When the federal budget cuts hit New Jersey, state officials had to decide whether to reduce services for alcoholics, ailing infants, pregnant mothers or neglected children in state day-care centers.

The grim options were laid out last year in an internal memo to then-governor Brendan T. Byrne. "Cuts in day-care services can be expected to produce protest, as the interest groups are well organized," the governor was warned.

But when the outgoing Democrat finally decided to close five of the state's 21 day-care centers, more than 250 neglected children were merely shifted to private centers that also were being financed with federal aid. The state even saved money on the switch.

"We should have done this before," said Ted Allen of the state's Department of Human Services. "A lot of those private centers weren't operating at full capacity, and the state day-care centers had a history of being more costly. The cutbacks did force some administrative efficiencies."

Across the continent, state governments are suddenly contracting after two decades of tremendous growth. The Reagan administration's budget cuts, a spate of tax-limit initiatives and shrinking revenues caused by the long recession have combined to put an unprecedented squeeze on state treasuries.

The contraction has forced state officials to choose among scores of programs once largely financed by Washington, and some of them say they have learned to deliver the same services in a more efficient way.

Without question, however, some of the federal retrenchments have been painful, especially when combined with the severe cutbacks that are being made in nearly half the 50 states. In this northern industrial state, more than 45,000 people lost their Medicaid benefits in the last year, 53,000 lost their food stamps and 68,000 have been removed from the welfare rolls.

No state has been rocked harder than Michigan, whose credit rating has sunk to the lowest in the nation. Twelve-thousand state workers have lost their jobs. The tax on cigarettes has gone from 11 to 21 cents a pack. Seven Supreme Court justices even agreed to sacrifice their $1,327 paychecks for a week.

The impact is felt in a hundred small ways. Michigan state troopers get out of their cars for 15 minutes every hour to save gas. The University of Michigan has dropped its geography department. Wayne County, Royal Oak and other towns have missed several payrolls. The village of Calumet had to lay off its town manager and police chief.

The Eagleton Institute of Politics in Princeton found that 60 percent of the federal budget cuts in New Jersey fell on direct aid to low- and moderate-income people. The state legislature simply passed on most of the reductions to those who had been receiving the federally funded services.

"The only thing that trickles down from the 'New Federalism' is the agony and bitterness of cutting people off," said Alan Karcher, 39, the Democrat who heads the New Jersey Assembly. "It goes from the president to the governor to the county executive to the guy at the local school board. He's the one with the real dirty end of the stick, the one who has to fire the teachers.

"You're given this block grant: Who do you pull the plug on? Do you pull it on people getting day care, drug care, or someone being treated for alcohol abuse? That's a wretched decision. It puts an unfair burden on us. If there's no money for senior citizen lunch programs, the president ought to say that. Let him take the political heat for it."

Clearly, not all states are suffering equally. This year's federal budget cuts cost Michigan $184 for every person in the state, New York $160, Ohio $141. But Texas lost just $103 for each resident, Utah $106 and Wyoming $96. By and large, the Sun Belt is faring far better than the older industrial states.

Federal budget cuts are almost irrelevant in oil-rich Alaska. The state spends five times as much for each resident as the national average. State officials have abolished the income tax and given $1,000 to every man, woman and child within its boundaries. Alaska even subsidizes television stations so they can pick up satellite broadcasts of faraway baseball and football games.

Donald Linky never imagined he would be intimately involved in deciding which programs in New Jersey should get the ax.

"When I was going to school, I didn't have much respect for the states," the 36-year-old lawyer said. "They seemed to be ignoring the needs of poor people and minorities. I thought the federal government had all the answers."

Linky's view gradually changed as New Jersey started a broad array of social programs, and in 1975, he agreed to become Byrne's counsel. It was then he began to see considerable waste in federally funded programs.

"Some of these programs seemed to be going on without any visible results," Linky said. "We were hiring people from year to year with federal money, and we were divorced from the responsibility of paying for them. A superstructure of bureaucracy had developed, and certain specialties such as planning flourished."

Last fall, the picture suddenly changed as the Reagan administration combined dozens of social programs into a handful of block grants to the states and cut the funding by 30 percent. As Linky prepared a series of decision memos for Byrne, he found himself under growing pressure. "The most complaints we received were from nonprofit groups who saw their programs being threatened," he said.

Linky had to make some unpleasant decisions. For example, he recommended ending a program for sudden infant death syndrome because it was "an after-the-fact program" designed to help families where a child already had died.

"These funds should be shifted to programs geared toward saving other lives instead," he wrote.

Linky also proposed cutting off "a supplementary program providing toys, counseling and minimal home services to families with severely disabled children" because it didn't provide any direct health care.

He described the political impact of other suggested cuts: "Mental health centers serving predominantly middle- and upper-class communities will bear the brunt of funding reductions . . . . Dental interests will express dismay over elimination of fluoridation program . . . . Nursing associations can be expected to complain" about cuts in home health care.

There were, of course, some compromises. Energy and weatherization grants to community agencies would have to be continued, Linky said, even though the groups had used the money to expand their own staff instead of providing services to the needy. These agencies have had "a series of fiscal scandals . . . but they are politically influential within local minority communities, and maybe you should not antagonize them on a Washington issue where we are not likely to have much clout anyway."

Many states have been forced to invent new ways to save money, some painful, some long overdue. Washington state has decided to cut grants to welfare recipients who share apartments. The state also has closed one of its two mental hospitals, forcing many patients to be housed in prison instead.

"The King County jail is now the second largest mental hospital in the state," one official said.

