61

5. TAX EXPENDITURES

The Congressional Budget Act of 1974 (Public Law

93–344) requires that a list of ‘‘tax expenditures’’ be

included in the budget. So-called tax expenditures may

be defined as provisions of the Federal tax laws with

exclusions, exemptions, deductions, credits deferrals, or

special tax rates. Underlying the ‘‘tax expenditure’’ concept is the notion that the Federal Government would

otherwise collect additional revenues but for these provisions. It assumes an arbitrary tax base is available

to the Government in its entirety as a resource to be

spent. Because of the breadth of this arbitrary tax base,

the Administration believes that the concept of ‘‘tax

expenditure’’ is of questionable analytic value. The discussion below is based on materials and formats developed and included in previous budgets. The Administration intends to reconsider this presentation in the future.

The largest tax expenditures tend to be associated

with the individual income tax. For example, sizeable

deductions and exclusions are provided for pension contributions and earnings, employer contributions for

medical insurance, mortgage interest payments on

owner-occupied homes, capital gains, and payments of

State and local individual income and property taxes.

Tax expenditures under the corporate income tax tend

to be related to the rate of cost recovery for various

investments; as is discussed below, the extent to which

these provisions are classified as tax expenditures varies according to the conceptual baseline used. Charitable contributions and credits for State taxes on bequests are the largest tax expenditures under the unified transfer (i.e., estate and gift) tax.

Because of potential interactions among provisions,

this chapter does not present a grand total for the

estimated tax expenditures. Moreover, past tax changes

entailing broad elimination of tax expenditures were

generally accompanied by changes in tax rates or other

basic provisions, so that the net effects on Federal revenues were considerably (if not totally) offset. Nevertheless, in aggregate, tax expenditures have revenue impacts of hundreds of billions of dollars, and are some

of the most important ways in which the Federal Government affects economic decisions.

Tax expenditures relating to the individual and corporate income taxes are considered first in this chapter.

They are estimated for fiscal years 2000–2006 using

three methods of accounting: revenue loss, outlay equivalent, and present value. The present value approach

provides estimates of the revenue losses for tax expenditures that involve deferrals of tax payments into the

future or have similar long-term effects. Tax expenditures relating to the unified transfer tax are considered

in a section at the end of the chapter.

The section of the chapter on performance measures

and economic effects presents information related to

assessment of the effect of tax expenditures on the

achievement of program performance goals. This section

is a complement to the government-wide performance

plan required by the Government Performance and Results Act of 1993 (see the Budget volume, which considers the Federal Government’s spending, regulatory,

and tax policies across functional areas).

TAX EXPENDITURES IN THE INCOME TAX

Tax Expenditure Estimates

All tax expenditure estimates presented here are

based upon tax law enacted as of December 31, 2000.

Expired or repealed provisions are not listed if their

revenue effects result only from taxpayer activity occurring before fiscal year 2000. Due to the time required

to estimate the large number of tax expenditures, the

estimates are based on mid-session economic assumptions; exceptions are the earned income tax credit and

child credit provisions, which involve outlay components

and hence are updated to reflect the economic assumptions used elsewhere in the budget.

The total revenue loss estimates for tax expenditures

for fiscal years 2000–2006 are displayed according to

the budget’s functional categories in Table 5–1. Descriptions of the specific tax expenditure provisions follow

the tables of estimates and discussion of general features of the tax expenditure concept.

As in prior years, two baseline concepts—the normal

tax baseline and the reference tax law baseline—are

used to identify tax expenditures. For the most part,

the two concepts coincide. However, items treated as

tax expenditures under the normal tax baseline, but

not the reference tax law baseline, are indicated by

the designation ‘‘normal tax method’’ in the tables. The

revenue losses for these items are zero using the reference tax rules. The alternative baseline concepts are

discussed in detail following the tables.

Table 5–2 reports the respective portions of the total

revenue effects that arise under the individual and corporate income taxes. Listing the estimates under the

individual and corporate headings does not imply that

these categories of filers benefit from the special tax

provisions in proportion to the respective tax expenditure amounts shown. Rather, these breakdowns show

the specific tax accounts through which the various proVerDate 11-MAY-2000 10:42 Apr 04, 2001 Jkt 010199 PO 00000 Frm 00001 Fmt 3625 Sfmt 3625 Z:\OMB_PDF\SPEC05.02 txed01 PsN: txed01
62 ANALYTICAL PERSPECTIVES

visions are cleared. The ultimate beneficiaries of corporate tax expenditures could be stockholders, employees, customers, or others, depending on economic forces.

Table 5–3 ranks the major tax expenditures by fiscal

year 2002 revenue loss. This table merges several individual entries provided in Table 5–1; for example, Table

5–3 contains one merged entry for charitable contributions instead of the three separate entries found in

Table 5–1.

Interpreting Tax Expenditure Estimates

The estimates shown for individual tax expenditures

in Tables 5–1, 5–2, and 5–3 do not necessarily equal

the increase in Federal revenues (or the change in the

budget balance) that would result from repealing these

special provisions, for the following reasons:

Eliminating a tax expenditure may have incentive

effects that alter economic behavior. These incentives

can affect the resulting magnitudes of the activity or

of other tax provisions or Government programs. For

example, if deductibility of mortgage interest were limited, some taxpayers would hold smaller mortgages,

with a concomitantly smaller effect on the budget than

if no such limits were in force.

Tax expenditures are interdependent even without

incentive effects. Repeal of a tax expenditure provision

can increase or decrease the tax revenues associated

with other provisions. For example, even if behavior

does not change, repeal of an itemized deduction could

increase the revenue costs from other deductions because some taxpayers would be moved into higher tax

brackets. Alternatively, repeal of an itemized deduction

could lower the revenue cost from other deductions if

taxpayers are led to claim the standard deduction instead of itemizing. Similarly, if two provisions were

repealed simultaneously, the increase in tax liability

could be greater or less than the sum of the two separate tax expenditures, because each is estimated assuming that the other remains in force. In addition, the

estimates reported in Table 5–1 are the totals of individual and corporate income tax revenue effects reported in Table 5–2 and do not reflect any possible

interactions between the individual and corporate income tax receipts. For this reason, the estimates in

Table 5–1 (as well as those in Table 5–5, which are

also based on summing individual and corporate estimates) should be regarded as approximations.

Revenues raised by changes to tax expenditures are

sensitive to timing effects and effective dates. Changes

in some provisions would yield their full potential revenue gains relatively quickly, whereas changes to other

provisions would only gradually yield their full revenue

potential, because certain deductions or exemptions

would likely be grandfathered.

The annual value of tax expenditures for tax deferrals is reported on a cash basis in all tables except

Table 5–4. Cash-based estimates reflect the difference

between taxes deferred in the current year and incoming revenues that are received due to deferrals of taxes

from prior years. Although such estimates are useful

as a measure of cash flows into the Government, they

do not accurately reflect the true economic cost of these

provisions. For example, for a provision where activity

levels have changed, so that incoming tax receipts from

past deferrals are greater than deferred receipts from

new activity, the cash-basis tax expenditure estimate

can be negative, despite the fact that in present-value

terms current deferrals do have a real cost to the Government. Alternatively, in the case of a newly enacted

deferral provision, a cash-based estimate can overstate

the real cost to the Government because the newly

deferred taxes will ultimately be received. Presentvalue estimates, which are a useful supplement to the

cash-basis estimates for provisions involving deferrals,

are discussed below.

Present-Value Estimates

Discounted present-value estimates of revenue effects

are presented in Table 5–4 for certain provisions that

involve tax deferrals or other long-term revenue effects.

These estimates complement the cash-based tax expenditure estimates presented in the other tables.

The present-value estimates represent the revenue

effects, net of future tax payments, that follow from

activities undertaken during calendar year 2000 which

cause the deferrals or other long-term revenue effects.

For instance, a pension contribution in 2000 would

cause a deferral of tax payments on wages in 2000

and on pension earnings on this contribution (e.g., interest) in later years. In some future year, however,

the 2000 pension contribution and accrued earnings will

be paid out and taxes will be due; these receipts are

included in the present-value estimate. In general, this

conceptual approach is similar to the one used for reporting the budgetary effects of credit programs, where

direct loans and guarantees in a given year affect future cash flows.

5. TAX EXPENDITURES 63

Table 5–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 1

(In millions of dollars)

Total from corporations and individuals

2000 2001 2002 2003 2004 2005 2006 2002–2006

National Defense

1 Exclusion of benefits, allowances, and certain pays to armed forces personnel ................................ 2,140 2,160 2,190 2,210 2,240 2,260 2,290 11,190

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 2,500 2,680 2,850 3,010 3,180 3,350 3,550 15,940

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 680 720 750 790 830 870 920 4,160

4 Exclusion of income of foreign sales corporations ................................................................................ 3,890 0 0 0 0 0 0 0

5 Extraterritorial income exclusion ............................................................................................................. 0 4,490 4,810 5,150 5,500 5,880 6,290 27,630

6 Inventory property sales source rules exception ................................................................................... 2,170 2,280 2,390 2,510 2,630 2,760 2,900 13,190

7 Deferral of income from controlled foreign corporations (normal tax method) .................................... 6,200 6,600 7,000 7,450 7,900 8,400 8,930 39,680

8 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,190 1,290 540 0 0 0 0 540

General science, space, and technology:

9 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,680 1,650 1,680 1,770 1,880 1,980 2,100 9,410

10 Credit for increasing research activities ................................................................................................. 1,630 6,050 6,760 5,390 4,710 2,720 1,160 20,740

Energy:

11 Expensing of exploration and development costs, fuels ....................................................................... 20 70 70 100 110 110 100 490

12 Excess of percentage over cost depletion, fuels .................................................................................. 340 340 340 340 340 350 350 1,720

13 Alternative fuel production credit ............................................................................................................ 970 920 860 540 130 130 130 1,790

14 Exception from passive loss limitation for working interests in oil and gas properties ....................... 20 20 20 20 20 20 20 100

15 Capital gains treatment of royalties on coal .......................................................................................... 70 70 80 80 80 90 90 420

16 Exclusion of interest on energy facility bonds ....................................................................................... 90 90 90 100 110 130 140 570

17 Enhanced oil recovery credit .................................................................................................................. 310 370 440 530 630 770 910 3,280

18 New technology credit ............................................................................................................................ 40 60 70 90 90 90 90 430

19 Alcohol fuel credits 2 ............................................................................................................................... 20 20 20 20 20 20 20 100

20 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 60 60 50 30 0 –30 –50 0

21 Exclusion from income of conservation subsidies provided by public utilities ..................................... 90 80 80 80 90 90 90 430

Natural resources and environment:

22 Expensing of exploration and development costs, nonfuel minerals .................................................... 20 20 20 20 20 20 20 100

23 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 270 280 300 310 320 330 350 1,610

24 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 400 400 410 450 510 560 610 2,540

25 Capital gains treatment of certain timber income ................................................................................. 70 70 80 80 80 90 90 420

26 Expensing of multiperiod timber growing costs ..................................................................................... 570 580 610 630 640 660 680 3,220

27 Investment credit and seven-year amortization for reforestation expenditures .................................... 0 0 0 0 10 10 10 30

28 Tax incentives for preservation of historic structures ............................................................................ 190 200 210 220 240 250 260 1,180

Agriculture:

29 Expensing of certain capital outlays ...................................................................................................... 160 160 160 170 170 180 180 860

30 Expensing of certain multiperiod production costs ................................................................................ 110 110 120 120 120 130 130 620

31 Treatment of loans forgiven for solvent farmers ................................................................................... 10 10 10 10 10 10 10 50

32 Capital gains treatment of certain income ............................................................................................. 700 740 780 820 860 900 950 4,310

33 Income averaging for farmers ................................................................................................................ 50 50 50 50 60 60 60 280

34 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 10 50

Commerce and housing:

Financial institutions and insurance:

35 Exemption of credit union income ..................................................................................................... 1,550 1,650 1,770 1,890 2,020 2,160 2,280 10,120

36 Excess bad debt reserves of financial institutions ............................................................................ 70 60 50 30 20 10 0 110

37 Exclusion of interest on life insurance savings ................................................................................. 13,950 15,170 16,520 17,990 19,610 21,370 23,330 98,820

38 Special alternative tax on small property and casualty insurance companies ................................ 10 10 10 10 10 10 10 50

39 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 230 240 250 270 280 300 310 1,410

40 Small life insurance company deduction ........................................................................................... 100 100 100 100 100 100 100 500

Housing:

41 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 790 800 820 870 990 1,090 1,200 4,970

42 Exclusion of interest on rental housing bonds .................................................................................. 160 160 170 170 200 230 260 1,030

43 Deductibility of mortgage interest on owner-occupied homes .......................................................... 60,270 63,190 65,750 68,050 70,470 73,100 76,150 353,520

44 Deductibility of State and local property tax on owner-occupied homes ......................................... 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

45 Deferral of income from post 1987 installment sales ....................................................................... 1,010 1,035 1,050 1,070 1,090 1,110 1,130 5,450

46 Capital gains exclusion on home sales ............................................................................................. 18,540 19,095 19,670 20,260 20,870 21,490 22,140 104,430

47 Exception from passive loss rules for $25,000 of rental loss .......................................................... 4,720 4,450 4,220 4,000 3,790 3,600 3,410 19,020

48 Credit for low-income housing investments ....................................................................................... 3,210 3,310 3,460 3,600 3,790 3,940 4,080 18,870

49 Accelerated depreciation on rental housing (normal tax method) .................................................... 4,740 5,140 5,520 5,830 6,040 6,140 6,210 29,740

Commerce:

50 Cancellation of indebtedness ............................................................................................................. 30 20 10 10 10 20 20 70

51 Exceptions from imputed interest rules ............................................................................................. 80 80 80 80 80 80 80 400

52 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 40,520 41,720 42,950 44,220 45,530 46,870 48,260 227,830

53 Capital gains exclusion of small corporation stock ........................................................................... 40 70 90 120 160 200 250 820

54 Step-up basis of capital gains at death ............................................................................................ 27,090 28,240 29,370 30,540 31,760 33,030 34,360 159,060

55 Carryover basis of capital gains on gifts ........................................................................................... 180 190 200 210 220 230 240 1,100

64 ANALYTICAL PERSPECTIVES

Table 5–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 1—Continued

(In millions of dollars)

Total from corporations and individuals

2000 2001 2002 2003 2004 2005 2006 2002–2006

56 Ordinary income treatment of loss from small business corporation stock sale ............................. 35 40 40 40 40 40 40 200

57 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 3,260 3,170 3,290 2,880 2,860 2,730 3,220 14,980

58 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 30,660 33,050 35,400 37,680 39,760 41,530 43,330 197,700

59 Expensing of certain small investments (normal tax method) .......................................................... 2,100 2,570 2,690 2,670 2,570 2,480 2,510 12,920

60 Amortization of start-up costs (normal tax method) .......................................................................... 200 200 200 210 220 220 220 1,070

61 Graduated corporation income tax rate (normal tax method) .......................................................... 6,480 6,700 7,140 7,460 7,540 7,760 7,960 37,860

62 Exclusion of interest on small issue bonds ....................................................................................... 290 300 310 330 360 410 450 1,860

Transportation:

63 Deferral of tax on shipping companies .................................................................................................. 20 20 20 20 20 20 20 100

64 Exclusion of reimbursed employee parking expenses .......................................................................... 1,880 1,980 2,090 2,190 2,300 2,420 2,550 11,550

65 Exclusion for employer-provided transit passes .................................................................................... 190 220 260 310 350 400 440 1,760

Community and regional development:

66 Investment credit for rehabilitation of structures (other than historic) .................................................. 30 30 30 30 30 30 30 150

67 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 620 630 640 690 780 850 950 3,910

68 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 60 60 70 70 320

69 Empowerment zones and enterprise communities ................................................................................ 310 320 660 1,140 1,210 1,340 1,480 5,830

70 New markets tax credit ........................................................................................................................... 0 10 90 200 310 440 640 1,680

71 Expensing of environmental remediation costs ..................................................................................... 160 350 410 330 30 –130 –80 560

Education, training, employment, and social services:

Education:

72 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,110 1,120 1,130 1,140 1,150 1,160 1,180 5,760

73 HOPE tax credit .................................................................................................................................. 4,210 4,480 4,610 4,280 4,110 4,360 4,630 21,990

74 Lifetime Learning tax credit ................................................................................................................ 2,420 2,570 2,580 2,960 4,490 4,460 4,660 19,150

75 Education Individual Retirement Accounts ........................................................................................ 20 30 50 60 80 100 120 410

76 Deductibility of student-loan interest .................................................................................................. 360 370 380 380 390 400 410 1,960

77 Deferral for state prepaid tuition plans .............................................................................................. 100 130 180 230 250 290 330 1,280

78 Exclusion of interest on student-loan bonds ..................................................................................... 210 230 230 240 270 290 330 1,360

79 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 520 540 550 580 650 740 810 3,330

80 Credit for holders of zone academy bonds ....................................................................................... 10 20 40 50 60 70 70 290

81 Exclusion of interest on savings bonds redeemed to finance educational expenses ..................... 10 10 10 10 10 10 10 50

82 Parental personal exemption for students age 19 or over ............................................................... 950 1,010 1,070 1,110 1,170 1,220 1,270 5,840

83 Deductibility of charitable contributions (education) .......................................................................... 2,730 2,830 2,930 3,090 3,200 3,300 3,540 16,060

84 Exclusion of employer-provided educational assistance ................................................................... 240 260 90 0 0 0 0 90

Training, employment, and social services:

85 Work opportunity tax credit ................................................................................................................ 390 400 300 180 80 30 10 600

86 Welfare-to-work tax credit .................................................................................................................. 50 70 70 50 20 10 0 150

87 Exclusion of employer provided child care ........................................................................................ 670 700 730 760 810 850 900 4,050

88 Adoption assistance ............................................................................................................................ 120 130 120 30 30 20 20 220

89 Assistance for adopted foster children .............................................................................................. 160 190 210 240 250 260 270 1,230

90 Exclusion of employee meals and lodging (other than military) ...................................................... 680 710 740 780 810 850 890 4,070

91 Child credit 3 ........................................................................................................................................ 19,330 19,310 18,980 18,410 18,000 17,430 16,790 89,610

92 Credit for child and dependent care expenses ................................................................................. 2,390 2,360 2,330 2,300 2,280 2,250 2,220 11,380

93 Credit for disabled access expenditures ........................................................................................... 40 40 50 50 50 50 50 250

94 Deductibility of charitable contributions, other than education and health ....................................... 20,150 21,020 22,030 23,160 24,240 25,380 26,780 121,590

