President Reagan last night gave a glowing assessment of the state of the Union, telling a joint session of Congress and a national television audience that his administration had, "at a critical moment in world history, reclaimed and restored the American dream."

In his final State of the Union address, Reagan said, "Let's make this the best of eight . . . . I don't buy the idea that this is the last year of anything, because we're not talking here tonight about registering temporary gains, but ways of making permanent our successes."

The president called for "a bipartisan consensus for the cause of world freedom" that would support both a strategic nuclear arms treaty with the Soviet Union and continued assistance to anticommunist "freedom fighters" in Nicaragua and Afghanistan. But Reagan was restrained in his appeal for new aid for the Nicaraguan contras and acknowledged that Nicaragua's leftist Sandinista government has taken some steps toward democratic reform.

The president said he will submit a new aid request Wednesday that "would sustain the freedom fighters" and challenge the Sandinistas "to take irreversible steps toward democracy." A White House official who briefed reporters said the aid package will total "less than $50 million," including about $5 million in military aid that is likely to be placed in a separate escrow account.

In the Democratic response, Senate Majority Leader Robert C. Byrd (W.Va.) and House Speaker Jim Wright (Tex.) sought to paint a sharp contrast between the priorities of the Democratic-led Congress and the final-year policies of an administration they think has lost its ability to hold sway on Capitol Hill. {Details, Page A9.}

Reagan's speech last night, interrupted 38 times by the applause of the assembled members of Congress and other high-ranking government officials, sought to recapture the emotional fervor of the campaign that brought him to the White House rather than to proclaim a new agenda, aides said. Reagan said the nation is "strong, prosperous, at peace and . . . free." He concluded the address with familiar lines, saying that the nation remains "a shining city on a hill" for future generations.

And as conservatives had wanted him to do, Reagan restated his commitment to the unfulfilled items of his social agenda, including an antiabortion "human life" amendment to the Constitution and another amendment to allow prayer in public schools.

The president also called for passage of constitutional amendments providing for a line-item veto and mandating a balanced budget, thus restating the theme of his first State of the Union message in 1982 that "the federal government is too big and it spends too much money." The federal budget deficit was nearly $80 billion in fiscal 1981 and is now $148 billion; the national debt was $715 billion when Reagan took office and is now nearly $2 trillion.

As part of the administration's effort to trim spending, Reagan said he will ask for budget rescissions of about $5 billion in previously approved expenditures for such items as cranberry research, blueberry research and the study of crawfish.

In an approach alternately conciliatory and critical, Reagan called upon Congress to enforce the two-year budget compromise reached last month that is designed to reduce federal deficits by $76 billion over two years. He said that "the budget process has broken down," producing "monstrous continuing resolutions that pack hundreds of billions of dollars worth of spending into one bill -- and a federal government on the brink of default."

Reagan won a standing ovation from Congress when he brandished three separate budget documents totaling 3,300 pages and promised to use his veto power if budget legislation reached him in a similar massive form this year. But he called upon Congress to avoid budget delays and the type of year-end confrontation with the administration that has on several occasions nearly brought the government to a halt.

"Let's change all this," said Reagan of the budget process. "Instead of a presidential budget that gets discarded and a congressional budget resolution that is not enforced, why not a simple partnership, a joint agreement that sets out the spending priorities within the available deadlines?"

Reagan also sent Congress a 39-page legislative message that includes strong criticism of legislation that would broaden federal power to combat racial discrimination in schools and other institutions receiving federal funds. Reagan said "the vague and sweeping language" of this measure, pending in the Senate, "threatens to subject nearly every facet of American life -- from the corner grocery to the local church or synagogue to local and state government -- to intrusive regulation by federal agencies and courts."

The legislative message also declared that "the most important piece of unfinished business" is to restore the tax break for capital gains that was eliminated by the 1986 tax act. Reagan did not specify how he wants to do this, and a senior official who briefed reporters before the speech said, "I can't tell you when or if we are going to send up a specific proposal this year."

Reagan sprinkled a number of other specific requests amidst the rhetoric of the address.

He called upon Congress to ratify the U.S.-Canadian Free Trade Agreement that he and Canadian Prime Minister Brian Mulroney signed Jan. 2, saying that "we're determined to expand this concept, South as well as North." The president said "trade matters will be of foremost concern" when he meets with Mexican President Miguel de la Madrid in Mazatlan next month.

"Our goal must be a day when the free flow of trade -- from the tip of Tierra del Fuego to the Arctic Circle -- unites the people of the Western Hemisphere in a bond of mutually beneficial exchange . . . ," said Reagan, who in the 1979 speech declaring his presidential candidacy called for a "North American accord." He restated that goal last night.

Reagan also called upon the Senate to ratify promptly the Intermediate-Range Nuclear Forces (INF) Treaty, which he and Soviet leader Mikhail Gorbachev signed at their summit here last month.

"In addition to the INF Treaty, we are within reach of an even more significant START {strategic arms reduction} agreement that will reduce U.S. and Soviet long-range missile or strategic arsenals by half," Reagan said.

At the same time, the president renewed his appeal for his missile defense plan known as the Strategic Defense Initiative (SDI), which faces funding cuts in Congress. Reagan said that SDI "reduces the risk of war and the threat of nuclear weapons to all mankind."

Reagan urged the Senate to move "quickly and decisively" in confirming Supreme Court nominee Judge Anthony M. Kennedy, who is expected to win the overwhelming endorsement of the Senate Judiciary Committee this week.

The president also called for changes in the welfare system to "give the states even more flexibility and encourage more reforms."

On education issues, Reagan endorsed the call of Education Secretary William J. Bennett for a stronger curriculum and merit pay for teachers. Reagan's legislative message supported "efforts to advance parental choice through the magnet schools program."

Reagan's State of the Union addresses have in the past included the introduction of various civilian and military "heroes." Last night his heroine was First Lady Nancy Reagan, whom the president credited for leading the battle for a "drug-free America" with her campaign to "just say no" to drugs. The First Lady stood in her box to acknowledge a standing ovation. When it died down, Reagan said, "Surprised you, didn't I?"

The president spoke with enthusiasm of what he said his administration has accomplished in international affairs. "From Central America to East Asia, ideas like free markets and democratic reforms and human rights are taking hold," he said. "We've replaced 'blame America' with 'look up to America.' "

Reagan's speech came as the latest Washington Post-ABC News Poll showed the public is increasingly pessimistic about the direction the nation is headed.

Nearly three out of five respondents -- 59 percent -- said the country has "gotten pretty seriously off on the wrong track," a 12-point increase in about a month. Only 39 percent said the country is headed in the right direction.

Reagan's approval rating remains essentially unchanged in January. Somewhat more than half -- 54 percent -- of those surveyed this month said they approve of the job Reagan is doing as president, while 45 percent disapprove.

Reagan's foreign affairs rating dropped significantly this month. Fewer than half -- 47 percent -- of those surveyed said they approve of the way Reagan is handling foreign affairs, down from 57 percent in December following the summit.Staff writers Bill McAllister and Paul Blustein and staff researcher Michelle Hall contributed to this report.