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General Fund Budget Outlook

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					 GENERAL FUND
BUDGET OUTLOOK




          November 9, 2007
                      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
       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
   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
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)

         Quarterly Collections (% change over prior year)

   10%
                                                              Average
   8%                                                       Growth 5.8%

   6%

   4%

   2%

   0%

   -2%

   -4%
     1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006




                                                                                  4
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

          Net withholdings, 4 quarter average change
  15.0%
  12.5%
  10.0%
   7.5%
   5.0%
   2.5%
   0.0%
  -2.5%
  -5.0%
  -7.5%
         92

         93

         94

         95

         95

         96

         97

         98

         98

         99

         00

         01

         01

         02

         03

         04

         04

         05

         06

         07
       19

       19

       19

       19

       19

       19

       19

       19

       19

       19

       20

       20

       20

       20

       20

       20

       20

       20

       20

       20
                                                                           5
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
          % change from prior year, quarterly collections

   75%




   50%




   25%



   0%




  -25%
         1996   1997   1998   1999   2000    2001   2002    2003   2004   2005   2006   2007




                                                                                               6
              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.

     01-02    02-03   03-04   04-05   05-06   06-07    07-08   08-09
      -6.3%   -0.4%    5.7%    9.4%   12.1%   9.2%     4.0%    4.6%



                                                                          7
              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
        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
      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
   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
 How is N.C. Economy Doing Relative To U.S.?

        % Change in Employment
    3
  2.5
    2
  1.5
    1
  0.5
    0
 -0.5
   -1
 -1.5
        1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
                                                     (est.) (est.)

                                     N.C.      U.S.

                                 CALENDAR YEAR

After the usual deeper decline during the recession, N.C. has been surging ahead of U.S.


                                                                                     12
        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
   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
          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
             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
             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
Related Budget Issues in The News

      • Medicaid Swap
      • Transportation Funding
      • Leandro Litigation
      • Tax Reform
      • Lottery


                                    18

				
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