Sure you can. What you can't do is declare a static variable inside a method, but that has nothing to with whether the method is static or not. Informally I'd say that a static variable logically belongs to the class, not an object or a method, so that's where you have to declare it. Someone who's a bit firmer on OO lingo can probably explain this more clearly.
[Added later] After seeing Aruns response I realize that you were talking about member classes not methods, so disregard what I wrote. Getting more coffee right now... [ August 04, 2005: Message edited by: Ulf Dittmer ]