95 Exclusion of certain foster care payments ........................................................................................ 550 570 300 630 660 700 730 3,020

96 Exclusion of parsonage allowances ................................................................................................... 330 350 370 400 430 460 490 2,150

Health:

97 Exclusion of employer contributions for medical insurance premiums and medical care ................... 76,530 84,350 92,230 99,800 107,620 115,770 124,690 540,110

98 Self-employed medical insurance premiums ......................................................................................... 1,340 1,510 1,760 2,470 3,580 3,900 4,220 15,930

99 Workers’ compensation insurance premiums ........................................................................................ 4,620 4,850 5,090 5,350 5,620 5,900 6,190 28,150

100 Medical Savings Accounts ...................................................................................................................... 20 20 30 20 20 20 20 110

101 Deductibility of medical expenses .......................................................................................................... 4,250 4,560 4,870 5,170 5,480 5,790 6,110 27,420

102 Exclusion of interest on hospital construction bonds ............................................................................ 1,080 1,100 1,130 1,210 1,350 1,490 1,660 6,840

103 Deductibility of charitable contributions (health) .................................................................................... 2,910 3,000 3,100 3,270 3,380 3,480 3,740 16,970

104 Tax credit for orphan drug research ...................................................................................................... 100 110 130 140 160 180 200 810

105 Special Blue Cross/Blue Shield deduction ............................................................................................. 230 250 280 320 290 280 250 1,420

Income security:

106 Exclusion of railroad retirement system benefits ................................................................................... 360 360 360 360 360 360 360 1,800

107 Exclusion of workers’ compensation benefits ........................................................................................ 5,120 5,560 5,810 6,070 6,320 6,600 6,900 31,700

108 Exclusion of public assistance benefits (normal tax method) ............................................................... 360 370 390 400 420 430 450 2,090

109 Exclusion of special benefits for disabled coal miners ......................................................................... 80 70 70 60 60 60 50 300

110 Exclusion of military disability pensions ................................................................................................. 120 120 130 130 130 140 140 670

Net exclusion of pension contributions and earnings:

111 Employer plans ................................................................................................................................... 89,120 93,220 97,510 103,010 108,480 114,220 121,990 545,210

112 Individual Retirement Accounts .......................................................................................................... 15,200 15,920 16,600 17,230 17,770 18,220 18,520 88,340

5. TAX EXPENDITURES 65

Table 5–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 1—Continued

(In millions of dollars)

Total from corporations and individuals

2000 2001 2002 2003 2004 2005 2006 2002–2006

113 Keogh plans ........................................................................................................................................ 5,500 5,830 6,180 6,540 6,930 7,330 7,750 34,730

Exclusion of other employee benefits:

114 Premiums on group term life insurance ............................................................................................ 1,720 1,750 1,780 1,830 1,860 1,900 1,930 9,300

115 Premiums on accident and disability insurance ................................................................................ 200 210 220 230 240 250 260 1,200

116 Income of trusts to finance supplementary unemployment benefits .................................................... 10 10 10 10 10 10 10 50

Special ESOP rules ................................................................................................................................ 1,240 1,290 1,340 1,400 1,460 1,540 1,610 7,350

118 Additional deduction for the blind ........................................................................................................... 30 30 30 30 40 40 40 180

119 Additional deduction for the elderly ........................................................................................................ 1,920 1,990 2,060 2,130 2,210 2,260 2,350 11,010

120 Tax credit for the elderly and disabled .................................................................................................. 30 30 30 30 30 30 30 150

121 Deductibility of casualty losses .............................................................................................................. 230 250 260 280 290 300 320 1,450

122 Earned income tax credit 4 ..................................................................................................................... 4,644 4,692 4,693 5,225 5,456 5,688 5,965 27,297

Social Security:

Exclusion of social security benefits:

123 Social Security benefits for retired workers ....................................................................................... 18,250 19,070 19,930 20,520 21,050 21,840 22,780 106,120

124 Social Security benefits for disabled ................................................................................................. 2,640 2,880 3,160 3,490 3,910 4,360 4,840 19,760

125 Social Security benefits for dependents and survivors ..................................................................... 3,910 4,030 4,210 4,440 4,730 5,070 5,380 23,830

Veterans benefits and services:

126 Exclusion of veterans death benefits and disability compensation ...................................................... 3,090 3,290 3,460 3,640 3,820 4,010 4,210 19,140

127 Exclusion of veterans pensions .............................................................................................................. 70 70 80 80 90 90 100 440

128 Exclusion of GI bill benefits .................................................................................................................... 80 90 90 100 100 110 110 510

129 Exclusion of interest on veterans housing bonds ................................................................................. 40 40 40 40 40 50 50 220

General purpose fiscal assistance:

130 Exclusion of interest on public purpose State and local bonds ........................................................... 22,600 23,050 23,510 23,980 24,460 24,950 25,450 122,350

131 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

132 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 2,470 2,520 2,560 2,580 2,610 2,630 1,060 11,440

Interest:

133 Deferral of interest on U.S. savings bonds ........................................................................................... 470 490 520 540 570 600 630 2,860

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 22,600 23,050 23,510 23,980 24,460 24,950 25,450 122,350

Energy facilities ................................................................................................................................... 90 90 90 100 110 130 140 570

Water, sewage, and hazardous waste disposal facilities ................................................................. 400 400 410 450 510 560 610 2,540

Small-issues ........................................................................................................................................ 290 300 310 330 360 410 450 1,860

Owner-occupied mortgage subsidies ................................................................................................. 790 800 820 870 990 1,090 1,200 4,970

Rental housing .................................................................................................................................... 160 160 170 170 200 230 260 1,030

Airports, docks, and similar facilities ................................................................................................. 620 630 640 690 780 850 950 3,910

Student loans ...................................................................................................................................... 210 230 230 240 270 290 330 1,360

Private nonprofit educational facilities ............................................................................................... 520 540 550 580 650 740 810 3,330

Hospital construction .......................................................................................................................... 1,080 1,100 1,130 1,210 1,350 1,490 1,660 6,840

Veterans’ housing ............................................................................................................................... 40 40 40 40 40 50 50 220

Credit for holders of zone academy bonds ........................................................................................... 10 20 40 50 60 70 70 290

1 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income tax

principles. For that reason, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions

define income under the general rule of U.S. income taxation. 2 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2000 $840; 2001 $880; 2002 $930; 2003 $950; 2004

$960; 2005 $960; and in 2006 $960.

3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $810; 2001 $790; 2002 $760; 2003 $720; 2004

$660; 2005 $630; and in 2006 $590.

4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $26,099; 2001 $25,923; 2002

$26,983; 2003 $27,875; 2004 $28,545; 2005 $29,373; and in 2006 $30,165.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.

All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.

66 ANALYTICAL PERSPECTIVES

Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX ESTIMATES OF TAX EXPENDITURES 1

(In millions of dollars)

Corporations Individuals

2000 2001 2002 2003 2004 2005 2006 2002– 2006 2000 2001 2002 2003 2004 2005 2006 2002– 2006

National Defense

1 Exclusion of benefits, allowances,

and certain pays to armed

forces personnel ......................... ............ ............ ............ ............ ............ ............ ............ .............. 2,140 2,160 2,190 2,210 2,240 2,260 2,290 11,190

International affairs:

2 Exclusion of income earned abroad

by U.S. citizens ........................... ............ ............ ............ ............ ............ ............ ............ .............. 2,500 2,680 2,850 3,010 3,180 3,350 3,550 15,940

3 Exclusion of certain allowances for

Federal employees abroad ......... ............ ............ ............ ............ ............ ............ ............ .............. 680 720 750 790 830 870 920 4,160

4 Exclusion of income of foreign

sales corporations ....................... 3,890 ............ ............ ............ ............ ............ ............ .............. ............ ............ .............. .............. .............. .............. .............. ..............

5 Extraterritorial income exclusion ..... ............ 4,490 4,810 5,150 5,500 5,880 6,290 27,630 ............ ............ .............. .............. .............. .............. .............. ..............

6 Inventory property sales source

rules exception ............................ 2,170 2,280 2,390 2,510 2,630 2,760 2,900 13,190 ............ ............ .............. .............. .............. .............. .............. ..............

7 Deferral of income from controlled

foreign corporations (normal tax

method) ....................................... 6,200 6,600 7,000 7,450 7,900 8,400 8,930 39,680 ............ ............ .............. .............. .............. .............. .............. ..............

8 Deferred taxes for financial firms

on certain income earned overseas ............................................. 1,190 1,290 540 ............ ............ ............ ............ 540 ............ ............ .............. .............. .............. .............. .............. ..............

General science, space, and technology:

9 Expensing of research and experimentation expenditures (normal

tax method) ................................. 1,650 1,620 1,650 1,740 1,840 1,940 2,060 9,230 30 30 30 30 40 40 40 180

10 Credit for increasing research activities .......................................... 1,620 5,990 6,700 5,340 4,670 2,700 1,160 20,570 10 60 60 50 40 20 .............. 170

Energy:

11 Expensing of exploration and development costs, fuels ................ 20 60 60 80 90 90 80 400 ............ 10 10 20 20 20 20 90

12 Excess of percentage over cost

depletion, fuels ............................ 290 290 290 290 290 300 300 1,470 50 50 50 50 50 50 50 250

13 Alternative fuel production credit .... 930 880 820 520 120 120 120 1,700 40 40 40 20 10 10 10 90

14 Exception from passive loss limitation for working interests in oil

and gas properties ...................... ............ ............ ............ ............ ............ ............ ............ .............. 20 20 20 20 20 20 20 100

15 Capital gains treatment of royalties

on coal ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 70 70 80 80 80 90 90 420

16 Exclusion of interest on energy facility bonds .................................. 20 20 20 20 30 40 40 150 70 70 70 80 80 90 100 420

17 Enhanced oil recovery credit .......... 280 340 400 480 580 700 830 2,990 30 30 40 50 50 70 80 290

18 New technology credit .................... 40 60 70 90 90 90 90 430 ............ ............ .............. .............. .............. .............. .............. ..............

19 Alcohol fuel credits 2 ....................... 10 10 10 10 10 10 10 50 10 10 10 10 10 10 10 50

20 Tax credit and deduction for cleanfuel burning vehicles ................... 50 50 40 20 ............ –30 –40 –10 10 10 10 10 .............. .............. –10 10

21 Exclusion from income of conservation subsidies provided by

public utilities .............................. ............ ............ ............ ............ ............ ............ ............ .............. 90 80 80 80 90 90 90 430

Natural resources and environment:

22 Expensing of exploration and development costs, nonfuel minerals ............................................ 20 20 20 20 20 20 20 100 ............ ............ .............. .............. .............. .............. .............. ..............

23 Excess of percentage over cost

depletion, nonfuel minerals ........ 250 260 280 290 300 310 330 1,510 20 20 20 20 20 20 20 100

24 Exclusion of interest on bonds for

water, sewage, and hazardous

waste facilities ............................. 100 100 100 120 130 140 150 640 300 300 310 330 380 420 460 1,900

25 Capital gains treatment of certain

timber income ............................. ............ ............ ............ ............ ............ ............ ............ .............. 70 70 80 80 80 90 90 420

26 Expensing of multiperiod timber

growing costs .............................. 280 290 310 320 330 340 360 1,660 290 290 300 310 310 320 320 1,560

27 Investment credit and seven-year

amortization for reforestation expenditures ................................... ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ .............. .............. 10 10 10 30

28 Tax incentives for preservation of

historic structures ........................ 170 180 190 200 210 220 230 1,050 20 20 20 20 30 30 30 130

Agriculture:

29 Expensing of certain capital outlays 20 20 20 20 20 20 20 100 140 140 140 150 150 160 160 760

30 Expensing of certain multiperiod

production costs .......................... 10 10 20 20 20 20 20 100 100 100 100 100 100 110 110 520

31 Treatment of loans forgiven for solvent farmers ................................ ............ ............ ............ ............ ............ ............ ............ .............. 10 10 10 10 10 10 10 50

5. TAX EXPENDITURES 67

Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX ESTIMATES OF TAX EXPENDITURES 1—Continued

(In millions of dollars)

Corporations Individuals

2000 2001 2002 2003 2004 2005 2006 2002– 2006 2000 2001 2002 2003 2004 2005 2006 2002– 2006

32 Capital gains treatment of certain

income ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 700 740 780 820 860 900 950 4,310

33 Income averaging for farmers ........ ............ ............ ............ ............ ............ ............ ............ .............. 50 50 50 50 60 60 60 280

34 Deferral of gain on sale of farm refiners ........................................... 10 10 10 10 10 10 10 50 ............ ............ .............. .............. .............. .............. .............. ..............

Commerce and housing:

Financial institutions and insurance:

35 Exemption of credit union income ....................................... 1,550 1,650 1,770 1,890 2,020 2,160 2,280 10,120 ............ ............ .............. .............. .............. .............. .............. ..............

36 Excess bad debt reserves of financial institutions .................. 70 60 50 30 20 10 ............ 110 ............ ............ .............. .............. .............. .............. .............. ..............

37 Exclusion of interest on life insurance savings ..................... 490 530 580 630 690 750 820 3,470 13,460 14,640 15,940 17,360 18,920 20,620 22,510 95,350

38 Special alternative tax on small

property and casualty insurance companies ..................... 10 10 10 10 10 10 10 50 ............ ............ .............. .............. .............. .............. .............. ..............

39 Tax exemption of certain insurance companies owned by

tax-exempt organizations ....... 230 240 250 270 280 300 310 1,410 ............ ............ .............. .............. .............. .............. .............. ..............

40 Small life insurance company

deduction ................................ 100 100 100 100 100 100 100 500 ............ ............ .............. .............. .............. .............. .............. ..............

Housing:

41 Exclusion of interest on owneroccupied mortgage subsidy

bonds ...................................... 200 200 210 220 250 270 290 1,240 590 600 610 650 740 820 910 3,730

42 Exclusion of interest on rental

housing bonds ........................ 40 40 40 40 50 60 70 260 120 120 130 130 150 170 190 770

43 Deductibility of mortgage interest

on owner-occupied homes ..... ............ ............ ............ ............ ............ ............ ............ .............. 60,270 63,190 65,750 68,050 70,470 73,100 76,150 353,520

44 Deductibility of State and local

property tax on owner-occupied homes ............................. ............ ............ ............ ............ ............ ............ ............ .............. 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

45 Deferral of income from post

1987 installment sales ........... 260 270 270 280 280 290 290 1,410 750 765 780 790 810 820 840 4,040

46 Capital gains exclusion on home

sales ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 18,540 19,095 19,670 20,260 20,870 21,490 22,140 104,430

47 Exception from passive loss

rules for $25,000 of rental

loss ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,720 4,450 4,220 4,000 3,790 3,600 3,410 19,020

48 Credit for low-income housing

investments ............................. 2,410 2,490 2,600 2,710 2,850 2,960 3,070 14,190 800 820 860 890 940 980 1,010 4,680

49 Accelerated depreciation on

rental housing (normal tax

method) ................................... 340 370 400 420 430 440 450 2,140 4,400 4,770 5,120 5,410 5,610 5,700 5,760 27,600

Commerce:

50 Cancellation of indebtedness ..... ............ ............ ............ ............ ............ ............ ............ .............. 30 20 10 10 10 20 20 70

51 Exceptions from imputed interest

rules ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 80 80 80 80 80 80 80 400

52 Capital gains (except agriculture,

timber, iron ore, and coal)

(normal tax method) ............... ............ ............ ............ ............ ............ ............ ............ .............. 40,520 41,720 42,950 44,220 45,530 46,870 48,260 227,830

53 Capital gains exclusion of small

corporation stock .................... ............ ............ ............ ............ ............ ............ ............ .............. 40 70 90 120 160 200 250 820

54 Step-up basis of capital gains at

death ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 27,090 28,240 29,370 30,540 31,760 33,030 34,360 159,060

55 Carryover basis of capital gains

on gifts .................................... ............ ............ ............ ............ ............ ............ ............ .............. 180 190 200 210 220 230 240 1,100

56 Ordinary income treatment of

loss from small business corporation stock sale ................. ............ ............ ............ ............ ............ ............ ............ .............. 35 40 40 40 40 40 40 200

57 Accelerated depreciation of

buildings other than rental

housing (normal tax method) 1,650 1,530 1,540 1,360 1,210 1,130 1,230 6,470 1,610 1,640 1,750 1,520 1,650 1,600 1,990 8,510

58 Accelerated depreciation of machinery and equipment (normal tax method) ..................... 28,020 30,230 32,400 34,530 36,470 38,110 39,770 181,280 2,640 2,820 3,000 3,150 3,290 3,420 3,560 16,420

59 Expensing of certain small investments (normal tax method) ........................................... 630 810 880 870 840 810 820 4,220 1,470 1,760 1,810 1,800 1,730 1,670 1,690 8,700

60 Amortization of start-up costs

(normal tax method) ............... 120 120 120 130 130 130 130 640 80 80 80 80 90 90 90 430

61 Graduated corporation income

tax rate (normal tax method) 6,480 6,700 7,140 7,460 7,540 7,760 7,960 37,860 ............ ............ .............. .............. .............. .............. .............. ..............

62 Exclusion of interest on small

issue bonds ............................ 70 80 80 90 90 100 110 470 220 220 230 240 270 310 340 1,390

68 ANALYTICAL PERSPECTIVES

Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX ESTIMATES OF TAX EXPENDITURES 1—Continued

(In millions of dollars)

Corporations Individuals

2000 2001 2002 2003 2004 2005 2006 2002–

2006 2000 2001 2002 2003 2004 2005 2006 2002–2006

Transportation:

63 Deferral of tax on shipping companies .............................................. 20 20 20 20 20 20 20 100 ............ ............ .............. .............. .............. .............. .............. ..............

64 Exclusion of reimbursed employee

parking expenses ........................ ............ ............ ............ ............ ............ ............ ............ .............. 1,880 1,980 2,090 2,190 2,300 2,420 2,550 11,550

65 Exclusion for employer-provided

transit passes .............................. ............ ............ ............ ............ ............ ............ ............ .............. 190 220 260 310 350 400 440 1,760

Community and regional development:

66 Investment credit for rehabilitation

of structures (other than historic) 20 20 20 20 20 20 20 100 10 10 10 10 10 10 10 50

67 Exclusion of interest for airport,

dock, and similar bonds ............. 160 160 160 180 200 210 240 990 460 470 480 510 580 640 710 2,920

68 Exemption of certain mutuals’ and

cooperatives’ income .................. 60 60 60 60 60 70 70 320 ............ ............ .............. .............. .............. .............. .............. ..............

