THREE YEARS AGO, the Reagan administration proposed to pick up the full tab for Medicaid and food stamps if the states would assume all welfare costs and take over a number of other functions.

Such streamlining of state and federal responsibilities has an appealing political and intellectual symmetry. As Arizona Democratic Gov. Bruce Babbitt observed, "Congress ought to be worrying about arms control and defense instead of the potholes in the street. We just might have both an increased chance of survival and better streets."

The idea is hardly new. It was proposed, and abandoned, by the Nixon administration. Reagan's plan -- dubbed The New Federalism -- made no more headway on Capitol Hill than Nixon's. State and federal officials were never able to move beyond the broad outlines of who would do what and, more important, who would pay for what.

In fact, most observers believe this reliagnment sank without a trace. But they're wrong. Indeed, in the last three years the states have emerged as new engines of innovation in job creation, economic development, foreign trade, health care, drunk driving, prison reform, education and many other areas.

In a word, the states have been exercising leadership at a time when the federal government has increasingly been paralyzed. This is the most interesting and important domestic policy change to emerge from the Reagan presidency.

The most visible source of this revolution doubtless was the administration's budget cutting, which forced states to take responsibility for social services they had become accustomed to, or go without them.

But the underlying reason is a dramatic transformation in the quality and competence of state government. Almost unnoticed in Washington, there has been a revolution in state capitals from Albany to Sante Fe, from Olympia to Tallahassee, and from Richmond to St. Paul. No longer the province primarily of hangers-on and political hacks, most state governments today are remarkably sophisticated and professional, competent to address problems that only a decade ago seemed beyond their grasp.

This is a startling change. For most of the 20th century, states were the weak link in the federal system. In 1933, a leading political scientist wrote, "The American state is finished. I do not predict that the states will go, but affirm that they have gone."

In 1965, Lyndon Johnson's policy architects viewed the states with scorn. They even had a name for it -- "The George Wallace Syndrome" -- as in, "Do you want to give (Alabama Gov.) George Wallace that much power and authority over federal money?" To some extent, this was deserved: state governments were often reactionary, synonymous with "massive resistance" to integration, for example.

Even state leaders were critical. Former North Carolina Gov. Terry Sanford began his 1967 book "Storm Over the States" with the admission: "The states are indecisive. The states are antiquated. The states are timid and ineffective. The states are not willing to face their problems. The states are not responsive. The states are not interested in the cities. These half dozen charges are true about all of the states some of the time and some of the states all of the time."

But the states have changed. State constitutions were modernized, allowing governors to have a second term, for example. Administrative reform has taken state government out of the petty-cash-in- the-cigar-box days and into advanced computerization, vastly increasing their capacity to govern. One-man one-vote reapportionment gave more progressive urban areas more power in the state legislatures. This changed legislators dramatically. Harvard professor Jerry Murphy writes that they are now thought to be "more intelligent, assertive, independent, diverse in background and critical of government policy" than ever before.

Not surprisingly, the best example of all this is the California legislature, a body with resources and a knowledge base that rival those of the U.S. Congress. But California is an anomaly, a "nation-state." A more appropriate example, astonishingly enough, may be Virginia -- a state that political scientist V.O. Key called "a political museum piece" less than 40 years ago.

Today, the legislature meets every year, instead of every other year. Its members are making at least five times what they made in 1970. It has a Joint Legislative Audit and Review Commission, similar in function to the congressional General Accounting Office, to provide an independent source of information and evaluation. A legislative counsel provides research and bill-drafting assistance. The legislature's committees meet throughout the year, not just while the legislature is in session. They have the authority to carry legislation from one session of the assembly to the next, thus ensuring the continuation of committee work. And the professional staff has increased substantially for both the legislators and the committees.

Alan Rosenthal of the Eagleton Institute at Rutgers identifies three categories of change in state legislatures -- capacity, composition and performance.

By capacity he means time, organization, assistance and information. In 1960, only 18 state legislatures met annually; today 43 do. Seven states -- California, Illinios, Massachusetts, Michigan, New York, Ohio, Pennsylvania -- have full-or nearly full-time legislators. More important, many legislators now describe themselves as professional legislators; it is their principal occupation. The trend away from the once-vaunted "citizen-lawmaker" may be a mixed blessing, but it does mean that today's legislators are more preoccupied with legislating than their predecessors.

The composition of state legislatures is clearly as important as their organizational capacity, and the membership has changed dramatically as well. There are fewer lawyers, businessmen and farmers in state legislatures than there were 20 years ago and more educators. State legislatures today more faithfully mirror the ethnic, racial and sexual breakdown of the population as a whole. Of the nation's 7,400 state legislators in 1983, 1,000 were women, and 300 were black. In nine states, women are more than 20 percent of the legislature. By contrast, of the 535 members of Congress, while there are 20 blacks, there are only 24 women.

Performance is the key, and as Rosenthal observes, how the legislature does its job depends largely on its capacity and composition. But if enacting laws is its job, one way to measure how well it performs is by examining the number of bills introduced, the number enacted, the appropriations process and legislative oversight. Rosenthal has done this and concludes that today's state legislatures are the strongest in our history.

