GENERAL FUND BUDGET OUTLOOK

1. GENERAL FUND BUDGET OUTLOOK November 9, 2007

2. Highlights • There have been significant revenue surpluses for the last three fiscal years. This was due in part to a strong state economy and the cautious revenue forecasts in light of sizable portion of the surplus coming from volatile sources. • The biggest risk surrounding the 2007-08 forecast is the continuing real estate slump plus the financial sector upheaval. • These risks should be adequately covered by a moderately cautious overall revenue forecast of only 3.8% baseline growth for 2007-08 (actual was 9.2% for 2006-07). • The revenue surplus in recent years has essentially eliminated the structural budget gap. 1

3. How Do 2007-08 Revenues Look So Far? • The first quarter of the fiscal year is the least important from an indicator point of view. • Major receipts in these months (sales, withholding tax) closely track the experience of the last few months of the prior fiscal year • Volatile revenue sources (corporate income, non-withholding), which have led to large surpluses in recent years, do not show up until the second half of the fiscal year. 2

4. How Do 2007-08 Revenues Look So Far? (cont.) • With these caveats in mind, we can report that the first quarter General Fund revenue came in about $70-$75 million ahead of a $4.5 billion target for the period. • In other words, collections are running 1.7% above expectations. The target growth rate for the first quarter was 5.0%, which is higher than total growth expected for the full fiscal year. • Total General Fund growth for the year is expected to be 3.8%. The slowdown is not expected to weaken revenue collections until later in the fiscal year and this is reflected in the targeted growth rates. 3

5. How Do 2007-08 Revenues Look So Far? (cont.) It is clear from looking at economy-based taxes that the mid-cycle economic slowdown is underway. Sales tax growth for July-September was 4.7%, well below the long-term average growth of 5.8% and the 8-10% rates earlier in the recovery. It is, however, above the budgeted first quarter growth rate of 3.7%. Sales & Use Tax Collections (adjusted for tax law changes) 4

6. How Do 2007-08 Revenues Look So Far? (cont.) Withholding continues to be surprisingly resilient with growth of 7.8% through September, which is essentially the same rate as 2006-07. It has slowed slightly from the 9-10% rate during 2005 and part of 2006, yet remains above historical growth of 6.3%. This suggest withholding has not been significantly impacted by the real estate recession. Withholding Tax Receipts 5

7. How Do 2007-08 Revenues Look So Far? (cont.) The real estate slump has significantly reduced real estate conveyance tax collections, though not at much as in many other states (California, Florida, Virginia). Collections were down 4.1% compared to July-September of last year. Though this tax does not go to the General Fund, it is a good economic indicator and real estate activity affects retail sales. Real Estate Conveyance Collections 6

8. 2007-08 Revenue Estimates • Estimates reflect consensus outlook of Governor’s Budget Office and Fiscal Research Division. • Forecast philosophy recognizes that much of recent extra revenue has been concentrated in volatile items (non-withholding portion of personal income tax, corporate income tax), adding to forecast uncertainty. • In addition, the projections provide a hedge against worsening residential real estimate market. Fiscal Research has been more bearish on housing outlook than most economists for last year. In our view, the unwinding of market “bubbles” is usually more severe and longer lasting than most observers believe. • Baseline General Fund Revenue Growth and budget forecasts are shown below. 01-0202-0303-0404-05 05-0606-0707-0808-09 -6.3% -0.4% 5.7% 9.4% 12.1% 9.2% 4.0% 4.6% 7

9. Revenue Forecast Assumptions • The residential real estate market slowdown will continue into 2008 and continue to be the biggest drag on the economy. • The effects of the slowdown have begun to show up in a major way in North Carolina’s housing data (see page 6). • The loss of household wealth from the real estate slowdown plus tighter consumer credit will lower consumer spending growth. This means that state sales tax growth, excluding tax law changes, will slow to 2.9% (4.5% in 06-07 and 9.2% in 2005-06). • Modest job growth in North Carolina, due to real estate problems and economic slowdown, will eventually lead to lower growth of income tax withholding. However, the State should continue to exceed the national experience. The specific 2007-08 forecast envisions withholding gains of 5.3% (7.7% in 06-07). 8

10. Revenue Forecast Assumptions (Cont.) • Following years of very high growth, volatile sources of revenue (corporate income tax and non-withholding portion of the personal income) should experience minimal progress • Non-withholdings portion of income tax projected to increase 4.0%, versus 19.3% in 06-07. • Baseline corporate income taxes will decline 3.5% as corporate profits begin to dwindle because of the national and global economic slowdown (6.9% positive growth in 06-07) . • The continuation of the real estate slowdown and the difficulties in the financial lending markets suggest that many of the effects of the slowdown will spillover into 2008 and keep a lid on 2008-09 revenues. 9