69 Empowerment zones and enterprise communities ....................... 80 80 210 300 310 350 370 1,540 230 240 450 840 900 990 1,110 4,290

70 New markets tax credit ................... ............ ............ 20 50 80 110 160 420 ............ 10 70 150 230 330 480 1,260

71 Expensing of environmental remediation costs ................................ 130 290 340 280 40 –110 –70 480 30 60 70 50 –10 –20 –10 80

Education, training, employment,

and social services:

Education:

72 Exclusion of scholarship and fellowship income (normal tax

method) ................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,110 1,120 1,130 1,140 1,150 1,160 1,180 5,760

73 HOPE tax credit .......................... ............ ............ ............ ............ ............ ............ ............ .............. 4,210 4,480 4,610 4,280 4,110 4,360 4,630 21,990

74 Lifetime Learning tax credit ........ ............ ............ ............ ............ ............ ............ ............ .............. 2,420 2,570 2,580 2,960 4,490 4,460 4,660 19,150

75 Education Individual Retirement

Accounts ................................. ............ ............ ............ ............ ............ ............ ............ .............. 20 30 50 60 80 100 120 410

76 Deductibility of student-loan interest ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 360 370 380 380 390 400 410 1,960

77 Deferral for state prepaid tuition

plans ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 100 130 180 230 250 290 330 1,280

78 Exclusion of interest on studentloan bonds .............................. 50 60 60 60 70 70 80 340 160 170 170 180 200 220 250 1,020

79 Exclusion of interest on bonds

for private nonprofit educational facilities ..................... 130 140 140 150 160 190 200 840 390 400 410 430 490 550 610 2,490

80 Credit for holders of zone academy bonds .............................. 10 20 40 50 60 70 70 290 ............ ............ .............. .............. .............. .............. .............. ..............

81 Exclusion of interest on savings

bonds redeemed to finance

educational expenses ............. ............ ............ ............ ............ ............ ............ ............ .............. 10 10 10 10 10 10 10 50

82 Parental personal exemption for

students age 19 or over ........ ............ ............ ............ ............ ............ ............ ............ .............. 950 1,010 1,070 1,110 1,170 1,220 1,270 5,840

83 Deductibility of charitable contributions (education) .............. 600 600 590 630 620 590 690 3,120 2,130 2,230 2,340 2,460 2,580 2,710 2,850 12,940

84 Exclusion of employer-provided

educational assistance ........... ............ ............ ............ ............ ............ ............ ............ .............. 240 260 90 .............. .............. .............. .............. 90

Training, employment, and social

services:

85 Work opportunity tax credit ........ 350 360 270 160 70 30 10 540 40 40 30 20 10 .............. .............. 60

86 Welfare-to-work tax credit .......... 40 60 60 40 20 10 ............ 130 10 10 10 10 .............. .............. .............. 20

87 Exclusion of employer provided

child care ................................ ............ ............ ............ ............ ............ ............ ............ .............. 670 700 730 760 810 850 900 4,050

88 Adoption assistance .................... ............ ............ ............ ............ ............ ............ ............ .............. 120 130 120 30 30 20 20 220

89 Assistance for adopted foster

children ................................... ............ ............ ............ ............ ............ ............ ............ .............. 160 190 210 240 250 260 270 1,230

90 Exclusion of employee meals

and lodging (other than military) ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 680 710 740 780 810 850 890 4,070

91 Child credit 3 ............................... ............ ............ ............ ............ ............ ............ ............ .............. 19,330 19,310 18,980 18,410 18,000 17,430 16,790 89,610

92 Credit for child and dependent

care expenses ........................ ............ ............ ............ ............ ............ ............ ............ .............. 2,390 2,360 2,330 2,300 2,280 2,250 2,220 11,380

93 Credit for disabled access expenditures ............................... 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200

94 Deductibility of charitable contributions, other than education and health .................... 750 740 730 790 760 730 860 3,870 19,400 20,280 21,300 22,370 23,480 24,650 25,920 117,720

95 Exclusion of certain foster care

payments ................................ ............ ............ ............ ............ ............ ............ ............ .............. 550 570 300 630 660 700 730 3,020

96 Exclusion of parsonage allowances ...................................... ............ ............ ............ ............ ............ ............ ............ .............. 330 350 370 400 430 460 490 2,150

5. TAX EXPENDITURES 69

Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX ESTIMATES OF TAX EXPENDITURES 1—Continued

(In millions of dollars)

Corporations Individuals

2000 2001 2002 2003 2004 2005 2006 2002–

2006 2000 2001 2002 2003 2004 2005 2006 2002–2006

Health:

97 Exclusion of employer contributions

for medical insurance premiums

and medical care ........................ ............ ............ ............ ............ ............ ............ ............ .............. 76,530 84,350 92,230 99,800 107,620 115,770 124,690 540,110

98 Self-employed medical insurance

premiums .................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,340 1,510 1,760 2,470 3,580 3,900 4,220 15,930

99 Workers’ compensation insurance

premiums .................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,620 4,850 5,090 5,350 5,620 5,900 6,190 28,150

100 Medical Savings Accounts .............. ............ ............ ............ ............ ............ ............ ............ .............. 20 20 30 20 20 20 20 110

101 Deductibility of medical expenses .. ............ ............ ............ ............ ............ ............ ............ .............. 4,250 4,560 4,870 5,170 5,480 5,790 6,110 27,420

102 Exclusion of interest on hospital

construction bonds ...................... 270 280 290 310 340 370 410 1,720 810 820 840 900 1,010 1,120 1,250 5,120

103 Deductibility of charitable contributions (health) ............................... 730 720 710 760 740 710 830 3,750 2,180 2,280 2,390 2,510 2,640 2,770 2,910 13,220

104 Tax credit for orphan drug research ......................................... 100 110 130 140 160 180 200 810 ............ ............ .............. .............. .............. .............. .............. ..............

105 Special Blue Cross/Blue Shield deduction ......................................... 230 250 280 320 290 280 250 1,420 ............ ............ .............. .............. .............. .............. .............. ..............

Income security:

106 Exclusion of railroad retirement

system benefits ........................... ............ ............ ............ ............ ............ ............ ............ .............. 360 360 360 360 360 360 360 1,800

107 Exclusion of workers’ compensation

benefits ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 5,120 5,560 5,810 6,070 6,320 6,600 6,900 31,700

108 Exclusion of public assistance benefits (normal tax method) ........... ............ ............ ............ ............ ............ ............ ............ .............. 360 370 390 400 420 430 450 2,090

109 Exclusion of special benefits for

disabled coal miners ................... ............ ............ ............ ............ ............ ............ ............ .............. 80 70 70 60 60 60 50 300

110 Exclusion of military disability pensions ............................................ ............ ............ ............ ............ ............ ............ ............ .............. 120 120 130 130 130 140 140 670

Net exclusion of pension contributions and earnings:

111 Employer plans ........................... ............ ............ ............ ............ ............ ............ ............ .............. 89,120 93,220 97,510 103,010 108,480 114,220 121,990 545,210

112 Individual Retirement Accounts .. ............ ............ ............ ............ ............ ............ ............ .............. 15,200 15,920 16,600 17,230 17,770 18,220 18,520 88,340

113 Keogh plans ................................ ............ ............ ............ ............ ............ ............ ............ .............. 5,500 5,830 6,180 6,540 6,930 7,330 7,750 34,730

Exclusion of other employee benefits:

114 Premiums on group term life insurance ................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,720 1,750 1,780 1,830 1,860 1,900 1,930 9,300

115 Premiums on accident and disability insurance ...................... ............ ............ ............ ............ ............ ............ ............ .............. 200 210 220 230 240 250 260 1,200

116 Income of trusts to finance supplementary unemployment

benefits ................................... 10 10 10 10 10 10 10 50 ............ ............ .............. .............. .............. .............. .............. ..............

117 Special ESOP rules .................... 940 980 1,020 1,070 1,120 1,180 1,240 5,630 300 310 320 330 340 360 370 1,720

118 Additional deduction for the blind ............ ............ ............ ............ ............ ............ ............ .............. 30 30 30 30 40 40 40 180

119 Additional deduction for the elderly ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 1,920 1,990 2,060 2,130 2,210 2,260 2,350 11,010

120 Tax credit for the elderly and

disabled .................................. ............ ............ ............ ............ ............ ............ ............ .............. 30 30 30 30 30 30 30 150

121 Deductibility of casualty losses .. ............ ............ ............ ............ ............ ............ ............ .............. 230 250 260 280 290 300 320 1,450

122 Earned income tax credit 4 ......... ............ ............ ............ ............ ............ ............ ............ .............. 4,644 4,692 4,963 5,225 5,436 5,688 5,965 27,297

Social Security:

Exclusion of social security benefits:

123 Social Security benefits for retired workers ........................... ............ ............ ............ ............ ............ ............ ............ .............. 18,250 19,070 19,930 20,520 21,050 21,840 22,780 106,120

124 Social Security benefits for disabled ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,640 2,880 3,160 3,490 3,910 4,360 4,840 19,760

125 Social Security benefits for dependents and survivors .......... ............ ............ ............ ............ ............ ............ ............ .............. 3,910 4,030 4,210 4,440 4,730 5,070 5,380 23,830

Veterans benefits and services:

126 Exclusion of veterans death benefits and disability compensation ............ ............ ............ ............ ............ ............ ............ .............. 3,090 3,290 3,460 3,640 3,820 4,010 4,210 19,140

127 Exclusion of veterans pensions ...... ............ ............ ............ ............ ............ ............ ............ .............. 70 70 80 80 90 90 100 440

128 Exclusion of GI bill benefits ............ ............ ............ ............ ............ ............ ............ ............ .............. 80 90 90 100 100 110 110 510

129 Exclusion of interest on veterans

housing bonds ............................ 10 10 10 10 10 10 10 50 30 30 30 30 30 40 40 170

General purpose fiscal assistance:

130 Exclusion of interest on public purpose State and local bonds ....... 5,730 5,840 5,960 6,080 6,200 6,320 6,450 31,010 16,870 17,210 17,550 17,900 18,260 18,630 19,000 91,340

131 Deductibility of nonbusiness state

and local taxes other than on

owner-occupied homes ............... ............ ............ ............ ............ ............ ............ ............ .............. 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

70 ANALYTICAL PERSPECTIVES

Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX ESTIMATES OF TAX EXPENDITURES 1—Continued

(In millions of dollars)

Corporations Individuals

2000 2001 2002 2003 2004 2005 2006 2002– 2006 2000 2001 2002 2003 2004 2005 2006 2002– 2006

132 Tax credit for corporations receiving income from doing business

in U.S. possessions .................... 2,470 2,520 2,560 2,580 2,610 2,630 1,060 11,440 ............ ............ .............. .............. .............. .............. .............. ..............

Interest:

133 Deferral of interest on U.S. savings

bonds .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 470 490 520 540 570 600 630 2,860

Addendum: Aid to State and local

governments:

Deductibility of:

Property taxes on owner-occupied homes ............................. ............ ............ ............ ............ ............ ............ ............ .............. 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

Nonbusiness State and local

taxes other than on owner-occupied homes ......................... ............ ............ ............ ............ ............ ............ ............ .............. 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

Exclusion of interest on State and

local bonds for:

Public purposes .......................... 5,730 5,840 5,960 6,080 6,200 6,320 6,450 31,010 16,870 17,210 17,550 17,900 18,260 18,630 19,000 91,340

Energy facilities ........................... 20 20 20 20 30 40 40 150 70 70 70 80 80 90 100 420

Water, sewage, and hazardous

waste disposal facilities .......... 100 100 100 120 130 140 150 640 300 300 310 330 380 420 460 1,900

Small-issues ................................ 70 80 80 90 90 100 110 470 220 220 230 240 270 310 340 1,390

Owner-occupied mortgage subsidies ....................................... 200 200 210 220 250 270 290 1,240 590 600 610 650 740 820 910 3,730

Rental housing ............................ 40 40 40 40 50 60 70 260 120 120 130 130 150 170 190 770

Airports, docks, and similar facilities ...................................... 160 160 160 180 200 210 240 990 460 470 480 510 580 640 710 2,920

Student loans .............................. 50 60 60 60 70 70 80 340 160 170 170 180 200 220 250 1,020

Private nonprofit educational facilities ...................................... 130 140 140 150 160 190 200 840 390 400 410 430 490 550 610 2,490

Hospital construction .................. 270 280 290 310 340 370 410 1,720 810 820 840 900 1,010 1,120 1,250 5,120

Veterans’ housing ....................... 10 10 10 10 10 10 10 50 30 30 30 30 30 40 40 170

Credit for holders of zone academy

bonds .......................................... 10 20 40 50 60 70 70 290 ............ ............ .............. .............. .............. .............. .............. ..............

1 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income

tax principles. For that reason, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions define income under the general rule of U.S. income taxation. 2 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2000 $840; 2001 $880; 2002 $930; 2003 $950;

2004 $960; 2005 $960; and in 2006 $960.

3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $810; 2001 $790; 2002 $760; 2003 $720;

2004 $660; 2005 $630; and in 2006 $590.

4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $26,099; 2001 $25,923; 2002

$26,983; 2003 $27,875; 2004 $28,545; 2005 $29,373; and in 2006 $30,165.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.

All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.

5. TAX EXPENDITURES 71

Table 5–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2002 PROJECTED REVENUE EFFECT

(In millions of dollars)

Provision 2002 2002–2006

Net exclusion of pension contributions and earnings: Employer Plans ............................................................................. 97,510 545,210

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 92,230 540,110

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 65,750 353,520

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 48,730 276,090

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 42,950 227,830

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 35,400 197,700

Step-up basis of capital gains at death .............................................................................................................................. 29,370 159,060

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 25,570 146,070

Exclusion of interest on public purpose State and local bonds ......................................................................................... 23,510 122,350

Deductibility of charitable contributions, other than education and health ......................................................................... 22,030 121,590

Exclusion of Social Security benefits for retired workers ................................................................................................... 19,930 106,120

Capital gains exclusion on home sales ............................................................................................................................... 19,670 104,430

Child credit ............................................................................................................................................................................ 18,980 89,610

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 16,600 88,340

Exclusion of interest on life insurance savings ................................................................................................................... 16,520 98,820

Graduated corporation income tax rate (normal tax method) ............................................................................................ 7,140 37,860

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,000 39,680

Credit for increasing research activities .............................................................................................................................. 6,760 20,740

Net exclusion of pension contributions and earnings: Keough Plans ................................................................................ 6,180 34,730

Exclusion of workers’ compensation benefits ...................................................................................................................... 5,810 31,700

Accelerated depreciation on rental housing (normal tax method) ...................................................................................... 5,520 29,740

Workers’ compensation insurance premiums ...................................................................................................................... 5,090 28,150

Earned income tax credit ..................................................................................................................................................... 4,963 27,297

Deductibility of medical expenses ........................................................................................................................................ 4,870 27,420

Extraterritorial income exclusion .......................................................................................................................................... 4,810 27,630

HOPE tax credit ................................................................................................................................................................... 4,610 21,990

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,220 19,020

Exclusion of Social Security benefits for dependents and survivors ................................................................................. 4,210 23,830

Credit for low-income housing investments ......................................................................................................................... 3,460 18,870

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,460 19,140

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... 3,290 14,980

Exclusion of Social Security benefits for disabled .............................................................................................................. 3,160 19,760

Deductibility of charitable contributions (health) .................................................................................................................. 3,100 16,970

Deductibility of charitable contributions (education) ............................................................................................................ 2,930 16,060

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,850 15,940

Expensing of certain small investments (normal tax method) ............................................................................................ 2,690 12,920

Lifetime Learning tax credit .................................................................................................................................................. 2,580 19,150

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 2,560 11,440

Inventory property sales source rules exception ................................................................................................................. 2,390 13,190

Credit for child and dependent care expenses ................................................................................................................... 2,330 11,380

Exclusion of benefits, allowances, and certain pays to armed forces personnel .............................................................. 2,190 11,190

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,090 11,550

Additional deduction for the elderly ..................................................................................................................................... 2,060 11,010

Exclusion of premiums on group term life insurance ......................................................................................................... 1,780 9,300

Exemption of credit union income ....................................................................................................................................... 1,770 10,120

Self-employed medical insurance premiums ....................................................................................................................... 1,760 15,930

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 1,680 9,410

Special ESOP rules .............................................................................................................................................................. 1,340 7,350

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,130 5,760

Exclusion of interest on hospital construction bonds .......................................................................................................... 1,130 6,840

Parental personal exemption for students age 19 or over ................................................................................................. 1,070 5,840

Deferral of income from post 1987 installment sales ......................................................................................................... 1,050 5,450

Alternative fuel production credit ......................................................................................................................................... 860 1,790

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 820 4,970

Capital gains treatment of certain income ........................................................................................................................... 780 4,310

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 750 4,160

Exclusion of employee meals and lodging (other than military) ........................................................................................ 740 4,070

Exclusion of employer provided child care .......................................................................................................................... 730 4,050

Empowerment zones and enterprise communities ............................................................................................................. 660 5,830

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 640 3,910

Expensing of multiperiod timber growing costs ................................................................................................................... 610 3,220

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 550 3,330

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 540 540

Deferral of interest on U.S. savings bonds ......................................................................................................................... 520 2,860

Enhanced oil recovery credit ............................................................................................................................................... 440 3,280

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 410 2,540

Expensing of environmental remediation costs ................................................................................................................... 410 560

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 390 2,090

Deductibility of student-loan interest .................................................................................................................................... 380 1,960

72 ANALYTICAL PERSPECTIVES

Table 5–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2002 PROJECTED REVENUE EFFECT—Continued

(In millions of dollars)

Provision 2002 2002–2006

Exclusion of parsonage allowances ..................................................................................................................................... 370 2,150

Exclusion of railroad retirement system benefits ................................................................................................................ 360 1,800

Excess of percentage over cost depletion, fuels ................................................................................................................ 340 1,720

Exclusion of interest on small issue bonds ......................................................................................................................... 310 1,860

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. 300 1,610

Work opportunity tax credit .................................................................................................................................................. 300 600

Exclusion of certain foster care payments .......................................................................................................................... 300 3,020

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 280 1,420

Exclusion for employer-provided transit passes .................................................................................................................. 260 1,760

Deductibility of casualty losses ............................................................................................................................................ 260 1,450

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 250 1,410

Exclusion of interest on student-loan bonds ....................................................................................................................... 230 1,360

Exclusion of premiums on accident and disability insurance ............................................................................................. 220 1,200

Tax incentives for preservation of historic structures ......................................................................................................... 210 1,180

Assistance for adopted foster children ................................................................................................................................ 210 1,230

Carryover basis of capital gains on gifts ............................................................................................................................. 200 1,100

Amortization of start-up costs (normal tax method) ............................................................................................................ 200 1,070

Deferral for state prepaid tuition plans ................................................................................................................................ 180 1,280

Exclusion of interest on rental housing bonds .................................................................................................................... 170 1,030

Expensing of certain capital outlays .................................................................................................................................... 160 860

Tax credit for orphan drug research .................................................................................................................................... 130 810

Exclusion of military disability pensions .............................................................................................................................. 130 670

Expensing of certain multiperiod production costs .............................................................................................................. 120 620

Adoption assistance .............................................................................................................................................................. 120 220

Small life insurance company deduction ............................................................................................................................. 100 500

Exclusion of interest on energy facility bonds .................................................................................................................... 90 570

Capital gains exclusion of small corporation stock ............................................................................................................. 90 820

New markets tax credit ........................................................................................................................................................ 90 1,680

Exclusion of employer-provided educational assistance ..................................................................................................... 90 90

Exclusion of GI bill benefits ................................................................................................................................................. 90 510

Capital gains treatment of royalties on coal ....................................................................................................................... 80 420

Exclusion from income of conservation subsidies provided by public utilities ................................................................... 80 430

Capital gains treatment of certain timber income ............................................................................................................... 80 420

Exceptions from imputed interest rules ............................................................................................................................... 80 400

Exclusion of veterans pensions ........................................................................................................................................... 80 440

Expensing of exploration and development costs, fuels .................................................................................................... 70 490

New technology credit .......................................................................................................................................................... 70 430

Welfare-to-work tax credit .................................................................................................................................................... 70 150

Exclusion of special benefits for disabled coal miners ....................................................................................................... 70 300

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 320

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 50 ............................

