consistent and measurable progress: We've recruited 15,000 new teachers for our schools, and 20,000 college students have taken advantage of our incentives to become future teachers. 100,000 teachers have received rigorous, world-class training under the auspices of the University of California. More than 1,300 teachers have met the high national standards for prestigious national certification - a ten-fold increase in three years. Last year alone, in part because of our incentives, 516 California teachers became Board-certified. More than 200,000 teachers have taken advantage of our teacher tax credit.

And we've put a college education within the reach of hundreds of thousands of Californians. For the first time ever, 100,000 students have earned Governor's Merit Scholarships, and nearly 200,000 will receive Cal Grants based on merit and need - the most ever at one time.

We take pride in all these numbers, but here's the one that counts the most: test scores have gone up three years in a row.

In health care, as well, the improvements are stunning: More than one million California children have received health insurance who lacked coverage just three years ago. Today, the Healthy Families Program covers 500,000 kids - a ten-fold increase since I took office. In fact, UCLA is about to announce the biggest two-year drop in the number of uninsured Californians since they began tracking those numbers.

California also leads the nation in HMO reform. Nearly a quarter million Californians have been served by our new Department of Managed Health Care - the first such patient protection agency in any state. With the help of that Department, 40,000 Californians have taken on their HMO's -- and won. They received the treatment their HMO denied - without having to go to court.

Our aggressive crackdown on Medi-Cal fraud has already saved $228 million in taxpayers' money. By this time next year, it will have saved half a billion.

On public safety, we've: Put more than 3,000 additional cops on our streets. And provided nearly 300 law enforcement agencies with state of the art equipment and access to new crime labs.

What else have we accomplished together? 600,000 families have benefited from our child-care tax credit. We've made the largest investments in history in clean water, land conservation and coastal protection, while cutting state park fees in half. An unprecedented $6 billion in transportation improvements have been allocated by the Transportation Commission. $1.3 billion has been designated for local streets and roads. Every one of these, my friends - every one - is a record achievement we can be proud of.

On top of these major investments, we have cut taxes by 4.3 billion dollars and put this money back into the pockets of California taxpayers. In place of political promises, we've delivered bipartisan results to the people of this great State. Every step of the way, we've linked opportunity with accountability, progress with fiscal prudence.

Now, no list of what we've achieved together would be complete without discussing our progress on energy. California defied the odds - and the prognosticators. As all of you know, when I stood here last year we were facing an imminent implosion of our electricity system. The flawed deregulation scheme we inherited backfired catastrophically. We'd experienced the first forced blackouts since the Second World War. Experts were predicting 32 days of blackouts over the summer.

We were 100% exposed to the wildly fluctuating energy market. Merchant generators - and even some of our own municipal utilities - were gouging us unconscionably. Manufacturing firms and other businesses were threatening to leave California because of the disruption of power. But, together, we confronted the challenge, and kept the power flowing to our homes and businesses, cities and farms.

As always, the people of California deserve the credit. They responded to our "Flex Your Power" campaign, conserved in record numbers, earned rebates in historic amounts and helped reduce our energy demand. But we also built more supply in record time. We licensed 17 new major power plants and 12 new peaker plants. Eleven of those plants were built and put on-line by the end of last year, including the first three major plants in 13 years. In 2001, we brought more new power on-line than in the previous 12 years combined, enough to power 2 million homes.

Against all odds, we also successfully pressured a reluctant federal government to finally restore price caps and consider refunds. We tamed the spot market with long-term contracts. And we established the California Power Authority to help ensure our energy future.

California has the most technologically advanced economy in the world - and it lives or dies on a stable supply of electricity. Our high tech industries cannot survive the lights flickering, much less going out. Make no mistake: my overriding imperative last year was to ensure California had reliable electricity. By doing so, we protected public health and safety, prevented a meltdown of our economy, kept business from leaving the State - and even created new jobs through expansions that were put on hold earlier in the year. Now that the supply of natural gas has stabilized and the price has fallen, we are renegotiating some of the long-term contracts to ensure ratepayers a reliable supply of electricity at less cost.

But the recent collapse of Enron is another sign of the extreme volatility and uncertainty we still face in the deregulated energy sector.

We must continue to conserve. We must continue to build more plants, cleaner plants, more-efficient plants to replace our aging facilities. We must maintain our vigilance to protect our economy and our citizens against further energy disruptions.

Now, with the same resolve we demonstrated during the energy crisis, we will squarely confront the current economic downturn and its consequences. In the coming year, we must have the courage to make tough decisions in tough times. The Department of Finance and the Legislative Analyst agree that we are facing a shortfall of more than 12 Billion dollars. We will have to be smarter and more focused. And we will - with confidence in our eventual resurgence and still bright future. But, in so doing, we will not back away from our historic commitments to education, economic growth, health care and public safety.

From Day One, we have exercised fiscal restraint and responsibility. In good times, we made smart investments in California's future. Still, even with our budgets flush - and well before the sharp decline of the technology sector and the attacks of September 11th - we were always careful with the taxpayers' dollar.

We invested a substantial portion of our surpluses into one-time investments - such as transportation - instead of ongoing spending. With both Democratic and Republican votes, we passed two back-to-back, on-time budgets in 1999 and 2000 - the first in 16 years. We established a $2.6 billion reserve in the current budget year - the largest rainy day fund in 23 years. And I exercised my veto authority to cut $7.4 billion in otherwise worthy proposals over three years. I also suspended allocation of $2 billion in the current budget year, cut operating expenses by $150 million and ordered an immediate hiring freeze.

While demonstrating good fiscal stewardship, we also addressed the critical issues facing California and provided for those most in need. After three years, we enter this new year with better schools, healthier families, increased worker protections and safer communities.

