(Reuters) - Virginia's governor said on Monday he wants to rebuild the state's rainy day and pension funds while remaining vigilant about possible local economic effects from perpetual budget wars at the federal level.

In unveiling his biennium budget proposal, Governor Bob McDonnell also swore off raising taxes.

The fiscal 2013-2014 budget would appropriate $84.9 billion for state government spending, with general fund revenues covering only 41 percent of that amount. By the end of fiscal 2014, the budget will have a balance of $31.4 million, McDonnell said in an address to the state legislature.

"This reflects the need for a greater cushion given our economic uncertainty," he said. "Virginia must have the liquidity and flexibility necessary to navigate through this tumultuous period, and to retain our critically important Aaa bond rating."

Virginia's fiscal years begin each July.

This summer, Moody's Investors Services gave a negative outlook to Virginia's credit strength because the state's nearness to the nation's capital indirectly links its economy to the federal budget. The automatic spending cuts that the U.S. government will have to enact by 2014 include military spending, and Virginia is home to many Navy installations.

McDonnell proposed setting aside $50 million "to mitigate a variety of negative impacts on Virginia related to likely future federal actions" and to pump up the state's budget reserves to more than $600 million by the end of fiscal 2014.

He expects revenues to grow 3.4 percent in fiscal 2013 and 4.5 percent in fiscal 2014. He noted that state spending is currently as low as it was in fiscal 2007.

During the recent recession, Virginia cut its contributions to employees' pensions. The Virginia Retirement System is at risk of having a little more than 60 percent of the money needed to cover state and local retirement benefits.

"Here's the simple truth: our state retirement system is underfunded, and this situation threatens the system's long-term solvency," McDonnell said. "We must fund VRS at substantially higher levels so that we can guarantee all benefits will be there for our hard-working teachers, police officers and other state and local employees."

He proposed making the biggest contribution to the system in state history - $2.21 billion - while assuming an 8 percent rate of return on the pension funds' investments. Local governments, which also pitch in to teachers' pensions, would not have to come up with a matching amount.

State employees would also be eligible for a 3 percent bonus next year, but only if they receive high marks on performance evaluations and there is enough discretionary money available to at least meet twice the cost of the bonuses.

Last March, the governor and legislature began a tense stand-off on how best to bring the retirement system back to health.

"We must act now and during the session we must pass other pension system reforms to permanently fix this system," he said on Monday.

McDonnell is also calling for putting more sales tax revenue toward infrastructure and for restoring $25 million in aid to cities and counties over the two years.

While the Republican governor stood strong on not raising taxes, he did suggest a $10 million fee increase to fund its motor vehicle department.

(Reporting By Lisa Lambert; Editing by Dan Grebler)