Income averaging for farmers .............................................................................................................................................. 50 280

Excess bad debt reserves of financial institutions .............................................................................................................. 50 110

Education Individual Retirement Accounts .......................................................................................................................... 50 410

Credit for disabled access expenditures ............................................................................................................................. 50 250

Ordinary income treatment of loss from small business corporation stock sale ............................................................... 40 200

Credit for holders of zone academy bonds ......................................................................................................................... 40 290

Exclusion of interest on veterans housing bonds ............................................................................................................... 40 220

Investment credit for rehabilitation of structures (other than historic) ................................................................................ 30 150

Medical Savings Accounts ................................................................................................................................................... 30 110

Additional deduction for the blind ........................................................................................................................................ 30 180

Tax credit for the elderly and disabled ............................................................................................................................... 30 150

Exception from passive loss limitation for working interests in oil and gas properties ..................................................... 20 100

Alcohol fuel credits ............................................................................................................................................................... 20 100

Expensing of exploration and development costs, nonfuel minerals ................................................................................. 20 100

Deferral of tax on shipping companies ............................................................................................................................... 20 100

Treatment of loans forgiven for solvent farmers ................................................................................................................. 10 50

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 50

Special alternative tax on small property and casualty insurance companies .................................................................. 10 50

Cancellation of indebtedness ............................................................................................................................................... 10 70

Exclusion of interest on savings bonds redeemed to finance educational expenses ....................................................... 10 50

Income of trusts to finance supplementary unemployment benefits .................................................................................. 10 50

Exclusion of income of foreign sales corporations ............................................................................................................. ............................ ............................

Investment credit and seven-year amortization for reforestation expenditures ................................................................. ............................ 30

5. TAX EXPENDITURES 73

Table 5–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN

CALENDAR YEAR 2000

(In millions of dollars)

Provision

Present

Value of

Revenue

Loss

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 6,360

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 1,130

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 1,650

4 Expensing of exploration and development costs—fuels .................................................................................... 140

5 Expensing of exploration and development costs—nonfuels .............................................................................. 10

6 Expensing of multiperiod timber growing costs ................................................................................................... 340

7 Expensing of certain multiperiod production costs—agriculture .......................................................................... 250

8 Expensing of certain capital outlays—agriculture ................................................................................................ 280

9 Deferral of income on life insurance and annuity contracts ................................................................................ 21,220

10 Accelerated depreciation of rental housing (normal tax method) ....................................................................... 4,470

11 Accelerated depreciation of buildings other than rental housing (normal tax method) ...................................... 460

12 Accelerated depreciation of machinery and equipment (normal tax method) .................................................... 35,760

13 Expensing of certain small investments (normal tax method) ............................................................................ 1,140

14 Amortization of start-up costs (normal tax method) ............................................................................................. 180

15 Deferral of tax on shipping companies ................................................................................................................ 20

16 Deferral for state prepaid tuition plans ................................................................................................................. 110

17 Credit for holders of zone academy bonds ......................................................................................................... 160

18 Credit for low-income housing investments ......................................................................................................... 2,490

19 Exclusion of pension contributions—employer plans ........................................................................................... 121,100

20 Exclusion of IRA contributions and earnings ....................................................................................................... 5,930

21 Exclusion of contributions and earnings for Keogh plans ................................................................................... 4,320

22 Exclusion of interest on public-purpose bonds .................................................................................................... 19,670

23 Exclusion of interest on non-public purpose bonds ............................................................................................. 5,170

24 Deferral of interest on U.S. savings bonds .......................................................................................................... 410

Outlay Equivalents

The concept of ‘‘outlay equivalents’’ is another theoretical measure of the budget effect of tax expenditures.

It is the amount of outlay that would be required to

provide the taxpayer the same after-tax income as

would be received through the tax provision. The outlay-equivalent measure allows the cost of the tax expenditure to be compared with a direct Federal outlay.

Outlay equivalents are reported in Table 5–5.

Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX 1

(In millions of dollars)

Outlay Equivalents

2000 2001 2002 2003 2004 2005 2006 2002–2006

National Defense

1 Exclusion of benefits, allowances, and certain pays to armed forces personnel ................................ 2,490 2,510 2,540 2,570 2,600 2,620 2,650 12,980

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 3,460 3,700 3,950 4,170 4,400 4,640 4,910 22,070

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 920 970 1,020 1,070 1,120 1,180 1,240 5,630

4 Exclusion of income of foreign sales corporations ................................................................................ 5,990 .............. .............. .............. .............. .............. .............. ...................

5 Extraterritorial income exclusion ............................................................................................................. .............. 6,910 7,410 7,920 8,470 9,050 9,670 42,520

6 Inventory property sales source rules exception ................................................................................... 3,340 3,500 3,670 3,860 4,050 4,250 4,460 20,290

7 Deferral of income from controlled foreign corporations (normal tax method) .................................... 6,200 6,600 7,000 7,450 7,900 8,400 8,930 39,680

8 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,190 1,290 540 .............. .............. .............. .............. 540

General science, space, and technology:

9 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,680 1,650 1,680 1,770 1,880 1,980 2,100 9,410

10 Credit for increasing research activities ................................................................................................. 2,510 9,320 10,390 8,300 7,240 4,190 1,790 31,910

Energy:

11 Expensing of exploration and development costs, fuels ....................................................................... 30 90 90 130 150 140 130 640

12 Excess of percentage over cost depletion, fuels .................................................................................. 450 450 460 460 460 470 470 2,320

13 Alternative fuel production credit ............................................................................................................ 1,310 1,230 1,150 730 170 170 170 2,390

14 Exception from passive loss limitation for working interests in oil and gas properties ....................... 20 20 20 20 20 20 20 100

15 Capital gains treatment of royalties on coal .......................................................................................... 90 100 100 110 110 120 120 560

16 Exclusion of interest on energy facility bonds ....................................................................................... 130 130 130 140 160 190 210 1,090

17 Enhanced oil recovery credit .................................................................................................................. 410 500 590 710 860 1,030 1,230 4,420

18 New technology credit ............................................................................................................................ 50 80 100 120 130 120 120 590

74 ANALYTICAL PERSPECTIVES

Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX 1—Continued

(In millions of dollars)

Outlay Equivalents

2000 2001 2002 2003 2004 2005 2006 2002–2006

19 Alcohol fuel credits 2 ............................................................................................................................... 20 20 20 20 20 20 20 100

20 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 80 90 70 40 10 –40 –60 20

21 Exclusion from income of conservation subsidies provided by public utilities ..................................... 110 110 110 110 120 120 120 580

Natural resources and environment:

22 Expensing of exploration and development costs, nonfuel minerals .................................................... 30 30 30 30 30 30 30 150

23 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 340 350 370 380 400 420 430 2,000

24 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 570 570 590 650 750 830 900 3,720

25 Capital gains treatment of certain timber income ................................................................................. 90 100 100 110 110 120 120 560

26 Expensing of multiperiod timber growing costs ..................................................................................... 740 770 800 820 840 870 890 4,220

27 Investment credit and seven-year amortization for reforestation expenditures .................................... .............. .............. .............. 10 10 10 10 40

28 Tax incentives for preservation of historic structures ............................................................................ 190 200 210 220 240 250 260 1,180

Agriculture:

29 Expensing of certain capital outlays ...................................................................................................... 200 200 200 210 210 220 220 1,060

30 Expensing of certain multiperiod production costs ................................................................................ 140 140 150 150 150 150 150 750

31 Treatment of loans forgiven for solvent farmers ................................................................................... 10 10 10 10 10 10 10 50

32 Capital gains treatment of certain income ............................................................................................. 940 990 1,040 1,100 1,150 1,210 1,270 5,770

33 Income averaging for farmers ................................................................................................................ 60 60 60 70 70 70 70 340

34 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 10 50

Commerce and housing:

Financial institutions and insurance:

35 Exemption of credit union income ..................................................................................................... 2,310 2,460 2,640 2,820 3,010 3,220 3,400 15,090

36 Excess bad debt reserves of financial institutions ............................................................................ 80 70 60 40 20 10 .............. 130

37 Exclusion of interest on life insurance savings ................................................................................. 13,950 15,170 16,520 17,990 19,610 21,370 23,330 98,820

38 Special alternative tax on small property and casualty insurance companies ................................ 10 10 10 10 10 10 10 50

39 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 300 310 320 340 360 380 400 1,800

40 Small life insurance company deduction ........................................................................................... 130 130 130 130 130 130 130 650

Housing:

41 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 1,130 1,140 1,170 1,270 1,440 1,600 1,790 7,270

42 Exclusion of interest on rental housing bonds .................................................................................. 230 230 240 240 290 340 390 1,500

43 Deductibility of mortgage interest on owner-occupied homes .......................................................... 60,270 63,190 65,750 68,050 70,470 73,100 76,150 353,520

44 Deductibility of State and local property tax on owner-occupied homes ......................................... 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

45 Deferral of income from post 1987 installment sales ....................................................................... 1,000 1,020 1,040 1,060 1,080 1,100 1,120 5,400

46 Capital gains exclusion on home sales ............................................................................................. 23,170 23,870 24,590 25,320 26,090 26,870 27,670 130,540

47 Exception from passive loss rules for $25,000 of rental loss .......................................................... 4,720 4,450 4,220 4,000 3,790 3,600 3,410 19,020

48 Credit for low-income housing investments ....................................................................................... 4,350 4,500 4,690 4,900 5,150 5,360 5,540 25,640

49 Accelerated depreciation on rental housing (normal tax method) .................................................... 4,740 5,140 5,520 5,830 6,040 6,140 6,210 29,740

Commerce:

50 Cancellation of indebtedness ............................................................................................................. 30 20 10 10 10 20 20 70

51 Exceptions from imputed interest rules ............................................................................................. 80 80 80 80 80 80 80 400

52 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 54,030 55,630 57,270 58,960 60,700 62,500 64,340 303,770

53 Capital gains exclusion of small corporation stock ........................................................................... 50 90 120 170 220 270 330 1,110

54 Step-up basis of capital gains at death ............................................................................................ 36,120 37,650 39,160 40,720 42,350 44,040 45,810 212,080

55 Carryover basis of capital gains on gifts ........................................................................................... 180 190 200 210 220 230 240 1,100

56 Ordinary income treatment of loss from small business corporation stock sale ............................. 40 50 50 50 60 60 60 280

57 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 3,260 3,170 3,290 2,880 2,860 2,730 3,220 14,980

58 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 30,660 33,050 35,400 37,680 39,760 41,530 43,330 197,700

59 Expensing of certain small investments (normal tax method) .......................................................... 2,100 2,570 2,690 2,670 2,570 2,480 2,510 12,920

60 Amortization of start-up costs (normal tax method) .......................................................................... 200 200 200 210 220 220 220 1,070

61 Graduated corporation income tax rate (normal tax method) .......................................................... 9,960 10,300 10,980 11,470 11,600 11,940 12,250 58,240

62 Exclusion of interest on small issue bonds ....................................................................................... 410 430 440 480 520 600 670 2,710

Transportation:

63 Deferral of tax on shipping companies .................................................................................................. 20 20 20 20 20 20 20 100

64 Exclusion of reimbursed employee parking expenses .......................................................................... 2,420 2,560 2,690 2,830 2,970 3,130 3,280 14,900

65 Exclusion for employer-provided transit passes .................................................................................... 260 300 360 430 490 550 610 2,440

Community and regional development:

66 Investment credit for rehabilitation of structures (other than historic) .................................................. 30 30 30 30 30 30 30 150

67 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 890 900 920 990 1,140 1,250 1,410 5,710

68 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 60 60 70 70 320

69 Empowerment zones and enterprise communities ................................................................................ 310 320 660 1,140 1,210 1,340 1,480 5,830

70 New markets tax credit ........................................................................................................................... .............. 10 120 250 390 560 810 2,130

71 Expensing of environmental remediation costs ..................................................................................... 200 440 510 410 40 –160 –100 700

Education, training, employment, and social services:

Education:

72 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,220 1,230 1,240 1,250 1,270 1,280 1,290 6,330

73 HOPE tax credit .................................................................................................................................. 5,400 5,750 5,910 5,490 5,260 5,590 5,930 28,180

5. TAX EXPENDITURES 75

Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX 1—Continued

(In millions of dollars)

Outlay Equivalents

2000 2001 2002 2003 2004 2005 2006 2002–2006

74 Lifetime Learning tax credit ................................................................................................................ 3,110 3,290 3,310 3,800 5,750 5,720 5,980 24,560

75 Education Individual Retirement Accounts ........................................................................................ 20 30 50 60 80 100 120 410

76 Deductibility of student-loan interest .................................................................................................. 430 440 450 460 470 480 490 2,350

77 Deferral for state prepaid tuition plans .............................................................................................. 100 130 180 230 250 290 330 1,280

78 Exclusion of interest on student-loan bonds ..................................................................................... 300 330 330 340 390 420 490 1,970

79 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 740 770 790 840 950 1,090 1,200 4,870

80 Credit for holders of zone academy bonds ....................................................................................... 10 30 50 70 90 100 100 410

81 Exclusion of interest on savings bonds redeemed to finance educational expenses ..................... 10 20 20 20 20 20 20 100

82 Parental personal exemption for students age 19 or over ............................................................... 1,060 1,120 1,180 1,230 1,290 1,350 1,410 6,460

83 Deductibility of charitable contributions (education) .......................................................................... 3,770 3,890 4,110 4,310 4,450 4,650 4,970 22,490

84 Exclusion of employer-provided educational assistance ................................................................... 300 320 110 .............. .............. .............. .............. 110

Training, employment, and social services:

85 Work opportunity tax credit ................................................................................................................ 390 400 300 180 80 30 10 600

86 Welfare-to-work tax credit .................................................................................................................. 50 70 70 50 20 10 .............. 150

87 Exclusion of employer provided child care ........................................................................................ 890 930 970 1,020 1,080 1,140 1,200 5,410

88 Adoption assistance ............................................................................................................................ 150 160 150 40 40 30 20 280

89 Assistance for adopted foster children .............................................................................................. 180 210 240 270 280 290 300 1,380

90 Exclusion of employee meals and lodging (other than military) ...................................................... 830 870 910 950 990 1,030 1,080 4,960

91 Child credit 3 ........................................................................................................................................ 25,770 25,750 25,310 24,550 24,000 23,240 23,240 120,340

92 Credit for child and dependent care expenses ................................................................................. 3,190 3,150 3,110 3,080 3,340 3,000 2,970 15,500

93 Credit for disabled access expenditures ........................................................................................... 60 60 70 70 70 70 80 360

94 Deductibility of charitable contributions, other than education and health ....................................... 27,070 28,280 29,760 31,300 32,810 34,460 36,340 164,670

95 Exclusion of certain foster care payments ........................................................................................ 630 660 690 730 760 800 840 3,820

96 Exclusion of parsonage allowances ................................................................................................... 410 440 470 500 530 570 610 2,680

Health:

97 Exclusion of employer contributions for medical insurance premiums and medical care ................... 98,640 108,840 119,110 129,040 139,290 150,010 161,800 699,250

98 Self-employed medical insurance premiums ......................................................................................... 1,660 1,870 2,200 3,080 4,480 4,880 5,290 19,930

99 Workers’ compensation insurance premiums ........................................................................................ 5,780 6,060 6,370 6,690 7,020 7,370 7,740 35,190

100 Medical Savings Accounts ...................................................................................................................... 30 30 30 30 30 30 20 140

101 Deductibility of medical expenses .......................................................................................................... 4,250 4,560 4,870 5,170 5,480 5,790 6,110 27,420

102 Exclusion of interest on hospital construction bonds ............................................................................ 1,540 1,570 1,620 1,750 1,980 2,190 2,470 10,010

103 Deductibility of charitable contributions (health) .................................................................................... 4,000 4,140 4,380 4,520 4,650 4,860 5,210 23,620

104 Tax credit for orphan drug research ...................................................................................................... 100 110 130 140 160 180 200 810

105 Special Blue Cross/Blue Shield deduction ............................................................................................. 320 250 390 460 410 390 350 2,000

Income security:

106 Exclusion of railroad retirement system benefits ................................................................................... 360 360 360 360 360 360 360 1,800

107 Exclusion of workers’ compensation benefits ........................................................................................ 5,120 5,560 5,810 6,070 6,320 6,600 6,900 31,700

108 Exclusion of public assistance benefits (normal tax method) ............................................................... 360 370 390 400 420 430 450 2,090

109 Exclusion of special benefits for disabled coal miners ......................................................................... 80 70 70 60 60 60 50 300

110 Exclusion of military disability pensions ................................................................................................. 120 120 130 130 130 140 140 670

Net exclusion of pension contributions and earnings:

111 Employer plans ................................................................................................................................... 104,170 109,010 114,010 120,710 127,260 134,160 143,530 639,670

112 Individual Retirement Accounts .......................................................................................................... 20,310 21,350 22,370 23,320 24,200 24,960 25,560 120,410

113 Keogh plans ........................................................................................................................................ 6,980 7,400 7,840 8,300 8,780 9,290 9,830 44,040

Exclusion of other employee benefits:

114 Premiums on group term life insurance ............................................................................................ 2,070 2,110 2,150 2,200 2,240 2,290 2,330 11,210

115 Premiums on accident and disability insurance ................................................................................ 250 260 270 290 300 320 330 1,510

116 Income of trusts to finance supplementary unemployment benefits .................................................... 10 10 10 10 10 10 10 50

117 Special ESOP rules ................................................................................................................................ 1,340 1,400 1,460 1,530 1,600 1,690 1,770 8,050

118 Additional deduction for the blind ........................................................................................................... 40 40 40 40 40 40 50 210

119 Additional deduction for the elderly ........................................................................................................ 2,320 2,410 2,490 2,570 2,680 2,730 2,840 13,310

120 Tax credit for the elderly and disabled .................................................................................................. 40 40 40 40 40 40 40 200

121 Deductibility of casualty losses .............................................................................................................. 260 270 290 310 320 330 350 1,600

122 Earned income tax credit 4 ..................................................................................................................... 5,160 5,214 5,515 5,806 6,062 6,320 6,628 30,331

Social Security:

Exclusion of social security benefits:.

