Virginia Gov. Terry McAuliffe. (Bob Brown/AP)

Gov. Terry McAuliffe said Thursday that Virginia’s budget picture is improving, but he warned that looming federal spending cuts known as sequestration could still cripple the state’s economy.

In the annual end-of-the-summer budget speech that the governor gives to a joint meeting of House and Senate money committees, McAuliffe (D) said his first two-year budget proposal will drive more dollars to the state’s education system. He’ll also work to shorten the length of standardized tests.

McAuliffe worked the crowd of lawmakers, lobbyists and state employees, doling out back slaps and ad-libbing lines from “Let’s go Virginia!” to “I want Virginia to be No. 1!”

But the economic update comes at time when his relations with the Republican-controlled General Assembly have hit a particularly low point. Minutes before the speech, Speaker William J. Howell (R-Stafford) sent McAuliffe a letter chiding him over what most Republicans consider the illegal adjournment of last week’s one-day special session and hinting that litigation is next.

The bitter dispute over the appointment of a Virginia Supreme Court justice and redistricting culminated in McAuliffe calling Republicans “small and ineffective.”

Still, on Thursday, the governor peppered the 37-minute address with nods to bipartisanship and touted what he called a “great working relationship” with lawmakers in charge of budget negotiations.

“We’re in love. Everybody’s in love,” McAuliffe told reporters after the speech. “We’re going to get things done. I’ve got to focus on big-picture items. I’m not here to play small ball.”

A year ago, McAuliffe announced a $2.4 billion budget shortfall, which was later addressed through layoffs and cuts. The administration and lawmakers came together to make two rounds of amendments to the spending plan to erase the shortfall.

“We made prudent, sensible spending decisions that put good governance and the best interests of the taxpayers ahead of ideology,” the governor said.

Then last month McAuliffe said higher-than-expected revenue collections had created a $553 million revenue surplus. He revised the number to $536 million on Thursday.

The money was used to bolster the state’s cash reserves, or rainy day fund, and made it possible for Virginia to go ahead with plans to give 2 percent pay raises to state employees.

McAuliffe made no mention of expanding Medicaid under the Affordable Care Act, which, along with job creation, has been a central theme of his term. He declined to say if the budget proposal will include a plan for insuring 400,000 Virginians, but noted that many of the state’s rural hospitals are struggling.

“Our Commonwealth’s full potential cannot be reached as long as hundreds of thousands of individuals have no access to the health care security that they deserve, and as long as many of our rural hospitals are struggling to keep their doors open,” he said. But he offered no solution, instead saying, “Folks, as you know I don’t have all the answers, but my door is open...”

On education, McAuliffe saved the details for when the public budget process begins in December, but talked about the hit the state’s schools took during the recession. More than 5,000 K-12 positions have disappeared since 2008, even though enrollment is on the rise and standards are tougher, he said.

“In other words, we are entering into the 2015 academic year with our schools being asked to do much more even while our investment in student success has essentially not increased since 2009,” he said.

Instead of blindly adding back jobs, McAuliffe said the state should make policy changes toward specific goals. To that end, he will host eight education roundtable discussions this fall. The first of the sessions, which will be open to the public, is set for Monday in Chesterfield County.