The budget I will submit to you in two days will be fair, will preserve the major gains of the last three years, will protect local government - and will not increase taxes. I will call on you to close the budget gap with a combination of cutbacks, deferred spending, internal borrowing and accelerated revenue.

Here are the basic principles I used in formulating the budget: First, my commitment to public education remains resolute. Let me be clear: education will be protected above everything else in my Budget. For three years in a row, we've increased our investment in K-12 education and met or exceeded the Prop-98 guarantee. This year, once again, I intend to invest more in schools in 2002 than we did in 2001 AND we will meet the Prop-98 guarantee. That is how progress is preserved. I have asked you to reduce some of the budget augmentations we made last year. But I will fight to protect those investments vital to the classroom itself, where teachers teach and students learn.

Second, we will maintain our full commitment to public safety. This is no time to weaken our resolve to combat crime and protect our citizens. The terrible events of September 11th underscored the value to us all of those who protect America - police, sheriffs, firefighters and emergency medical personnel.

Third, I will expand our commitment to children. I'll be proposing an expansion of safe and affordable child care to serve 100,000 more children. I'll propose an expansion of the Childhood Lead Poisoning Prevention Program. And, although I asked you to postpone the expansion of before and after school programs in the current year, in my budget, I'll propose an increase of $75 million - the largest ever made to this program.

Fourth, I am opposed to balancing the State's budget on the backs of local government. Whether we are elected at the State or local level, we all took the same oath - to serve the people. So I will continue the State's commitment to repay vehicle license fees to local government.

Fifth, I will not advocate raising taxes. That would further burden individuals and businesses struggling to stay afloat in these difficult economic times. These are the principles that guided me in preparing the budget. And, even with the cutbacks I will propose, California will be much stronger than it was just three years ago.

As a critical step in addressing our budget shortfall, I have called a concurrent Special Session of the Legislature. I urge you to take up as your first order of business $2 billion in cuts in the current budget year that I called for in November. Failure to act quickly on these cuts will only increase the pain for our fellow citizens who depend on the State for vital services. Given our softening economy, we must do everything we can to help those who've lost their jobs. We must also stimulate the economy and create new jobs.

Now, most of the tools to accomplish these goals are in the hands of our representatives in Washington. I urge the President and Congress to pass an economic stimulus package. But we have to do our part, too. Here at the state level, we must do all we can to reinvigorate our economy.

First, I will ask you to make retroactive to September 11th the increases in unemployment benefits I approved last year. Those who lost their jobs, especially as a result of terrorism, deserve the higher levels of unemployment assistance that went into effect two days ago. This change alone will put $400 million in benefits into the hands of laid-off California workers. Second, I'll also be sending you legislation to authorize $678 million dollars in lease revenue bonds to accelerate new public works projects that are ready to go. Third, world-class schools need world-class facilities. I was proud to chair the successful Proposition 39 campaign that will help to finance the construction of local schools. But our state bond funds are exhausted. So I will urge you to support $30 billion in school bonds over three general elections to build new schools and modernize existing ones.

One key component of California's workforce is our nursing corps. We must recruit and train thousands of new nurses who are the backbone of our medical delivery system. In the coming weeks, I will propose measures to expand the number of nurses throughout the State. I will provide incentives to clinics and hospitals that support clinical placements for nursing students, new graduates and returning nurses. We will also remove barriers to qualified licensed nurses moving to California from other states and other countries.

Now, a faltering economy forces us to take a hard look at California's job training and workforce development system. It's a 4.6-billion-dollar Goliath made up of 34 different programs in 13 different agencies. The demands of our new economy - especially in this time of change - requires a new approach. That is why I'll be sending you a proposal to reorganize these entities into a new Cabinet-level Labor and Workforce Development Agency. In streamlining these programs, we will achieve greater accountability and efficiency. While we generate new jobs and serve our workers, we also need to protect our older citizens. So I propose we reauthorize the Medicare Drug Discount Program, which provides seniors the same prescription drug discounts the state enjoys - of 20-30 percent.

On one more issue that affects us all - protecting individual privacy - we've already made significant strides. We established the first statewide Office of Privacy Protection and our first "do not call" list for unwanted telemarketing calls. We've banned phantom calling, enhanced opt-out rights for credit card consumers and required businesses to tighten controls on dissemination of personal information. But we have not done enough. So I will propose legislation that, in clear and simple language, gives consumers more power to control whether, when and where sensitive, personal information may be used or sold by financial institutions. When we're done, we'll have the most comprehensive, consumer-friendly privacy laws in the nation.

Tonight, in this hard hour, the challenges of leadership are many. Restoring abundance in a time of economic shortfall; Maintaining safety in a time of global conflict; Sustaining hope and tranquility in a time of fear and uncertainty. The true measure of leadership is how we master these moments. Because of the smart investments we've made together over the past three years, because of our fiscal caution, because we put progress above partisanship, we are better prepared to meet the challenges ahead. If, on occasion, we doubt our capacity to succeed, let us find inspiration in the courageous passengers of Flight 93, who on an ordinary morning boarded an ordinary plane and did extraordinary things. These were everyday people who upon realizing their fate summoned up the courage to overpower their captors. Their heroism rallied the nation and guaranteed that no more innocent lives would be lost. We may never know how many thousands of lives they saved. But this we do know. Flight 93 was one of freedom's finest hours. With God's grace - and with the courage of these heroes and our own lasting values as our guide - we will continue to turn adversity into accomplishment and lead this great State forward.

May God shine his magnificent grace on the United States of America. May God bless our great state. And may God bless each and every one of you.