123 Social Security benefits for retired workers ........................................................................................... 18,250 19,070 19,930 20,520 21,050 21,840 22,780 106,120

124 Social Security benefits for disabled ...................................................................................................... 2,640 2,880 3,160 3,490 3,910 4,360 4,840 19,760

125 Social Security benefits for dependents and survivors ......................................................................... 3,910 4,030 4,210 4,440 4,730 5,070 5,380 23,830

Veterans benefits and services:

126 Exclusion of veterans death benefits and disability compensation ...................................................... 3,090 3,290 3,460 3,640 3,820 4,010 4,210 19,140

127 Exclusion of veterans pensions .............................................................................................................. 70 70 80 80 90 90 100 440

128 Exclusion of GI bill benefits .................................................................................................................... 80 90 90 100 100 110 100 500

129 Exclusion of interest on veterans housing bonds ................................................................................. 60 60 60 60 60 70 70 320

General purpose fiscal assistance:

76 ANALYTICAL PERSPECTIVES

Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX 1—Continued

(In millions of dollars)

Outlay Equivalents

2000 2001 2002 2003 2004 2005 2006 2002–2006

130 Exclusion of interest on public purpose State and local bonds ........................................................... 32,380 33,030 33,690 34,370 35,050 35,750 36,470 175,330

131 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

132 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 3,530 3,600 3,650 3,690 3,720 3,760 1,510 16,330

Interest:

133 Deferral of interest on U.S. savings bonds ........................................................................................... 470 490 520 540 570 600 630 2,860

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 22,140 23,920 25,570 27,220 29,080 30,980 33,220 146,070

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 42,650 45,730 48,730 51,780 55,030 58,390 62,160 276,090

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 32,380 33,030 33,690 34,370 35,050 35,750 36,470 175,330

Energy facilities ................................................................................................................................... 130 130 130 140 160 190 210 1,090

Water, sewage, and hazardous waste disposal facilities ................................................................. 570 570 590 650 750 830 900 3,720

Small-issues ........................................................................................................................................ 410 430 440 480 520 600 670 2,710

Owner-occupied mortgage subsidies ................................................................................................. 1,130 1,140 1,170 1,270 1,440 1,600 1,790 7,270

Rental housing .................................................................................................................................... 230 230 240 240 290 340 390 1,500

Airports, docks, and similar facilities ................................................................................................. 890 900 920 990 1,140 1,250 1,410 5,710

Student loans ...................................................................................................................................... 300 330 330 340 390 420 490 1,970

Private nonprofit educational facilities ............................................................................................... 740 770 790 840 950 1,090 1,200 4,870

Hospital construction .......................................................................................................................... 1,540 1,570 1,620 1,750 1,980 2,190 2,470 10,010

Veterans’ housing ............................................................................................................................... 60 60 60 60 60 70 70 320

Credit for holders of zone academy bonds ........................................................................................... 10 30 50 70 90 100 100 410

1 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income tax

principles. For that reason, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions

define income under the general rule of U.S. income taxation. 2 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2000 $840; 2001 $880; 2002 $930; 2003 $950; 2004

$960; 2005 $960; and in 2006 $960.

3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $810; 2001 $790; 2002 $760; 2003 $720; 2004

$660; 2005 $630; and in 2006 $590.

4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2000 $26,099; 2001 $25,923; 2002

$26,983; 2003 $27,875; 2004 $28,545; 2005 $29,373; and in 2006 $30,165.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.

All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.

Tax Expenditure Baselines

A tax expenditure is an exception to the baseline

provisions of the tax structure. The 1974 Congressional

Budget Act did not specify the baseline provisions of

the tax law. Deciding whether provisions are exceptions, therefore, is a matter of judgement. As in prior

years, this year’s tax expenditure estimates are presented using two baselines: the normal tax baseline,

which is used by the Joint Committee on Taxation,

and the reference tax law baseline, which has been

reported by the Administration since 1983.

The normal tax baseline is patterned on a comprehensive income tax, which defines income as the

sum of consumption and the change in net wealth in

a given period of time. The normal tax baseline allows

personal exemptions, a standard deduction, and deductions of the expenses incurred in earning income. It

is not limited to a particular structure of tax rates,

or by a specific definition of the taxpaying unit.

The reference tax law baseline is also patterned on

a comprehensive income tax, but is closer to existing

law. Tax expenditures under the reference law baseline

are generally tax expenditures under the normal tax

baseline, but the reverse is not always true.

Both the normal and reference tax baselines allow

several major departures from a pure comprehensive

income tax. For example:

• Income is taxable only when it is realized in exchange. Thus, neither the deferral of tax on unrealized capital gains nor the tax exclusion of imputed income (such as the rental value of owneroccupied housing or farmers’ consumption of their

own produce) is regarded as a tax expenditure.

Both accrued and imputed income would be taxed

under a comprehensive income tax.

• There is a separate corporation income tax. Under

a comprehensive income tax, corporate income

would be taxed only once—at the shareholder

level, whether or not distributed in the form of

dividends.

• Values of assets and debt are not adjusted for

inflation. A comprehensive income tax would adjust the cost basis of capital assets and debt for

changes in the price level during the time the

assets or debt are held. Thus, under a comprehensive income tax baseline, the failure to take account of inflation in measuring depreciation, capital gains, and interest income would be regarded

as a negative tax expenditure (i.e., a tax penalty),

and failure to take account of inflation in measVerDate 11-MAY-2000 10:42 Apr 04, 2001 Jkt 010199 PO 00000 Frm 00016 Fmt 3625 Sfmt 3625 Z:\OMB_PDF\SPEC05.02 txed01 PsN: txed01
5. TAX EXPENDITURES 77

1Gross income does, however, include transfer payments associated with past employment,

such as social security benefits. 2 In the case of individuals who hold ‘‘passive’’ equity interests in businesses, however,

the pro-rata shares of sales and expense deductions reportable in a year are limited. A

passive business activity is defined to be one in which the holder of the interest, usually

a partnership interest, does not actively perform managerial or other participatory functions.

The taxpayer may generally report no larger deductions for a year than will reduce taxable

income from such activities to zero. Deductions in excess of the limitation may be taken

in subsequent years, or when the interest is liquidated. In addition, costs of earning income

may be limited under the alternative minimum tax.

3 Committee on Government Affairs, United States Senate, A Government Performance

and Results Act of 1993 (Report 103–58, 1993).

uring interest costs would be regarded as a positive tax expenditure (i.e., a tax subsidy).

Although the reference law and normal tax baselines

are generally similar, areas of difference include:

• Tax rates. The separate schedules applying to the

various taxpaying units are included in the reference law baseline. Thus, corporate tax rates

below the maximum statutory rate do not give

rise to a tax expenditure. The normal tax baseline

is similar, except that it specifies the current maximum rate as the baseline for the corporate income tax. The lower tax rates applied to the first

$10 million of corporate income are thus regarded

as a tax expenditure. Similarly, under the reference law baseline, preferential tax rates for capital gains generally do not yield a tax expenditure;

only capital gains treatment of otherwise ‘‘ordinary income,’’ such as that from coal and iron

ore royalties and the sale of timber and certain

agricultural products, is considered a tax expenditure. The alternative minimum tax is treated as

part of the baseline rate structure under both the

reference and normal tax methods.

• Income subject to the tax. Income subject to tax

is defined as gross income less the costs of earning

that income. The Federal income tax defines gross

income to include: (1) consideration received in

the exchange of goods and services, including labor

services or property; and (2) the taxpayer’s share

of gross or net income earned and/or reported by

another entity (such as a partnership). Under the

reference tax rules, therefore, gross income does

not include gifts—defined as receipts of money or

property that are not consideration in an exchange—or most transfer payments, which can be

thought of as gifts from the Government. 1 The

normal tax baseline also excludes gifts between

individuals from gross income. Under the normal

tax baseline, however, all cash transfer payments

from the Government to private individuals are

counted in gross income, and exemptions of such

transfers from tax are identified as tax expenditures. The costs of earning income are generally

deductible in determining taxable income under

both the reference and normal tax baselines. 2

• Capital recovery. Under the reference tax law

baseline no tax expenditures arise from accelerated depreciation. Under the normal tax baseline,

the depreciation allowance for machinery and

equipment is determined using straight-line depreciation over tax lives equal to mid-values of

the asset depreciation range (a depreciation system in effect from 1971 through 1980). The normal

tax baseline for real property is computed using

40-year straight-line depreciation.

• Treatment of foreign income. Both the normal and

reference tax baselines allow a tax credit for foreign income taxes paid (up to the amount of U.S.

income taxes that would otherwise be due), which

prevents double taxation of income earned abroad.

Under the normal tax method, however, controlled

foreign corporations (CFCs) are not regarded as

entities separate from their controlling U.S. shareholders. Thus, the deferral of tax on income received by CFCs is regarded as a tax expenditure

under this method. In contrast, except for tax

haven activities, the reference law baseline follows

current law in treating CFCs as separate taxable

entities whose income is not subject to U.S. tax

until distributed to U.S. taxpayers. Under this

baseline, deferral of tax on CFC income is not

a tax expenditure because U.S. taxpayers generally are not taxed on accrued, but unrealized,

income.

In addition to these areas of difference, the Joint

Committee on Taxation considers a somewhat broader

set of tax expenditures under its normal tax baseline

than is considered here.

Performance Measures and the Economic

Effects of Tax Expenditures

The Government Performance and Results Act of

1993 (GPRA) directs Federal agencies to develop annual

and strategic plans for their programs and activities.

These plans set out performance objectives to be

achieved over a specific time period. Most of these objectives will be achieved through direct expenditure programs. However, tax expenditures may also contribute

to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA 3 calls on the

Executive branch to undertake a series of analyses to

assess the effect of specific tax expenditures on the

achievement of agencies’ performance objectives.

The Executive Branch is continuing to focus on the

availability of data needed to assess the effects of the

tax expenditures designed to increase savings. Treasury’s Office of Tax Analysis and Statistics of Income

Division (IRS) have developed the specifications for a

new sample of individual income tax filers as one part

of this effort. This new ‘‘panel’’ sample will follow the

same taxpayers over a period of at least ten years.

The first year of this panel sample will be drawn from

tax returns filed in 2000 for tax year 1999. The sample

will capture the changing demographic and economic

circumstances of individuals and the effects of changes

in tax law over an extended period of time. Data from

the sample will therefore permit more extensive, and

better, analyses of many tax provisions than can be

performed using only annual (‘‘cross-section’’) data. In

particular, data from this panel sample will enhance

our ability to analyze the effect of tax expenditures

78 ANALYTICAL PERSPECTIVES

4 Although this section focuses upon tax expenditures under the income tax, tax expenditures also arise under the unified transfer, payroll, and excise tax systems. Such provisions

can be useful when they relate to the base of those taxes, such as an excise tax exemption

for certain types of consumption deemed meritorious.

designed to increase savings. Other efforts by OMB,

Treasury, and other agencies to improve data available

for the analysis of savings tax expenditures will continue over the next several years.

Comparison of tax expenditure, spending, and

regulatory policies. Tax expenditures by definition

work through the tax system and, particularly, the income tax. Thus, they may be relatively advantageous

policy approaches when the benefit or incentive is related to income and is intended to be widely available. 4

Because there is an existing public administrative and

private compliance structure for the tax system, the

incremental administrative and compliance costs for a

tax expenditure may be low in many cases. In addition,

some tax expenditures actually simplify the tax system,

(for example, the exclusion for up to $500,000 of capital

gains on home sales). Tax expenditures also implicitly

subsidize certain activities. Spending, regulatory or taxdisincentive policies can also modify behavior, but may

have different economic effects. Finally, a variety of

tax expenditure tools can be used—e.g., deductions;

credits; exemptions; deferrals; floors; ceilings; phase-ins;

phase-outs; dependent on income, expenses, or demographic characteristics (age, number of family members,

etc.). This wide range means that tax expenditures can

be flexible and can have very different economic effects.

Tax expenditures also have limitations. In many

cases they add to the complexity of the tax system,

which raises both administrative and compliance costs.

For example, targeting personal exemptions and credits

can complicate filing and decisionmaking. The income

tax system may have little or no contact with persons

who have no or very low incomes, and does not require

information on certain characteristics of individuals

used in some spending programs, such as wealth. These

features may reduce the effectiveness of tax expenditures for addressing certain income-transfer objectives.

Tax expenditures also generally do not enable the same

degree of agency discretion as an outlay program. For

example, grant or direct Federal service delivery programs can prioritize which activities are addressed with

what amount of resources in a way that is difficult

to emulate with tax expenditures. Finally, tax expenditures may not receive the same level of scrutiny afforded to other programs.

Outlay programs, in contrast, have advantages where

direct government service provision is particularly warranted—such as equipping and providing the armed

forces or administering the system of justice. Outlay

programs may also be specifically designed to meet the

needs of low-income families who would not otherwise

be subject to income taxes or need to file a return.

Outlay programs may also receive more year-to-year

oversight and fine tuning, through the legislative and

executive budget process. In addition, many different

types of spending programs—including direct government provision; credit programs; and payments to State

and local governments, the private sector, or individuals

in the form of grants or contracts—provide flexibility

for policy design. On the other hand, certain outlay

programs—such as direct government service provision—may rely less directly on economic incentives and

private-market provision than tax incentives, which

may reduce the relative efficiency of spending programs

for some goals. Spending programs also require resources to be raised via taxes, user charges, or government borrowing. Finally, spending programs, particularly on the discretionary side, may respond less readily

to changing activity levels and economic conditions than

tax expenditures.

Regulations have more direct and immediate effects

than outlay and tax-expenditure programs because regulations apply directly and immediately to the regulated party (i.e., the intended actor)—generally in the

private sector. Regulations can also be fine-tuned more

quickly than tax expenditures, because they can generally be changed by the executive branch without legislation. Like tax expenditures, regulations often rely

largely upon voluntary compliance, rather than detailed

inspections and policing. As such, the public administrative costs tend to be modest, relative to the private

resource costs associated with modifying activities. Historically, regulations have tended to rely on proscriptive

measures, as opposed to economic incentives. This reliance can diminish their economic efficiency, although

this feature can also promote full compliance where

(as in certain safety-related cases) policymakers believe

that trade-offs with economic considerations are not of

paramount importance. Also, regulations generally do

not directly affect Federal outlays or receipts. Thus,

like tax expenditures, they may escape the type of scrutiny that outlay programs receive. However, most regulations are subjected to a formal benefit-cost analysis

that goes well beyond the analysis required for outlays

and tax-expenditures. To some extent, the GPRA requirement for performance evaluation will address this

lack of formal analysis.

Some policy objectives are achieved using multiple

approaches. For example, minimum wage legislation,

the earned income tax credit, and the food stamp program are regulatory, tax expenditure, and direct outlay

programs, respectively, all having the objective of improving the economic welfare of low-wage workers.

Tax expenditures, like spending and regulatory programs, have a variety of objectives and effects. These

include: encouraging certain types of activities (e.g.,

saving for retirement or investing in certain sectors);

increasing certain types of after-tax income (e.g., favorable tax treatment of social security income); reducing

private compliance costs and government administrative costs (e.g., the exclusion for up to $500,000 of capital gains on home sales); and promoting tax neutrality

(e.g., accelerated depreciation in the presence of inflation). Some of these objectives are well suited to quantitative measurement, while others are less well suited.

Also, many tax expenditures, including those cited

5. TAX EXPENDITURES 79

above, may have more than one objective. For example,

accelerated depreciation may encourage investment. In

addition, the economic effects of particular provisions

can extend beyond their intended objectives (e.g., a provision intended to promote an activity or raise certain

incomes may have positive or negative effects on tax

neutrality).

Performance measurement is generally concerned

with inputs, outputs, and outcomes. In the case of tax

expenditures, the principal input is usually the tax revenue loss. Outputs are quantitative or qualitative measures of goods and services, or changes in income and

investment, directly produced by these inputs. Outcomes, in turn, represent the changes in the economy,

society, or environment that are the ultimate goals of

programs.

Thus, for a provision that reduces taxes on certain

investment activity, an increase in the amount of investment would likely be a key output. The resulting

production from that investment, and, in turn, the associated improvements in national income, welfare, or security, could be the outcomes of interest. For other provisions, such as those designed to address a potential

inequity or unintended consequence in the tax code,

an important performance measure might be how they

change effective tax rates (the discounted present-value

of taxes owed on new investments or incremental earnings) or excess burden (an economic measure of the

distortions caused by taxes). Effects on the incomes of

members of particular groups may be an important

measure for certain provisions.

An overview of evaluation issues by budget function. The discussion below considers the types of measures that might be useful for some major programmatic

groups of tax expenditures. The discussion is intended

to be illustrative and not all encompassing. However,

it is premised on the assumption that the data needed

to perform the analysis are available or can be developed. In practice, data availability is likely to be a

major challenge, and data constraints may limit the

assessment of the effectiveness of many provisions. In

addition, such assessments can raise significant challenges in economic modeling.

