61

5. TAX EXPENDITURES

Tax expenditures are revenue losses due to preferential provisions of the Federal tax laws, such as

special exclusions, exemptions, deductions, credits, deferrals, or tax rates. Tax expenditures are an alternative to other Government policy instruments, such

as direct expenditures and regulations. The Congressional Budget Act of 1974 (Public Law 93–344) requires

that a list of tax expenditures be included in the budget.

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

followed by those relating to the unified transfer tax.

The supplement at the end of the chapter presents

major tax expenditures in the income tax ranked by

revenue loss.

Tax expenditures are estimated for fiscal years

1995–2001 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 IN THE INCOME TAX

Tax Expenditure Estimates

The Treasury Department prepared all tax expenditure estimates presented here based upon income tax

law enacted as of December 31, 1995. Expired or repealed provisions are not listed if their revenue effects

result only from taxpayer activity occurring before fiscal

year 1995.

The total revenue loss estimates for tax expenditures

for fiscal years 1995–2001 are displayed by 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 estimates.

Table 5–2 reports the respective portions of the total

revenue losses that arise under the individual and corporate income taxes. Listing revenue loss 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 provisions are cleared. The ultimate beneficiaries of corporate tax expenditures, for example,

could be stockholders, employees, customers, or others,

depending on the circumstances.

Table 5–6 at the end of this chapter ranks the major

tax expenditures by fiscal year 1997 revenue loss. This

table merges several individual entries provided in

table 5–1; for example, table 5–6 contains one merged

entry for charitable contributions instead of the three

separate entries found in table 5–1.
62 ANALYTICAL PERSPECTIVES

TABLE 5–1. TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX

(In millions of dollars)

Provision

Total Revenue Loss

1995 1996 1997 1998 1999 2000 2001 1997–2001

National defense:

Exclusion of benefits and allowances to armed forces personnel .................................................................................................... 2,000 2,060 2,080 2,095 2,120 2,140 2,160 10,595

International affairs:

Exclusion of income earned abroad by United States citizens ......................................................................................................... 1,670 1,870 2,100 2,355 2,645 2,965 3,330 13,395

Exclusion of income of foreign sales corporations ............................................................................................................................ 1,400 1,500 1,600 1,700 1,800 1,900 2,000 9,000

Inventory property sales source rules exception ............................................................................................................................... 1,300 1,400 1,500 1,600 1,700 1,800 1,900 8,500

Interest allocation rules exception for certain financial operations ................................................................................................... 95 95 95 95 95 95 95 475

Deferral of income from controlled foreign corporations (normal tax method) ................................................................................. 1,700 1,800 2,000 2,200 2,400 2,600 2,900 12,100

General science, space, and technology:

Expensing of research and experimentation expenditures (normal tax method) ............................................................................. 1,635 1,740 1,840 1,945 2,065 2,190 2,320 10,360

Credit for increasing research activities ............................................................................................................................................. 1,185 675 285 120 40 5 ........... 450

Suspension of the allocation of research and experimentation expenditures .................................................................................. 325 ........... ........... ........... ........... ........... ........... ...................

Energy:

Expensing of exploration and development costs:

Oil and gas ...................................................................................................................................................................................... –300 –255 –165 –75 0 95 80 –65

Other fuels ....................................................................................................................................................................................... 15 15 15 15 15 15 20 80

Excess of percentage over cost depletion:

Oil and gas ...................................................................................................................................................................................... 945 985 1,020 1,060 1,105 1,145 1,195 5,525

Other fuels ....................................................................................................................................................................................... 120 120 125 140 140 155 155 715

Alternative fuel production credit ........................................................................................................................................................ 970 1,000 990 940 880 820 760 4,390

Exception from passive loss limitation for working interests in oil and gas properties ................................................................... 55 60 60 65 65 70 75 335

Capital gains treatment of royalties on coal ...................................................................................................................................... 15 15 15 15 15 15 15 75

Exclusion of interest on State and local IDBs for energy facilities ................................................................................................... 175 180 180 175 175 165 160 855

New technology credit ......................................................................................................................................................................... 140 140 145 155 165 175 185 825

Alcohol fuel credit 1 ............................................................................................................................................................................. 10 10 10 10 10 10 10 50

Tax credit and deduction for clean-fuel burning vehicles and properties ......................................................................................... 65 65 65 75 80 85 90 395

Exclusion from income of conservation subsidies provided by public utilities ................................................................................. 130 155 165 165 155 155 145 785

Natural resources and environment:

Expensing of exploration and development costs, nonfuel minerals ................................................................................................ 35 35 35 35 35 35 35 175

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................................ 220 225 235 240 245 245 255 1,220

Capital gains treatment of iron ore ..................................................................................................................................................... 0 0 0 0 0 0 0 0

Special rules for mining reclamation reserves ................................................................................................................................... 50 50 50 50 50 50 50 250

Exclusion of interest on State and local IDBs for pollution control and sewage and waste disposal facilities .............................. 635 630 615 605 600 575 555 2,950

Capital gains treatment of certain timber income .............................................................................................................................. 15 15 15 15 15 15 15 75

Expensing of multiperiod timber growing costs ................................................................................................................................. 370 395 415 440 460 485 505 2,305

Investment credit and seven-year amortization for reforestation expenditures ................................................................................ 45 45 50 50 50 50 50 250