California has created a new health czar who has the power to negotiate tough contracts with hospitals that promise big Medicaid savings.

Half the hospitals in the San Francisco area have agreed to cut their Medicaid charges by 10 percent, and the other half can no longer receive Medicaid money, except in emergencies.

"The state should have done this years ago," said California budget analyst Thomas Dooley.

Other changes amount to passing the buck. California has shifted responsibility for 275,000 medically needy patients back to the counties, many of which cannot handle the extra burden.

And Louisiana has slashed aid to local charities that work with the handicapped and mentally retarded.

Many of the state cutbacks have fallen heavily on cities and counties, which now receive more aid from their states than from Washington.

Connecticut officials eliminated a $30 million revenue-sharing program, most of which was going to Hartford and Bridgeport.

Minnesota's local aid cutbacks forced St. Paul to lay off 100 police and fire officers.

In many places, officials have decided that some service is better than no service.

Colorado has dropped police patrols in some areas after midnight. Indiana has stopped recruiting for the National Guard. Nebraska has limited special legal training for judges. Kentucky has cut back on school supplies and increased the size of its kindergarten classes. Idaho employes tookoff one day a week to avoid lay-offs.

In an abandoned trolley station a few blocks from the New Jersey statehouse, Errol Lennard worries about the clients he hasn't seen for months.

Lennard uses the grimy, three-story building to run the Mercer County Drug Clinic. When federal aid for New Jersey's drug abuse program was cut by a third to $6 million, the Mercer clinic was not among the dozen drug and alcoholism centers shut down by the state.

Instead, state officials ordered Lennard to start charging fees. Heroin addicts now have to pay $56 a month if they want to be admitted to the only facility in the area that can still treat them.

In federal jargon, this is known as "cost sharing" or "user fees." In practice, Lennard says, more than 20 of the clinic's 200 heroin addicts had to drop out because they didn't have the money. Others addicts simply stopped applying, including most of the 83 people who had spent months on the waiting list.

The program has been relatively successful, with more than half the clients staying off drugs. But Lennard says some of those who are turned away are drifting back into crime. One young man had almost kicked the habit when he lost his job and was ousted from the program. "He's just lost to us," Lennard said.

New Jersey state officials are cutting corners wherever they can. At the remaining 16 day-care centers, they laid off 200 employes and began charging parents an additional $5 a week. But many of the biggest decisions were made in Washington.

Last year, 478,000 New Jersey residents were receiving payments from aid to families with dependent children, with the average family of four getting $414 a month. When the federal government raised the income eligibility standards this year, 68,000 people -- more than 14 percent -- no longer qualified.

Those stricken from the rolls, mostly women with young children, are hardly affluent. They earn, on the average, just over $600 a month. But the legislature decided not to continue their welfare payments with state money, which in turn caused most of them to lose their Medicaid benefits as well.

"These are the working poor, the kind of people who fall between the cracks," said state Medicaid director Thomas Russo. "If they have a severe illness, they can't afford to pay for both medical care and daily living expenses. It's the safety-net issue."

The impact also has reached the public schools, where 90,000 fewer students are receiving free lunches each day, a one-third reduction over last year. Some are no longer eligible; others now have to pay 40 cents a meal. And school officials say many parents are discouraged by the more rigorous application forms.

"All those changes were made at the federal level," said school lunch coordinator Susan Solleder. "Some of these children are now buying just a partial meal or just a container of milk."

The federal cutbacks are reaching higher on the income ladder now, and people who don't care much about welfare or drug clinics are starting to complain.

The early cutbacks fell mainly on low-income families. But Republican Thomas H. Kean, who replaced Byrne in January, has been forced to start trimming some of the most popular programs for the middle class.

Each day, for example, the state subsidizes the fares of 325,000 commuters who ride the buses and trains. Over the summer, Kean approved a 17 percent fare increase and agreed to cut back service on some routes. But this wasn't enough to make up for a one-third reduction in federal operating subsidies, so Kean's aides are raising fares 25 percent more.

All this is expected to drive 40,000 commuters back to their cars. The fact that many of these riders are affluent commuters to New York and Philadelphia has hardly diminished the political fallout.

Kean also has laid off 1,500 state workers, and he recently ordered all agencies to cut spending by 3 percent to close a $150 million budget gap. The most sensitive reductions are in state aid to public schools, which is dispensed under a court-ordered formula that favors poorer neighborhoods. Now affluent school districts from Princeton to Paramus are losing some of their aid, and they are angry.

"The constituent pressures are building," said state treasurer Kenneth Biederman. "The commuters, the welfare people, the letters from every board of education -- we're in a real squeeze."

All this can't be blamed on the Reagan administration. For all its urban problems, New Jersey's wealthy suburbs make it the third-richest state in the nation after Alaska and Connecticut. But the income tax here is a modest 2 to 2 1/2 percent, and Kean has resisted all efforts to raise it for people earning more than $50,000 a year.

Joseph Merlino, a gravel-voiced Democrat who once ran the state Senate, says this is the real question facing the states: who is going to pay the greatest price in an era of austerity. President Reagan's New Federalism, he said, "is really an effort to eliminate programs for the poor under the guise of making them more efficient."

Fewer targeted programs from Washington, he said, mean more power for the 356 registered lobbyists who now roam the Trenton statehouse, with their telltale red badges, on behalf of every interest group from drug companies to retired firemen to ice cream manufacturers.

"You can't send the money here the way Reagan wants or the strong will grab it all," Merlino said. "Whoever's in power in the statehouse will give it to their favorites. It will never get to places like Newark."