National defense.—Some tax expenditures are intended to assist governmental activities. For example,

tax preferences for military benefits reflect, among

other things, the view that benefits such as housing,

subsistence, and moving expenses are intrinsic aspects

of military service, and are provided, in part, for the

benefit of the employer, the U.S. Government. Tax benefits for service in a combat zone or qualified hazardous

duty area are intended to reduce tax burdens on military personnel undertaking hazardous service for the

Nation. A portion of the tax expenditure associated with

foreign earnings is targeted to benefit U.S. Government

civilian personnel working abroad by offsetting the living costs that can be higher than those in the United

States. These tax expenditures should be considered

together with direct agency budget costs in making programmatic decisions.

International affairs.—Tax expenditures are also

aimed at goals such as promoting tax neutrality. These

include the exclusion for income earned abroad by nongovernmental employees and exclusions for income of

U.S.-controlled foreign corporations. Measuring the effectiveness of these provisions raises challenging issues.

General science, space and technology; energy;

natural resources and the environment; agriculture; and commerce and housing.—A series of

tax expenditures reduces the cost of investment, both

in specific activities—such as research and experimentation, extractive industries, and certain financial activities—and more generally, through accelerated depreciation for plant and equipment. These provisions can

be evaluated along a number of dimensions. For example, it could be useful to consider the strength of the

incentives by measuring their effects on the cost of

capital (the interest rate which investments must yield

to cover their costs) and effective tax rates. The impact

of these provisions on the amounts of corresponding

forms of investment (e.g., research spending, exploration activity, equipment) might also be estimated. In

some cases, such as research, there is evidence that

the investment can provide significant positive

externalities—that is, economic benefits that are not

reflected in the market transactions between private

parties. It could be useful to quantify these externalities

and compare them with the size of tax expenditure.

Measures could also indicate the effects on production

from these investments—such as numbers or values

of patents, energy production and reserves, and industrial production. Issues to be considered include the

extent to which the tax expenditures increase production (as opposed to benefitting existing output) and

their cost-effectiveness relative to other policies. Analysis could also consider objectives that are more difficult to measure but still are ultimate goals, such as

promoting the Nation’s technological base, energy security, environmental quality, or economic growth. Such

an assessment is likely to involve tax analysis as well

as consideration of non-tax matters such as market

structure, scientific, and other information (such as the

effects of increased domestic fuel production on imports

from various regions, or the effects of various energy

sources on the environment).

Housing investment also benefits from tax expenditures, including the mortgage interest deduction and

exclusion for capital gains on homes. Measures of the

effectiveness of these provisions could include their effects on increasing the extent of home ownership and

the quality of housing. In addition, the mortgage interest deduction offsets the taxable nature of investment

income received by homeowners, so the relationship between the deduction and such earnings is also relevant

to evaluation of this provision. Similarly, analysis of

the extent of accumulated inflationary gains is likely

to be relevant to evaluation of the capital gains for

80 ANALYTICAL PERSPECTIVES

home sales. Deductibility of State and local property

taxes assists with making housing more affordable as

well as easing the cost of providing community services

through these taxes. Provisions intended to promote

investment in rental housing could be evaluated for

their effects on making such housing more available

and affordable. These provisions should then be compared with alternative programs that address housing

supply and demand.

Transportation.—Employer-provided parking is a

fringe benefit that, for the most part, is excluded from

taxation. The tax expenditure estimates reflect the cost

of parking that is leased by employers for employees;

an estimate is not currently available for the value

of parking owned by employers and provided to their

employees. The exclusion for employer-provided transit

passes is intended to promote use of this mode of transportation, which has environmental and congestion benefits. The tax treatments of these different benefits

could be compared with alternative transportation policies.

Community and regional development.—A series

of tax expenditures is intended to promote community

and regional development by reducing the costs of financing specialized infrastructure, such as airports,

docks, and stadiums. Empowerment zone and enterprise community provisions are designed to promote

activity in disadvantaged areas. These provisions can

be compared with grants and other policies designed

to spur economic development.

Education, training, employment, and social

services.—Major provisions in this function are intended to promote post-secondary education, to offset

costs of raising children, and to promote a variety of

charitable activities. The education incentives can be

compared with loans, grants, and other programs designed to promote higher education and training. The

child credits are intended to adjust the tax system for

the costs of raising children; as such, they could be

compared to other Federal tax and spending policies,

including related features of the tax system, such as

personal exemptions (which are not defined as a tax

expenditure). Evaluation of charitable activities requires consideration of the beneficiaries of these activities, who are generally not the parties receiving the

tax reduction.

Health.—Individuals also benefit from favorable

treatment of employer-provided health insurance. Measures of these benefits could include increased coverage

and pooling of risks. The effects of insurance coverage

on final outcome measures of actual health (e.g., infant

mortality, days of work lost due to illness, or life expectancy) or intermediate outcomes (e.g., use of preventive

health care or health care costs) could also be investigated.

Income security, social security, and veterans

benefits and services.—Major tax expenditures in the

income security function benefit retirement savings,

through employer-provided pensions, individual retirement accounts, and Keogh plans. These provisions

might be evaluated in terms of their effects on boosting

retirement incomes, private savings, and national savings (which would include the effect on private savings

as well as public savings or deficits). Interactions with

other programs, including social security, also may

merit analysis. As in the case of employer-provided

health insurance, analysis of employer-provided pension

programs requires imputing the benefits provided at

the firm level to individuals.

Other provisions principally affect the incomes of

members of certain groups, rather than affecting incentives. For example, tax-favored treatment of social security benefits, certain veterans benefits, and deductions

for the blind and elderly provide increased incomes to

eligible parties. The earned-income tax credit, in contrast, should be evaluated for its effects on labor force

participation as well as the income it provides lowerincome workers.

General purpose fiscal assistance and interest.—

The tax-exemption for public purpose State and local

bonds reduces the costs of borrowing for a variety of

purposes (borrowing for non-public purposes is reflected

under other budget functions). The deductibility of certain State and local taxes reflected under this function

primarily relates to personal income taxes (property tax

deductibility is reflected under the commerce and housing function). Tax preferences for Puerto Rico and other

U.S. possessions are also included here. These provisions can be compared with other tax and spending

policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings

bonds benefits savers who invest in these instruments.

The extent of these benefits and any effects on Federal

borrowing costs could be evaluated.

The above illustrative discussion, although broad, is

nevertheless incomplete, both for the provisions mentioned and the many that are not explicitly cited. Developing a framework that is sufficiently comprehensive,

accurate, and flexible to reflect the objectives and effects of the wide range of tax expenditures will be a

significant challenge. OMB, Treasury, and other agencies will work together, as appropriate, to address this

challenge. As indicated above, over the next few years

the Executive Branch’s focus will be on the availability

of the data needed to assess the effects of the tax expenditures designed to increase savings.

Descriptions of Income Tax Provisions

Descriptions of the individual and corporate income

tax expenditures reported upon in this chapter follow.

These descriptions relate to current law and do not

reflect proposals made elsewhere in the Budget.

5. TAX EXPENDITURES 81

5The determination of whether a provision is a tax expenditure is made on the basis

of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under

general U.S. income tax principles. For that reason, the tax expenditure estimates include,

for example, estimates related to the exclusion of extraterritorial income, as well as other

exclusions, notwithstanding that such exclusions define income under the general rule of

U.S. income taxation.

National Defense

1. Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, as well as certain

amounts of pay related to service in a combat zone

or qualified hazardous duty area are excluded from income subject to tax.

International Affairs

2. Income earned abroad.—U.S. citizens who lived

abroad, worked in the private sector, and satisfied a

foreign residency requirement in 2000 may exclude up

to $76,000 in foreign earned income from U.S. taxes.

The exclusion increases to $78,000 in 2001 and to

$80,000 in 2002. In addition, if these taxpayers receive

a specific allowance for foreign housing from their employers, they may also exclude the value of that allowance. If they do not receive a specific allowance for

housing expenses, they may deduct against their U.S.

taxes that portion of such expenses that exceeds onesixth the salary of a civil servant at grade GS-14, step

1 ($65,983 in 2000).

3. Exclusion of certain allowances for federal

employees abroad.—U.S. Federal civilian employees

and Peace Corps members who work outside the continental United States are allowed to exclude from U.S.

taxable income certain special allowances they receive

to compensate them for the relatively high costs associated with living overseas. The allowances supplement

wage income and cover expenses like rent, education,

and the cost of travel to and from the United States.

4. Income of Foreign Sales Corporations.—The

Foreign Sales Corporation (FSC) provisions exempt

from tax a portion of U.S. exporters’ foreign trading

income to reflect the FSC’s sales functions as foreign

corporations. The FSC provisions were generally repealed by the FSC Repeal and Extraterritorial Income

Exclusion Act of 2000, effective for transactions after

September 30, 2000.

5. Extraterritorial income exclusion5.—For purposes of calculating U.S. tax liability, a taxpayer may

exclude from gross income the qualifying foreign trade

income attributable to foreign trading gross receipts.

The exclusion generally applies to income from the sale

or lease of qualifying foreign trade property and certain

types of services income. The exclusion is generally

available for transactions entered into after September

30, 2000.

6. Sales source rule exceptions.—The worldwide

income of U.S. persons is taxable by the United States

and a credit for foreign taxes paid is allowed. The

amount of foreign taxes that can be credited is limited

to the pre-credit U.S. tax on the foreign source income.

The sales source rules for inventory property allocates

earnings between the United States and abroad equally, which may increase foreign source income use of

foreign tax credits.

7. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled

by U.S. shareholders is not subject to U.S. taxation.

The income becomes taxable only when the controlling

U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal

tax method, the currently attributable foreign source

pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not

distributed. Thus, the normal tax method considers the

amount of controlled foreign corporation income not distributed to a U.S. shareholder as tax-deferred income.

8. Exceptions under subpart F for active financing income.—Consistent with the rules applicable to

U.S.-controlled foreign corporations, financial firms can

defer taxes on income earned overseas in an active

business. Taxes on income earned through December

31, 2001 can be deferred.

General Science, Space, and Technology

9. Expensing R&E expenditures.—Research and

experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue

for several years. It is often difficult, however, to identify whether a specific R&E project is successful and,

if successful, what its expected life will be. Under the

normal tax method, the expensing of R&E expenditures

is viewed as a tax expenditure. The baseline assumed

for the normal tax method is that all R&E expenditures

are successful and have an expected life of five years.

10. R&E credit.—The research and experimentation

(R&E) credit is 20 percent of qualified research expenditures in excess of a base amount. The base amount

is generally determined by multiplying a ‘‘fixed-base

percentage’’ by the average amount of the company’s

gross receipts for the prior four years. The taxpayer’s

fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through

1988. Taxpayers may also elect an alternative credit

regime. Under the alternative credit regime the taxpayer is assigned a three-tiered fixed-base percentage

that is lower than the fixed-base percentage that would

otherwise apply, and the credit rate is reduced (the

rates range from 2.65 percent to 3.75 percent). A 20-

percent credit with a separate threshold is provided

for a taxpayer’s payments to universities for basic research. The credit applies to research conducted before

July 1, 2004 and extends to research conducted in Puerto Rico and the U.S. possessions.

Energy

11. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of

unsalvageable materials used in constructing wells)

may be expensed rather than amortized over the productive life of the property. Integrated oil companies

82 ANALYTICAL PERSPECTIVES

may deduct only 70 percent of such costs and must

amortize the remaining 30 percent over five years. The

same rule applies to the exploration and development

costs of surface stripping and the construction of shafts

and tunnels for other fuel minerals.

12. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed

to take percentage depletion deductions rather than

cost depletion on limited quantities of output. Under

cost depletion, outlays are deducted over the productive

life of the property based on the fraction of the resource

extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent

for oil, gas and oil shale; and 10 percent for coal. The

deduction is limited to 50 percent of net income from

the property, except for oil and gas where the deduction

can be 100 percent of net property income. Production

from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit

on output and no limitation with respect to qualified

producers. Unlike depreciation or cost depletion, percentage depletion deductions can exceed the cost of the

investment.

13. Alternative fuel production credit.—A nontaxable credit of $3 per barrel (in 1979 dollars) of oilequivalent production is provided for several forms of

alternative fuels. The credit is generally available if

the price of oil stays below $29.50 (in 1979 dollars).

The credit generally expires on December 31, 2002.

14. Oil and gas exception to passive loss limitation.—Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations.

As a result, the working interest-holder, who manages

on behalf of himself and all other owners the development of wells and incurs all the costs of their operation,

may aggregate negative taxable income from such interests with his income from all other sources.

15. Capital gains treatment of royalties on

coal.—Sales of certain coal under royalty contracts can

be treated as capital gains rather than ordinary income.

16. Energy facility bonds.—Interest earned on

State and local bonds used to finance construction of

certain energy facilities is tax-exempt. These bonds are

generally subject to the State private-activity bond annual volume cap.

17. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for

tertiary oil recovery on U.S. projects. Qualifying costs

include tertiary injectant expenses, intangible drilling

and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property.

18. New technology credits.—A credit of 10 percent

is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from

renewable resources such as wind, biomass, and poultry

waste facilities. The renewable resources credit applies

only to electricity produced by a facility placed in service on or before December 31, 2001.

19. Alcohol fuel credits.—An income tax credit is

provided for ethanol that is derived from renewable

sources and used as fuel. The credit equals 54 cents

per gallon in 2000; 53 cents per gallon in 2001 and

2002; 52 cents per gallon in 2003 and 2004; and 51

cents per gallon in 2005, 2006, and 2007. To the extent

that ethanol is mixed with taxable motor fuel to create

gasohol, taxpayers may claim an exemption of the Federal excise tax rather than the income tax credit. In

addition, small ethanol producers are eligible for a separate 10 cents per gallon credit.

20. Credit and deduction for clean-fuel vehicles

and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles

and owners of clean-fuel refueling property may deduct

part of their expenditures. The credit and deduction

are phased out from 2002 through 2005.

21. Exclusion of utility conservation subsidies.—

Non-business customers can exclude from gross income

subsidies received from public utilities for expenditures

on energy conservation measures.

Natural Resources and Environment

22. Exploration and development costs.—Certain

capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than

depreciated over the life of the asset.

23. Percentage depletion.—Most nonfuel mineral

extractors may use percentage depletion rather than

cost depletion, with percentage depletion rates ranging

from 22 percent for sulfur to 5 percent for sand and

gravel.

24. Sewage, water, solid and hazardous waste

facility bonds.—Interest earned on State and local

bonds used to finance the construction of sewage, water,

or hazardous waste facilities is tax-exempt. These bonds

are generally subject to the State private-activity bond

annual volume cap.

25. Capital gains treatment of certain timber.—

Certain timber sold under a royalty contract can be

treated as a capital gain rather than ordinary income.

26. Expensing multiperiod timber growing

costs.—Most of the production costs of growing timber

may be expensed rather than capitalized and deducted

when the timber is sold. In most other industries, these

costs are capitalized under the uniform capitalization

rules.

27. Credit and seven-year amortization for reforestation.—A 10-percent investment tax credit is allowed for up to $10,000 invested annually to clear land

and plant trees for the production of timber. Up to

$10,000 in forestation investment may also be amortized over a seven-year period rather than capitalized

and deducted when the trees are sold or harvested.

The amount of forestation investment that may be amortized is not reduced by any of the allowable investment credit.

5. TAX EXPENDITURES 83

28. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20-

percent investment credit, but the depreciable basis

must be reduced by the full amount of the credit taken.

Agriculture

29. Expensing certain capital outlays.—Farmers,

except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for

feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though

these expenditures are for inventories held beyond the

end of the year, or for capital improvements that would

otherwise be capitalized.

30. Expensing multiperiod livestock and crop

production costs.—The production of livestock and

crops with a production period of less than two years

is exempt from the uniform cost capitalization rules.

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale

with a production period of two years or more may

elect not to capitalize costs. If they do, they must apply

straight-line depreciation to all depreciable property

they use in farming.

31. Loans forgiven solvent farmers.—Farmers are

forgiven the tax liability on certain forgiven debt. Normally, a debtor must include the amount of loan forgiveness as income or reduce his recoverable basis in

the property to which the loan relates. If the debtor

elects to reduce basis and the amount of forgiveness

exceeds his basis in the property, the excess forgiveness

is taxable. For insolvent (bankrupt) debtors, however,

the amount of loan forgiveness reduces carryover losses,

then unused credits, and then basis; any remainder

of the forgiven debt is excluded from tax. Farmers with

forgiven debt are considered insolvent for tax purposes,

and thus qualify for income tax forgiveness.

32. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops,

can be treated as capital gains rather than ordinary

income.

33. Income averaging for farmers.—Taxpayers can

lower their tax liability by averaging, over the prior

three-year period, their taxable income from farming.

34. Deferral of gain on sales of farm refiners.—

A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement

property.

Commerce and Housing

This category includes a number of tax expenditure

provisions that also affect economic activity in other

functional categories. For example, provisions related

to investment, such as accelerated depreciation, could

be classified under the energy, natural resources and

environment, agriculture, or transportation categories.

35. Credit union income.—The earnings of credit

unions not distributed to members as interest or dividends are exempt from income tax.

36. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings

banks, and savings and loan associations may deduct

additions to bad debt reserves in excess of actually

experienced losses.

37. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided

for investment income within qualified life insurance

and annuity contracts. Investment income earned on

qualified life insurance contracts held until death is

permanently exempt from income tax. Investment income distributed prior to the death of the insured is

tax-deferred, if not tax-exempt. Investment income

earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits

from tax deferral without annual contribution or income

limits generally applicable to other tax-favored retirement income plans.

38. Small property and casualty insurance companies.—Insurance companies that have annual net

premium incomes of less than $350,000 are exempt

from tax; those with $350,000 to $2.1 million of net

premium incomes may elect to pay tax only on the

income earned by their investment portfolio.

39. Insurance companies owned by exempt organizations.—Generally, the income generated by life

and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations

conducted by such exempt organizations as fraternal

societies and voluntary employee benefit associations,

however, are exempt from tax.

40. Small life insurance company deduction.—

Small life insurance companies (gross assets of less

than $500 million) can deduct 60 percent of the first

$3 million of otherwise taxable income. The deduction

phases out for otherwise taxable income between $3

million and $15 million.

41. Mortgage housing bonds.—Interest earned on

State and local bonds used to finance homes purchased

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds

that can be issued to finance these and other private

activity is limited. The combined volume cap for private

activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial

development bonds, is $50 per capita ($150 million minimum) per State in 2000, $62.50 per capita ($187.5

million minimum) in 2001, and $75 per capita ($225

million minimum) in 2002. The Community Renewal

Tax Relief Act of 2000 accelerated the scheduled increase in the state volume cap and indexed the cap

for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle homebuyers to income tax

credits for a specified percentage of interest on qualified

mortgages. The total amount of MCCs issued by a State

cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds.