11. National Economic Outlook • Below normal economic growth is expected for the remainder of 2007 and 2008: 1% to 2 % inflation-adjusted growth instead of 3%. • A slowing economy will mean below average growth in employment and consumer spending • Partly to blame is the housing slowdown where the median housing price declined for the first time in 16 years. • Sub-prime lending will continue to implode and affect financial sectors, prolonging the impact of the housing slump. • Exports to developing countries has been a major support for economic growth in recent years. A slowdown in the international trade sector would raise recession fears in the U.S. • The Federal Reserve has responded aggressively to lowered inflation expectations and problems in real estate with a 50 basis point cut in the banks’ lending rate. The Fed will be monitoring the financial sector upheaval closely for fear of spillover into other parts of the economy. 10

12. Additional Thoughts on 2007-08 Outlook • In general, the economy will remain in choppy waters for the next couple of years as the nation’s businesses and consumers work through the housing market slump. • To date, the resilient job market in the North Carolina is putting enough extra dollars in consumers pockets to offset the economic slowdown resulting in only a mild slowdown in economy based taxes. • The biggest impact to the state’s economy from the mid-cycle slowdown, along with the housing and financial sector slump, is projected to occur in 2008. • Several risks are associated with the slowdown that will need to be monitored as we move into 2008. While these risks exist, their occurrence is not anticipated and the economic slowdown is projected to be significant, but relatively mild. 11

13. How is N.C. Economy Doing Relative To U.S.? % Change in Employment CALENDAR YEAR After the usual deeper decline during the recession, N.C. has been surging ahead of U.S. 12

14. Long-Term Budget Outlook • Barring any major surprises, the cautious nature of the 2007-08 and 2008-09 consensus revenue estimates should help in meeting 2008-09 and future year spending needs. • Budget availability for later years is highly dependent on health care costs (State Health Plan, Medicaid). During the last three decades, high growth in these areas has crowded out spending on other budget priorities. • A tight budget situation can still occur if the improved outlook leads to an increase in commitments (expansion budget requests, tax cut proposals, catch-up pay raises). In addition it is still possible the economic slowdown could turn into a full-blown recession or Medicaid expenses could accelerate. 13

15. Long-Term Budget Outlook (Continued) • Fiscal Research has not estimated 2008 session budget availability. However, an outside group projects $645 million of budget resources to fund: • Pay raises for teacher and state employees ($100 million for each 1%) • $100-125 million in incentive compensation for outstanding teachers • Any additional dollars needed for state health plan and higher education enrollment increases above tentative budget amounts • New public school initiatives (Pre-K Programs, class size reduction) 14

16. Turnaround in State Budget Reserves • During the last decade a combination of natural disasters, tax lawsuit payouts, and economic woes depleted the state’s financial reserves. This was a major reason for temporary loss of our Triple A bond rating by Moody’s. • The strong economic performance in recent years, coupled with stock market and real estate gains and cautious revenue estimates, has helped to restore budget reserves. • The current reserves are the highest in more than a decade. • Rainy-day fund amounts to almost $800 million • Repairs/renovations funding of $145 million can be pulled back in emergencies • Capital appropriations can be reverted if necessary • Governor can force agencies to revert more authorized spending • Cautious revenue estimates for 2007-08 should provide a final cushion 15

17. Why Is North Carolina Budget News Better Than Other States? • Recent news reports indicate budget shortfall problems in a number of other states. This could include special sessions, executive spending cutbacks, and concerns about the upcoming budget being out of balance. • States with revenue concerns include Arizona, Florida, Virginia, South Carolina, Tennessee, Nevada, Rhode Island, Massachusetts, California. There very well may be others. • There are a number of reasons why North Carolina is experiencing a revenue surplus while other states are having problems • For one, our revenue estimates for the last couple of years have been more cautious 16

18. Why Is North Carolina Budget News Better Than Other States? (cont.) • Our job growth in North Carolina is at least one percentage point higher than the national experience and has not slowed during last 12 months. This is important because withholding tax collections represent 40% of total revenues. • Residential real estate slowdown in North Carolina compares to an outright housing recession in many of the markets that experienced a pricing bubble. • In at least two states (Virginia, Florida) real estate conveyance taxes are part of the General Fund revenue base. In N.C., the proceeds go to a special fund for dedicated purposes. • Healthy income growth and a milder real estate slowdown means that our sales tax growth is more stable. 17

19. Related Budget Issues in The News • Medicaid Swap • Transportation Funding • Leandro Litigation • Tax Reform • Lottery 18