State governors have also changed. Gubernatorial powers have been expanded and strengthened by the use of the executive budget, which organized what had frequently been a haphazard and uncoordinated process. The introduction of modern planning and management tools such as computers was a major innovation in some states. Moreover, governors have more and better staff than a generation ago. Larry Sabato, a professor at the University of Virginia who is one of the nation's leading authorities on governors, notes that governors "are younger, better educated than ever, and more thoroughly trained for their specific responsibilities. Greater numbers have concentrated beforehand on developing legislative expertise, while fewer come directly to the executive from minor offices."

Surely, megastates have always been capable of producing great governors such as Franklin Delano Roosevelt in New York, Adlai Stevenson in Illinois and George Romney in Michigan. But this is the first time you can reach down to the less populated states, such as Arizona, Colorado or Utah and consistently find impressive governors.

State administrative agencies also have been improved. It is no longer unusual to find multi-degreed economists, urban planners or ecologists working there. And, sometimes at the urging of the federal government, the numbers of state employes has risen, between 1954 and 1983, from 1.1 million to 3.8 million, a growth of 250 percent, according to the Census Bureau. During the same period, the number of federal employes only grew 20 percent. Again, this may be a mixed blessing, but if you want stronger state governments that can tackle more issues, more staff is required.

But merely improving the capacity to govern and the structure of state government would mean little if the states did not use their new capabilities. And this is where the states have been most impressive.

In health care, for example, several states, including Florida, Virginia, Wisconsin and California, have enacted laws making "preferred provider health care options" available, a step that many analysts believe will help reduce health care costs. Another important area is state efforts, such as in Florida and Texas, to ensure that the indigent have access to high-quality health services, a need that has become more acute because of budget cuts in Medicaid and other Health and Human Services programs. Still another trend is the effort to help elderly citizens find care less costly than nursing homes, such as letting the state pay for a day nurse to serve them in their own homes.

Most states have taken impressive steps to enhance economic development. States have always tried this, but recent efforts have been much more sophisticated. Several states, including Massachusetts, Connecticut and Michigan, have launched venture capital programs to provide seed money for new businesses, a risky and innovative (for state governments) strategy. The Massachusetts Technology Development Corporation, for example, has already invested $7 million in 33 companies in 20 industries.

Other states now use tax incentives to draw industries to poor urban areas. Sound familiar? It's the "enterprise zone" idea proposed by the Reagan administration. While Washington debates it, half the states have enacted laws creating them. In Kentucky, for example, eligible corporations can receive dollar-a-year leases and are exempt from all state and local taxes.

More dramatic, because it was least expected, is state involvement in international trade. Secretary of Labor Bill Brock observed that, "A lot of states have done a remarkably good job of trying to shift the attention (of business) to the (export) opportunities internationally." Over half the states operate overseas trade offices. A few states have even created export trading companies to provide businesses with market research, transportation, documentation, freight forwarding, insurance and other services.

Despite the importance of these and similar efforts in other areas, there is no better illustration of the states' willingness to address problems than their efforts to improve education. States have always played a major role in education. But over the last decade, the state role has increased while the local and federal efforts have diminished. Between 1973 and 1983, the state share of education expenditures increased in 45 of the 50 states. In Washington it climbed from 52 to 80 percent; in Indiana from 34 to 63 percent and in California from 38 to 75 percent. State aid now accounts for more than 60 percent of school revenue in 14 states.

Critical studies of American education prompted even greater state action. The issues these reports raised -- graduation requirements, teacher licensing and compensation, financing, the length of the school day and school year -- are all state questions. A recent poll of the nation's governors concluded that improving the schools was the number one priority in most state capitols.

This is a big change. State legislators and governors have historically deferred to "experts" and education interest groups. But as state expenditures increased and the quality of education declined, the willingness of elected officials to let educators make the decision also waned.

In Arkansas, for example, Democratic Gov. Bill Clinton demanded a competency test for teachers already in the classroom. The state legislators agreed, over the vociferous objections of the National Education Association.

In Texas, Republican businessman H. Ross Perot, with the active support of Democratic Gov. Mark White, led a massive reform effort that included higher salaries and a career ladder for teachers, mandatory competency testing for teachers and students, smaller classes, mandatory pre-kindergarten and mandatory tutoring for students with low grades. The state will even restrict extracurricular activities to students with passing grades, taking on Texas' most sacred cow, high school football. When the smoke had cleared, the state had approved the most far-reaching education reform in a quarter century and, for the first time in a decade, raised taxes to pay for it.

The same thing will continue to happen in other areas. As states discover they can successfully tackle complex and demanding issues, they develop a taste for doing more of it. Once having assumed new muscle and responsibility, the states will be reluctant to yield it to the federal government.

In a very real sense, then, the first four years of the Reagan administration were a triumph of New Federalism, albeit one that was not planned and is now only dimly recognized. Princeton University Prof. Richard Nathan calls this the "major sleeper issue" of the Reagan presidency, one which will have a substantial and lasting impact. Adds Michael Timpane, president of Columbia University's Teachers College: "The attitude used to be . . . if you got in trouble the federal government would be available as a last resort . . . . The states no longer believe that the cavalry is coming over the hill. They realize that the responsibility will continue to be theirs, and they have decided to carry it out."

Not all states have made equal progress. States have always varied in their political and administrative capabilities and they always will. But in general, the promising developments are to be applauded. Clearly, they have not escaped the public. For the first time, in 1984, the Gallup Poll revealed that Americans believe they get more for their tax dollars from state government than they do from Washington. So for those who wish to see the shape of things to come in public policy: keep your eyes on the states.