42. Rental housing bonds.—Interest earned on

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84 ANALYTICAL PERSPECTIVES

tifamily rental housing projects is tax-exempt. At least

20 percent (15 percent in targeted areas) of the units

must be reserved for families whose income does not

exceed 50 percent of the area’s median income; or 40

percent for families with incomes of no more than 60

percent of the area median income. Other tax-exempt

bonds for multifamily rental projects are generally

issued with the requirement that all tenants must be

low or moderate income families. Rental housing bonds

are subject to the volume cap discussed in the mortgage

housing bond section above.

43. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on

their primary and secondary residences as itemized

nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the

owner’s basis in the residence and, for debt incurred

after October 13, 1987, it is limited to no more than

$1 million. Interest on up to $100,000 of other debt

secured by a lien on a principal or second residence

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions

on personal residences are tax expenditures because

the taxpayers are not required to report the value of

owner-occupied housing services as gross income.

44. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their

primary and secondary residences even though they are

not required to report the value of owner-occupied housing services as gross income.

45. Installment sales.—Dealers in real and personal

property (i.e., sellers who regularly hold property for

sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment.

Nondealers (i.e., sellers of real property used in their

business) are required to pay interest on deferred taxes

attributable to their total installment obligations in excess of $5 million. Only properties with sales prices

exceeding $150,000 are includable in the total. The payment of a market rate of interest eliminates the benefit

of the tax deferral. The tax exemption for nondealers

with total installment obligations of less than $5 million

is, therefore, a tax expenditure.

46. Capital gains exclusion on home sales.—A

homeowner can exclude from tax up to $500,000

($250,000 for singles) of the capital gains from the sale

of a principal residence. The exclusion may not be used

more than once every two years.

47. Passive loss real estate exemption.—In general, passive losses may not offset income from other

sources. Losses up to $25,000 attributable to certain

rental real estate activity, however, are exempt from

this rule.

48. Low-income housing credit.—Taxpayers who

invest in certain low-income housing are eligible for

a tax credit. The credit rate is set so that the present

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other

Federal benefits (such as tax-exempt bond financing),

or (2) substantially rehabilitated existing housing. The

credit is allowed in equal amounts over 10 years. State

agencies determine who receives the credit; States are

limited in the amount of credit they may authorize

annually to $1.25 per resident in 2000. The Community

Renewal Tax Relief Act of 2000 increased the per-resident limit to $1.50 in 2001 and to $1.75 in 2002 and

indexed the limit for inflation, beginning in 2003. The

Act also created a $2 million minimum annual cap for

small States beginning in 2002; the cap is indexed for

inflation, beginning in 2003.

49. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of

the reference law rules, and thus do not give rise to

tax expenditures under the reference method. Under

the normal tax method, however, a 40-year tax life

for depreciable real property is the norm. Thus, a statutory depreciation period for rental property of 27.5

years is a tax expenditure. In addition, tax expenditures arise from pre-1987 tax allowances for rental

property.

50. Cancellation of indebtedness.—Individuals are

not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not

reported as current income, however, the basis of the

underlying property must be reduced by the amount

canceled.

51. Imputed interest rules.—Holders (issuers) of

debt instruments are generally required to report interest earned (paid) in the period it accrues, not when

paid. In addition, the amount of interest accrued is

determined by the actual price paid, not by the stated

principal and interest stipulated in the instrument. In

general, any debt associated with the sale of property

worth less than $250,000 is excepted from the general

interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but

is under normal law. Exceptions above $250,000 are

a tax expenditure under reference law; these exceptions

include the following: (1) sales of personal residences

worth more than $250,000, and (2) sales of farms and

small businesses worth between $250,000 and $1 million.

52. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held

for more than 1 year are taxed at a lower rate than

ordinary income. The lower rate on capital gains is

considered a tax expenditure under the normal tax

method but not under the reference law method.

For most assets held for more than 1 year, the top

capital gains tax rate is 20 percent. For assets acquired

after December 31, 2000, the top capital gains tax rate

for assets held for more than 5 years is 18 percent.

On January 1, 2001, taxpayers may mark-to-market

existing assets to start the 5-year holding period. Losses

from the mark-to-market are not recognized.

For assets held for more than 1 year by taxpayers

in the 15-percent ordinary tax bracket, the top capital

gains tax rate is 10 percent. After December 31, 2000,

5. TAX EXPENDITURES 85

the top capital gains tax rate for assets held by these

taxpayers for more than 5 years is 8 percent.

53. Capital gains exclusion for small business

stock.—An exclusion of 50 percent is provided for capital gains from qualified small business stock held by

individuals for more than 5 years. A qualified small

business is a corporation whose gross assets do not

exceed $50 million as of the date of issuance of the

stock.

54. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are

not subject to capital gains taxes. The cost basis of

the appreciated assets is adjusted upward to the market value at the owner’s date of death. The step-up

in the heir’s cost basis means that, in effect, the tax

on the capital gain is forgiven.

55. Carryover basis of capital gains on gifts.—

When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the

transferred property was first acquired) carries-over to

the donee. The carryover of the donor’s basis allows

a continued deferral of unrealized capital gains.

56. Ordinary income treatment of losses from

sale of small business corporate stock shares.—

Up to $100,000 in losses from the sale of small business

corporate stock (capitalization less than $1 million) may

be treated as ordinary losses. Such losses would, thus,

not be subject to the $3,000 annual capital loss writeoff limit.

57. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus

do not give rise to tax expenditures under reference

law. Under normal law, however, a 40-year life for nonrental-housing buildings is the norm. Thus, the 39-year

depreciation period for property placed in service after

February 25, 1993, the 31.5-year depreciation period

for property placed in service from 1987 to February

25, 1993, and the pre-1987 depreciation periods create

a tax expenditure.

58. Accelerated depreciation of machinery and

equipment.—The tax depreciation allowance provisions

are part of the reference law rules, and thus do not

give rise to tax expenditures under reference law. Statutory depreciation of machinery and equipment, however, is accelerated somewhat relative to the normal

tax baseline, creating a tax expenditure.

59. Expensing of certain small investments.—In

2000, qualifying investments in tangible property up

to $20,000 can be expensed rather than depreciated

over time. The expensing limit increases to $24,000

in 2001 and to $25,000 in 2003. To the extent that

qualifying investment during the year exceeds

$200,000, the amount eligible for expensing is decreased. In 2000, the amount expensed is completely

phased out when qualifying investments exceed

$220,000.

60. Business start-up costs.—When taxpayers enter

into a new business, certain start-up expenses, such

as the cost of legal services, are normally incurred.

Taxpayers may elect to amortize these outlays over 60

months even though they are similar to other payments

made for nondepreciable intangible assets that are not

recoverable until the business is sold. The normal tax

method treats this amortization as a tax expenditure;

the reference tax method does not.

61. Graduated corporation income tax rate

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000

of taxable income, 25 percent on the next $25,000, and

34 percent on the next $9.925 million. Compared with

a flat 34-percent rate, the lower rates provide an

$11,750 reduction in tax liability for corporations with

taxable income of $75,000. This benefit is recaptured

for corporations with taxable incomes exceeding

$100,000 by a 5-percent additional tax on corporate

incomes in excess of $100,000 but less than $335,000.

The corporate tax rate is 35 percent on income over

$10 million. Compared with a flat 35-percent tax rate,

the 34-percent rate provides a $100,000 reduction in

tax liability for corporations with taxable incomes of

$10 million. This benefit is recaptured for corporations

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but

less than $18.33 million. Because the corporate rate

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method.

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower

rates is considered a tax expenditure under this concept.

62. Small issue industrial development bonds.—

Interest earned on small issue industrial development

bonds (IDBs) issued by State and local governments

to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must

be depreciated, however, using the straight-line method.

The annual volume of small issue IDBs is subject to

the unified volume cap discussed in the mortgage housing bond section above.

Transportation

63. Deferral of tax on U.S. shipping companies.—

Certain companies that operate U.S. flag vessels can

defer income taxes on that portion of their income used

for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment

of loans to finance these investments. Once indefinite,

the deferral has been limited to 25 years since January

1, 1987.

64. Exclusion of employee parking expenses.—

Employee parking expenses that are paid for by the

employer or that are received in lieu of wages are excludable from the income of the employee. In 2000,

the maximum amount of the parking exclusion is $175

(indexed) per month. The tax expenditure estimate does

not include parking at facilities owned by the employer.

65. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in

86 ANALYTICAL PERSPECTIVES

lieu of wages to defray an employee’s commuting costs

are excludable from the employee’s income. In 2000,

the maximum amount of the exclusion is $65 (indexed)

per month. In 2002, the maximum amount of the exclusion increases to $100 (indexed) per month.

Community and Regional Development

66. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation

of buildings that are used for business or productive

activities and that were erected before 1936 for other

than residential purposes. The taxpayer’s recoverable

basis must be reduced by the amount of the credit.

67. Airport, dock, and similar facility bonds.—

Interest earned on State and local bonds issued to finance high-speed rail facilities and government-owned

airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to

a volume cap.

68. Exemption of income of mutuals and cooperatives.—The incomes of mutual and cooperative telephone and electric companies are exempt from tax if

at least 85 percent of their revenues are derived from

patron service charges.

69. Empowerment zones, enterprise communities,

and renewal communities.—Qualifying businesses in

designated economically depressed areas can receive tax

benefits such as an employer wage credit, increased

expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain

capital gains incentives. In addition, certain first-time

buyers of a principal residence in the District of Columbia can receive a tax credit on homes purchased on

or before December 31, 2003, and investors in certain

D.C. property can receive a capital gains break. The

Community Renewal Tax Relief Act of 2000 created

the renewal communities tax benefits, which begin on

January 1, 2002 and expire on December 31, 2009.

The Act also created additional empowerment zones,

increased the tax benefits for empowerment zones, and

extended the expiration date of (1) empowerment zones

from December 31, 2004 to December 31, 2009, and

(2) the D.C. homebuyer credit from December 31, 2001

to December 31, 2003.

70. New markets tax credit.—Taxpayers who invest

in a community development entity (CDE) after December 31, 2000 are eligible for a tax credit. The total

equity investment available for the credit across all

CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and

2003, $2.0 billion in 2004 and 2005, and $3.5 billion

in 2006 and 2007. The amount of the credit equals

(1) 5 percent in the year of purchase and the following

2 years, and (2) 6 percent in the following 4 years.

A CDE is any domestic firm whose primary mission

is to serve or provide investment capital for low-income

communities/individuals; a CDE must be accountable

to residents of low-income communities. The Community Renewal Tax Relief Act of 2000 created the new

markets tax credit.

71. Expensing of environmental remediation

costs.—Taxpayers who clean up certain hazardous substances at a qualified site may expense the clean-up

costs, rather than capitalize the costs, even though the

expenses may increase the value of the property significantly. The expensing only applies to clean-up costs

incurred on or before December 31, 2003. The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2001 to December 31,

2003. The Act also expanded the number of qualified

sites.

Education, Training, Employment, and Social

Services

72. Scholarship and fellowship income.—Scholarships and fellowships are excluded from taxable income

to the extent they pay for tuition and course-related

expenses of the grantee. Similarly, tuition reductions

for employees of educational institutions and their families are not included in taxable income. From an economic point of view, scholarships and fellowships are

either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus,

under the reference law method, this exclusion is not

a tax expenditure because this method does not include

either gifts or price reductions in a taxpayer’s gross

income. The exclusion, however, is considered a tax expenditure under the normal tax method, which includes

gift-like transfers of government funds in gross income

(many scholarships are derived directly or indirectly

from government funding).

73. HOPE tax credit.—The non-refundable HOPE

tax credit allows a credit for 100 percent of an eligible

student’s first $1,000 of tuition and fees and 50 percent

of the next $1,000 of tuition and fees. The credit only

covers tuition and fees paid during the first two years

of a student’s post-secondary education. The credit is

phased out ratably for taxpayers with modified AGI

between $80,000 and $100,000 ($40,000 and $50,000

for singles).

74. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for

20 percent of an eligible student’s tuition and fees. For

tuition and fees paid before January 1, 2003, the maximum credit per return is $1,000. For tuition and fees

paid after December 31, 2002, the maximum credit per

return is $2,000. The credit is phased out ratably for

taxpayers with modified AGI between $80,000 and

$100,000 ($40,000 and $50,000 for singles). The credit

applies to both undergraduate and graduate students.

75. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is

not taxed when earned, and investment income from

an education IRA is tax-exempt when withdrawn to

pay for a student’s tuition and fees. The maximum contribution to an education IRA is $500 per year per

beneficiary. The maximum contribution is phased down

ratably for taxpayers with modified AGI between

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5. TAX EXPENDITURES 87

gles). Contributions may not be made to an education

IRA in any year in which a contribution has been made

to a State tuition plan for the same beneficiary.

76. Student-loan interest.—In 2000, taxpayers may

claim an above-the-line deduction of up to $2,000 on

interest paid on an education loan. The maximum deduction increases to $2,500 in 2001. Interest may only

be deducted for the first five years in which interest

payments are required. The maximum deduction is

phased down ratably for taxpayers with modified AGI

between $60,000 and $75,000 ($40,000 and $55,000 for

singles).

77. State prepaid tuition plans.—Some States

have adopted prepaid tuition plans and prepaid room

and board plans, which allow persons to pay in advance

for college expenses for designated beneficiaries. Taxes

on the earnings from these plans are paid by the beneficiaries and are deferred until the tuition is actually

paid.

78. Student-loan bonds.—Interest earned on State

and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds

that each State may issue annually is limited.

79. Bonds for private nonprofit educational institutions.—Interest earned on State and local government bonds issued to finance the construction of facilities used by private nonprofit educational institutions

is not taxed.

80. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds

receive a non-refundable tax credit (at a rate set by

the Treasury Department) rather than interest. The

credit is included in gross income. Proceeds from zone

academy bonds may only be used to renovate, but not

construct, qualifying schools and for certain other

school purposes. The total amount of zone academy

bonds that may be issued is limited to $1.6 billion—

$400 million in each year from 1998 to 2001.

81. U.S. savings bonds for education.—Interest

earned on U.S. savings bonds issued after December

31, 1989 is tax-exempt if the bonds are transferred

to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers

with AGI between $81,100 and $111,100 ($54,100 and

$69,100 for singles) in 2000.

82. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent

children age 19 or over who (1) receive parental support

payments of $1,000 or more per year, (2) are full-time

students, and (3) do not claim a personal exemption

on their own tax returns.

83. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the assets’ current value without being taxed on

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent

of adjusted gross income; a corporation’s total charitable

contributions generally may not exceed 10 percent of

pre-tax income.

84. Employer-provided educational assistance.—

Employer-provided educational assistance is excluded

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. This exclusion applies only to non-graduate courses beginning on or before December 31, 2001.

85. Work opportunity tax credit.—Employers can

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2001

and who are certified as members of various targeted

groups. The amount of the credit that can be claimed

is 25 percent for employment of less than 400 hours

and 40 percent for employment of 400 hours or more.

The maximum credit per employee is $2,400 and can

only be claimed on the first year of wages an individual

earns from an employer. Employers must reduce their

deduction for wages paid by the amount of the credit

claimed.

86. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible

wages paid to qualified long-term family assistance recipients during the first two years of employment. The

credit is 35 percent of the first $10,000 of wages in

the first year of employment and 50 percent of the

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The

credit applies to wages paid to employees who are hired

on or before December 31, 2001.

87. Employer-provided child care.—Employer-provided child care is excluded from an employee’s gross

income even though the employer’s costs for the child

care are a deductible business expense.

88. Assistance for adopted foster children.—Taxpayers who adopt eligible children from the public foster care system can receive monthly payments for the

children’s significant and varied needs and a reimbursement of up to $2,000 for nonrecurring adoption expenses. These payments are excluded from gross income.

89. Adoption credit and exclusion.—Taxpayers can

receive a nonrefundable tax credit for qualified adoption

expenses. The maximum credit is $5,000 per child

($6,000 for special needs adoptions). The credit is

phased-out ratably for taxpayers with modified AGI between $75,000 and $115,000. Unused credits may be

carried forward and used during the five subsequent

years. Taxpayers may also exclude qualified adoption

expenses from income, subject to the same maximum

amounts and phase-out as the credit. The same expenses cannot qualify for tax benefits under both programs; however, a taxpayer may use the benefits of

the exclusion and the tax credit for different expenses.

Stepchild adoptions are not eligible for either benefit.

Both of the current tax benefits expire at the end of

2001, except for the tax credit for expenses associated

with special needs adoptions, which is permanent.

90. Employer-provided meals and lodging.—Employer-provided meals and lodging are excluded from

88 ANALYTICAL PERSPECTIVES

an employee’s gross income even though the employer’s

costs for these items are a deductible business expense.

91. Child credit.—Taxpayers with children under

age 17 can qualify for a $500 child credit. The credit

is phased out for taxpayers at the rate of $50 per

$1,000 of modified AGI above $110,000 ($75,000 for

singles). The child credit is refundable for taxpayers

with three or more children.

92. Child and dependent care expenses.—Married

couples with child and dependent care expenses may

claim a tax credit when one spouse works full time

and the other works at least part time or goes to school.

The credit may also be claimed by single parents and

by divorced or separated parents who have custody of

children. Expenditures up to a maximum $2,400 for

one dependent and $4,800 for two or more dependents

are eligible for the credit. The credit is equal to 30

percent of qualified expenditures for taxpayers with incomes of $10,000 or less. The credit is reduced to a

minimum of 20 percent by one percentage point for

each $2,000 of income between $10,000 and $28,000.

93. Disabled access expenditure credit.—Small

businesses (less than $1 million in gross receipts or

fewer than 31 full-time employees) can claim a 50-percent credit for expenditures in excess of $250 to remove

access barriers for disabled persons. The credit is limited to $5,000.

94. Charitable contributions, other than education and health.—Taxpayers may deduct contributions to charitable, religious, and certain other nonprofit organizations. Taxpayers who donate capital assets to charitable organizations can deduct the assets’

current value without being taxed on any appreciation

in value. An individual’s total charitable contribution

generally may not exceed 50 percent of adjusted gross

income; a corporation’s total charitable contributions

generally may not exceed 10 percent of pre-tax income.

95. Foster care payments.—Foster parents provide

a home and care for children who are wards of the

State, under contract with the State. Compensation received for this service is excluded from the gross incomes of foster parents; the expenses they incur are

nondeductible.

96. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income.

