I recently did a makeover for someone who wanted their labels displayed in a drop down menu rather than a bulky list. Blogger does not offer this option yet, and I had no clue how to do it. Luckily, I stumbled upon this tutorial by Amanda over at BloggingTips.com. Woooo hooooo! Jackpot!
Amanda's drop down labels tutorial requires that you make changes to the HTML of your template. It is NOT for beginners. I recommend that you download a copy of your current template before beginning. Practice this tutorial on a practice blog and make sure you completely understand what to do and are successful in doing so BEFORE installing this feature on your real blog.
Make sure you have a labels gadget on your blog (or practice blog) before getting started or you will not be able to find the code that needs to be replaced in your template.
Good luck, have fun, and BE CAREFUL! While you're in there, consider decluttering your sidebars even more by removing some gadgets (the more you have, the slower your blog will load), putting your archives in a drop down menu, or removing the dotted separators in between your sidebar items. :)
Drop Down Menus- Archives
Drop Down Menus- Custom (Intermediate)
Remove Dotted Sidebar/Post Separators (Intermediate)