Health

97. Employer-paid medical insurance and expenses.—Employer-paid health insurance premiums

and other medical expenses (including long-term care)

are deducted as a business expense by employers, but

they are not included in employee gross income. The

self-employed also may deduct part of their family

health insurance premiums.

98. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums.

Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 2000 and 2001, 70

percent in 2002, and 100 percent in 2003 and thereafter.

99. Workers compensation insurance premiums.—Workers compensation insurance premiums

are paid by employers and deducted as a business expense, but the premiums are not included in employee

gross income.

100. Medical savings accounts.—Some employees

may deduct annual contributions to a medical savings

account (MSA); employer contributions to MSAs (except

those made through cafeteria plans) for qualified employees are also excluded from income. An employee

may contribute to an MSA in a given year only if the

employer does not contribute to the MSA in that year.

MSAs are only available to self-employed individuals

or employees covered under an employer-sponsored high

deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the

deductible under the high deductible plan for family

coverage (65 percent for individual coverage). Earnings

from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No

new MSAs may be established after December 31, 2002.

The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2000

to December 31, 2002.

101. Medical care expenses.—Personal expenditures for medical care (including the costs of prescription drugs) exceeding 7.5 percent of the taxpayer’s adjusted gross income are deductible.

102. Hospital construction bonds.—Interest earned

on State and local government debt issued to finance

hospital construction is excluded from income subject

to tax.

103. Charitable contributions to health institutions.—Individuals and corporations may deduct contributions to nonprofit health institutions. Tax expenditures resulting from the deductibility of contributions

to other charitable institutions are listed under the education, training, employment, and social services function.

104. Orphan drugs.—Drug firms can claim a tax

credit of 50 percent of the costs for clinical testing required by the Food and Drug Administration for drugs

that treat rare physical conditions or rare diseases.

105. Blue Cross and Blue Shield.—Blue Cross and

Blue Shield health insurance providers in existence on

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that

substantially reduce (or even eliminate) their tax liabilities.

Income Security

106. Railroad retirement benefits.—Railroad retirement benefits are not generally subject to the income tax unless the recipient’s gross income reaches

5. TAX EXPENDITURES 89

a certain threshold. The threshold is discussed more

fully under the social security function.

107. Workers’ compensation benefits.—Workers

compensation provides payments to disabled workers.

These benefits, although income to the recipients, are

not subject to the income tax.

108. Public assistance benefits.—Public assistance

benefits are excluded from tax. The normal tax method

considers cash transfers from the government as taxable and, thus, treats the exclusion for public assistance

benefits as a tax expenditure.

109. Special benefits for disabled coal miners.—

Disability payments to former coal miners out of the

Black Lung Trust Fund, although income to the recipient, are not subject to the income tax.

110. Military disability pensions.—Most of the

military pension income received by current disabled

retired veterans is excluded from their income subject

to tax.

111. Employer-provided pension contributions

and earnings.—Certain employer contributions to pension plans are excluded from an employee’s gross income even though the employer can deduct the contributions. In addition, the tax on the investment income earned by the pension plans is deferred until the

money is withdrawn.

112. 401(k) plans and Individual Retirement Accounts.—Individual taxpayers can take advantage of

several different tax-preferenced retirement plans: deductible IRAs, non-deductible IRAs, Roth IRAs, and

401(k) plans (and 401(k)-type plans like 403(b) plans

and the federal government’s Thrift Savings Plan).

In 2000, an employee could exclude up to $10,500

(indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k). In 2000, employees

can annually contribute to a deductible IRA up to

$2,000 (or 100 percent of compensation, if less) or

$4,000 on a joint return with only one working spouse

if: (a) neither the individual nor spouse is an active

participant in an employer-provided retirement plan,

or (b) their AGI is below $52,000 ($32,000 for singles).

The AGI limit increases annually until it reaches

$80,000 in 2007 ($50,000 in 2005 for singles). In 2000,

the IRA deduction is phased out for taxpayers with

AGI between $52,000 and $62,000 ($32,000 and $42,000

for singles). The phase-out range increases annually

until it reaches $80,000 to $100,000 in 2007 ($50,000

to $60,000 in 2005 for singles). Taxpayers whose AGI

is above the start of the IRA phase-out range or who

are active participants in an employer-provided retirement plan can contribute to a non-deductible IRA. The

tax on the investment income earned by 401(k) plans,

non-deductible IRAs, and deductible IRAs is deferred

until the money is withdrawn.

An employed taxpayer can make a non-deductible

contribution of up to $2,000 (a non-employed spouse

can also contribute up to $2,000 if a joint return is

filed) to a Roth IRA. Investment income of a Roth IRA

is not taxed when earned. Withdrawals from a Roth

IRA are tax free if (1) the Roth IRA was opened at

least 5 years before the withdrawal, and (2) the taxpayer either (a) is at least 591⁄2, (b) dies, (c) is disabled,

or (d) purchases a first-time house. The maximum contribution to a Roth IRA is phased out for taxpayers

with AGI between $150,000 and $160,000 ($95,000 and

$110,000 for singles). Total annual contributions to a

taxpayer’s deductible, non-deductible, and Roth IRAs

cannot exceed $2,000 ($4,000 for joints).

113. Keogh plans.—Self-employed individuals can

make deductible contributions to their own retirement

(Keogh) plans equal to 25 percent of their income, up

to a maximum of $30,000 per year. In addition, the

tax on the investment income earned by Keogh plans

is deferred until the money is withdrawn.

114. Employer-provided life insurance benefits.—

Employer-provided life insurance benefits are excluded

from an employee’s gross income even though the employer’s costs for the insurance are a deductible business expense.

115. Employer-provided accident and disability

benefits.—Employer-provided accident and disability

benefits are excluded from an employee’s gross income

even though the employer’s costs for the benefits are

a deductible business expense.

116. Employer-provided supplementary unemployment benefits.—Employer-provided supplementary unemployment benefits are excluded from an

employee’s gross income even though the employer’s

costs for the benefits are a deductible business expense.

117. Employer Stock Ownership Plan (ESOP)

provisions.—ESOPs are a special type of tax-exempt

employee benefit plan. Employer-paid contributions (the

value of stock issued to the ESOP) are deductible by

the employer as part of employee compensation costs.

They are not included in the employees’ gross income

for tax purposes, however, until they are paid out as

benefits. The following special income tax provisions

for ESOPs are intended to increase ownership of corporations by their employees: (1) annual employer contributions are subject to less restrictive limitations; (2)

ESOPs may borrow to purchase employer stock, guaranteed by their agreement with the employer that the

debt will be serviced by his payment (deductible by

him) of a portion of wages (excludable by the employees) to service the loan; (3) employees who sell appreciated company stock to the ESOP may defer any taxes

due until they withdraw benefits; and (4) dividends

paid to ESOP-held stock are deductible by the employer.

118. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,000

standard deduction if single, or $800 if married.

119. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,000 standard deduction if single, or $800 if

married.

120. Tax credit for the elderly and disabled.—

Individuals who are 65 years of age or older, or who

are permanently disabled, can take a tax credit equal

to 15 percent of the sum of their earned and retirement

90 ANALYTICAL PERSPECTIVES

income. Income is limited to no more than $5,000 for

single individuals or married couples filing a joint return where only one spouse is 65 years of age or older,

and up to $7,500 for joint returns where both spouses

are 65 years of age or older. These limits are reduced

by one-half of the taxpayer’s adjusted gross income over

$7,500 for single individuals and $10,000 for married

couples filing a joint return.

121. Casualty losses.—Neither the purchase of property nor insurance premiums to protect its value are

deductible as costs of earning income; therefore, reimbursement for insured loss of such property is not reportable as a part of gross income. Taxpayers, however,

may deduct uninsured casualty and theft losses of more

than $100 each, but only to the extent that total losses

during the year exceed 10 percent of AGI.

122. Earned income tax credit (EITC).—The EITC

may be claimed by low income workers. For a family

with one qualifying child, the credit is 34 percent of

the first $6,920 of earned income in 2000. The credit

is 40 percent of the first $9,720 of income for a family

with two or more qualifying children. When the taxpayer’s income exceeds $12,690, the credit is phased

out at the rate of 15.98 percent (21.06 percent if two

or more qualifying children are present). It is completely phased out at $27,413 of modified adjusted gross

income ($31,152 if two or more qualifying children are

present).

The credit may also be claimed by workers who do

not have children living with them. Qualifying workers

must be at least age 25 and may not be claimed as

a dependent on another taxpayer’s return. The credit

is not available to workers age 65 or older. In 2000,

the credit is 7.65 percent of the first $4,610 of earned

income. When the taxpayer’s income exceeds $5,770,

the credit is phased out at the rate of 7.65 percent.

It is completely phased out at $10,380 of modified adjusted gross income.

For workers with or without children, the income

level at which the credit’s phase-outs begin and the

maximum amounts of income on which the credit can

be taken are adjusted for inflation. Earned income tax

credits in excess of tax liabilities owed through the

individual income tax system are refundable to individuals. This portion of the credit is shown as an outlay,

while the amount that offsets tax liabilities is shown

as a tax expenditure.

Social Security

123. Social Security benefits for retired workers.—Social security benefits that exceed the beneficiary’s contributions out of taxed income are deferred

employee compensation and the deferral of tax on that

compensation is a tax expenditure. These additional

retirement benefits are paid for partly by employers’

contributions that were not included in employees’ taxable compensation. Portions (reaching as much as 85

percent) of recipients’ social security and tier 1 railroad

retirement benefits are included in the income tax base,

however, if the recipient’s provisional income exceeds

certain base amounts. Provisional income is equal to

adjusted gross income plus foreign or U.S. possession

income and tax-exempt interest, and one half of social

security and tier 1 railroad retirement benefits. The

tax expenditure is limited to the portion of the benefits

received by taxpayers who are below the base amounts

at which 85 percent of the benefits are taxable.

124. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund,

for disability and for dependents and survivors, are excluded from a beneficiary’s gross incomes.

125. Social Security benefits for dependents and

survivors.—Benefit payments from the Social Security

Trust Fund for dependents and survivors are excluded

from a beneficiary’s gross income.

Veterans Benefits and Services

126. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded

from taxable income.

127. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income.

128. G.I. Bill benefits.—G.I. Bill benefits paid by

the Veterans Administration are excluded from gross

income.

129. Tax-exempt mortgage bonds for veterans.—

Interest earned on general obligation bonds issued by

State and local governments to finance housing for veterans is excluded from taxable income. The issuance

of such bonds is limited, however, to five pre-existing

State programs and to amounts based upon previous

volume levels for the period January 1, 1979 to June

22, 1984. Furthermore, future issues are limited to veterans who served on active duty before 1977.

General Government

130. Public purpose State and local bonds.—Interest earned on State and local government bonds

issued to finance public-purpose construction (e.g.,

schools, roads, sewers), equipment acquisition, and

other public purposes is tax-exempt. Interest on bonds

issued by Indian tribal governments for essential governmental purposes is also tax-exempt.

131. Deductibility of certain nonbusiness State

and local taxes.—Taxpayers may deduct State and

local income taxes and property taxes even though

these taxes primarily pay for services that, if purchased

directly by taxpayers, would not be deductible.

132. Business income earned in U.S. possessions.—U.S. corporations operating in a U.S. possession

(e.g., Puerto Rico) can claim a credit against some or

all of their U.S. tax liability on possession business

income. The credit expires December 31, 2005.

Interest

133. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until

the bonds are redeemed.

5. TAX EXPENDITURES 91

6 An additional tax, at a flat rate of 55 percent, is imposed on lifetime, generationskipping transfers in excess of $1 million (indexed). It is considered a generation-skipping

transfer whenever the transferee is at least two generations younger than the transferor,

as it would be in the case of transfers to grandchildren or great-grandchildren. The liability

of this tax is on the recipients of the transfer.

TAX EXPENDITURES IN THE UNIFIED TRANSFER TAX

Exceptions to the general terms of the Federal unified

transfer tax favor particular transferees or dispositions

of transferors, similar to Federal direct expenditure or

loan programs. The transfer tax provisions identified

as tax expenditures satisfy the reference law criteria

for inclusion in the tax expenditure budget that were

described above. There is no generally accepted normal

tax baseline for transfer taxes.

Unified Transfer Tax Reference Rules

The reference tax rules for the unified transfer tax

from which departures represent tax expenditures include:

• Definition of the taxpaying unit. The payment of

the tax is the liability of the transferor whether

the transfer of cash or property was made by gift

or bequest.

• Definition of the tax base. The base for the tax

is the transferor’s cumulative, taxable lifetime

gifts made plus the net estate at death. Gifts in

the tax base are all annual transfers in excess

of $10,000 (indexed) to any donee except the donor’s spouse. Excluded are, however, payments on

behalf of family members’ educational and medical

expenses, as well as the cost of ceremonial gatherings and celebrations that are not in honor of

the donor.

• Property valuation. In general, property is valued

at its fair market value at the time it is transferred. This is not necessarily the case in the valuation of property for transfer tax purposes. Executors of estates are provided the option to value

assets at the time of the testator’s death or up

to six months later.

• Tax rate schedule. A single graduated tax rate

schedule applies to all taxable transfers. This is

reflected in the name of the ‘‘unified transfer tax’’

that has replaced the former separate gift and

estate taxes. The tax rates vary from 18 percent

on the first $10,000 of aggregate taxable transfers,

to 55 percent on amounts exceeding $3 million.

A lifetime credit is provided against the tax in

determining the final amount of transfer taxes

that are due and payable. For decedents dying

in 2000, this credit allows each taxpayer to make

a $675,000 tax-free transfer of assets that otherwise would be liable to the unified transfer tax.

This figure is scheduled to increase in steps to

$1 million in 2006. 6

• Time when tax is due and payable. Donors are

required to pay the tax annually as gifts are

made. The generation-skipping transfer tax is payable by the donees whenever they accede to the

gift. The net estate tax liability is due and payable

within nine months after the decedent’s death.

The Internal Revenue Service may grant an extension of up to 10 years for a reasonable cause.

Interest is charged on the unpaid tax liability at

a rate equal to the cost of Federal short-term borrowing, plus three percentage points.

Tax Expenditures by Function

The estimates of tax expenditures in the Federal unified transfer tax for fiscal years 2000–2006 are displayed by functional category in Table 5–6. Outlay

equivalent estimates are similar to revenue loss estimates for transfer tax expenditures and, therefore, are

not shown separately. A description of the provisions

follows.

Natural Resources and Environment

1. Donations of conservation easements.—Bequests of property and easements (in perpetuity) for

conservation purposes can be excluded from taxable estates. Use of the property and easements must be restricted to at least one of the following purposes: outdoor recreation or scenic enjoyment for the general public; protection of the natural habitats of fish, wildlife,

plants, etc.; and preservation of historic land areas and

structures. Conservation gifts are similarly excluded

from the gift tax. Up to 40 percent of the value of

land subject to certain conservation easements may be

excluded from taxable estates; the maximum amount

of the exclusion is $300,000 in 2000 and increases to

$400,000 in 2001 and to $500,000 in 2002.

Agriculture

2. Special-use valuation of farms.—In 2000, up

to $750,000 (indexed) in farmland owned and operated

by a decedent and/or a member of the family may be

valued for estate tax purposes on the basis of its ‘‘continued use’’ as farmland if: (1) the value of the farmland

is at least 25 percent of the gross estate; (2) the entire

value of all farm property is at least 50 percent of

the gross estate; and (3) family heirs to the farm agree

to continue to operate the property as a farm for at

least 10 years.

3. Tax deferral of closely held farms.—The tax

on a decedent’s farm can be deferred for up to 14 years

if the value of the farm is at least 35 percent of the

gross estate. For the first 4 years of deferral, no tax

need be paid. During the last 10 years of deferral, the

tax liability must be paid in equal annual installments.

Throughout the 14-year period, interest is charged. A

2-percent interest rate (non-deductible) is applied to the

first $1 million (indexed) of deferred taxable value.

Commerce and Housing

4. Special-use valuation of closely-held businesses.—The special-use valuation rule available for

family farms is also available for nonfarm family businesses. To be eligible for the special-use valuation, the

92 ANALYTICAL PERSPECTIVES

same three conditions previously described must be

met.

5. Tax deferral of closely-held businesses.—The

tax-deferral rule available for family farms is also available for nonfarm family businesses. To be eligible for

the tax deferral, the value of stock in closely-held corporations must exceed 35 percent of the decedent’s

gross estate, less debt and funeral expenses.

6. Exclusion for family-owned businesses.—Certain family-owned businesses that are bequeathed to

qualified heirs can be excluded from taxable estates.

The exclusion cannot exceed $675,000. The combined

value of the exclusion and the exemption value of the

unified credit cannot exceed $1.3 million. The exclusion

is recaptured if certain conditions are not maintained

for 10 years.

Education, Training, Employment, and Social

Services

7. Charitable contributions to educational institutions.—Bequests to educational institutions can be

deducted under the estate tax.

8. Charitable contributions, other than education and health.—Bequests to charitable, religious,

and certain other nonprofit organizations can be deducted under the estate tax.

Health

9. Charitable contributions to health institutions.—Bequests to health institutions can be deducted

under the estate tax.

General Government

10. State and local death taxes.—A credit against

the Federal estate tax is allowed for State taxes on

bequests. The amount of this credit is determined by

a rate schedule that reaches a maximum of 16 percent

of the taxable estate in excess of $60,000.

5. TAX EXPENDITURES 93

Table 5–6. ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED TRANSFER TAX

(In millions of dollars)

Description 2000 2001 2002 2003 2004 2005 2006 2002–2006

Natural Resources and Environment:

1 Donations of conservation easements .......................................................... .............. .............. .............. 10 10 10 20 50

Agriculture:

2 Special use valuation of farm real property .................................................. 110 110 120 120 130 130 130 630

3 Tax deferral of closely held farms ................................................................. .............. .............. 10 10 20 20 30 90

Commerce:

4 Special use valuation of real property used in closely held businesses ..... 10 10 10 10 10 10 10 50

5 Tax deferral of closely held business ............................................................ –20 30 60 80 100 130 140 510

6 Exclusion for family owned businesses ......................................................... 130 140 150 160 170 170 170 820

Education, training, employment, and social services:

7 Deduction for charitable contributions (education) ........................................ 780 880 960 990 1,030 1,060 1,100 5,140

8 Deduction for charitable contributions (other than education and health) ... 2,300 2,600 2,830 2,930 3,050 3,120 3,260 15,190

Health:

9 Deduction for charitable contributions (health) .............................................. 700 800 870 900 930 960 1,000 4,660

General government:

10 Credit for State death taxes .......................................................................... 6,420 6,720 7,030 7,340 7,660 8,000 8,350 38,380