Tax incentives for preservation of historic structures ........................................................................................................................ 125 125 120 115 115 110 105 565

Agriculture:

Expensing of certain capital outlays ................................................................................................................................................... 70 65 65 65 70 70 70 340

Expensing of certain multiperiod production costs ............................................................................................................................ 85 80 80 80 85 85 85 415

Treatment of loans forgiven solvent farmers as if insolvent ............................................................................................................. 10 10 10 10 10 10 10 50

Capital gains treatment of certain income ......................................................................................................................................... 145 145 140 145 145 150 155 735

Commerce and housing:

Financial institutions and insurance:

Exemption of credit union income .................................................................................................................................................. 630 650 710 780 860 940 1,030 4,320

Excess bad debt reserves of financial institutions ........................................................................................................................ 95 105 115 125 135 150 160 685

Exclusion of interest on life insurance savings ............................................................................................................................. 9,905 10,670 11,470 12,340 13,260 14,255 14,950 66,275

Special alternative tax on small property and casualty insurance companies ............................................................................. 5 5 5 5 5 5 5 25

Tax exemption of certain insurance companies ............................................................................................................................ 235 240 245 255 260 280 300 1,340

Small life insurance company deduction ....................................................................................................................................... 110 115 120 130 135 140 145 670

Housing:

Exclusion of interest on owner-occupied mortgage subsidy bonds .............................................................................................. 1,810 1,810 1,770 1,710 1,655 1,605 1,540 8,280

Exclusion of interest on State and local debt for rental housing ................................................................................................. 925 875 815 760 700 630 545 3,450

Deductibility of mortgage interest on owner-occupied homes ...................................................................................................... 48,080 50,575 53,075 55,750 58,590 61,655 64,915 293,985

Deductibility of State and local property tax on owner-occupied homes ..................................................................................... 15,275 16,070 16,860 17,710 18,615 19,590 20,620 93,395

Deferral of income from post 1987 installment sales ................................................................................................................... 935 955 975 995 1,015 1,035 1,055 5,075

Deferral of capital gains on home sales ........................................................................................................................................ 14,180 14,605 15,040 15,490 15,955 16,435 16,930 79,850

Exclusion of capital gains on home sales for persons age 55 and over .................................................................................... 5,160 5,185 5,075 5,465 5,280 5,755 5,480 27,055

Exception from passive loss rules for $25,000 of rental loss ....................................................................................................... 4,515 4,235 3,985 3,745 3,520 3,305 3,070 17,625

Accelerated depreciation on rental housing (normal tax method) ................................................................................................ 1,045 1,170 1,305 1,485 1,675 2,165 2,455 9,085

Commerce:

Cancellation of indebtedness .......................................................................................................................................................... 105 70 40 15 0 –10 –5 40

Permanent exceptions from imputed interest rules ....................................................................................................................... 150 150 155 155 160 160 160 790

Capital gains (other than agriculture, timber, iron ore, and coal) (normal tax method) .............................................................. 7,125 7,000 6,920 7,035 7,195 7,385 7,560 36,095

Capital gains exclusion of small corporation stock ....................................................................................................................... 0 0 0 5 30 70 110 215
5. TAX EXPENDITURES 63

TABLE 5–1. TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued

(In millions of dollars)

Provision

Total Revenue Loss

1995 1996 1997 1998 1999 2000 2001 1997–2001

Step-up basis of capital gains at death ......................................................................................................................................... 28,305 29,480 30,265 30,710 31,160 31,615 32,075 155,825

Carryover basis of capital gains on gifts ....................................................................................................................................... 130 140 150 160 170 180 190 850

Ordinary income treatment of loss from small business corporation stock sale ......................................................................... 105 215 305 370 380 355 305 1,715

Accelerated depreciation of buildings other than rental housing (normal tax method) ............................................................... 7,440 6,735 5,720 4,590 3,410 2,420 1,600 17,740

Accelerated depreciation of machinery and equipment (normal tax method) .............................................................................. 24,460 27,160 29,500 31,210 33,030 33,575 32,240 159,555

Expensing of certain small investments (normal tax method) ...................................................................................................... 1,815 1,520 1,120 795 600 320 155 2,990

Amortization of start-up costs (normal tax method) ...................................................................................................................... 185 195 200 205 210 210 220 1,045

Graduated corporation income tax rate (normal tax method) ....................................................................................................... 4,105 4,435 4,730 5,015 5,345 5,710 6,085 26,885

Exclusion of interest on small issue IDBs ..................................................................................................................................... 555 435 345 295 280 265 260 1,445

Deferral of gains from sale of broadcasting facilities to minority owned business ...................................................................... 285 ........... ........... ........... ........... ........... ........... ...................

Treatment of Alaska Native Corporations ...................................................................................................................................... 30 20 15 10 5 5 5 40

Transportation:

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

Exclusion of reimbursed employee parking expenses ....................................................................................................................... 1,215 1,255 1,290 1,330 1,370 1,410 1,455 6,855

Exclusion for employer-provided transit passes ................................................................................................................................. 35 50 60 70 85 100 120 435

Community and regional development:

Credit for low-income housing investments ....................................................................................................................................... 2,260 2,600 2,945 3,270 3,500 3,595 3,445 16,755

Investment credit for rehabilitation of structures (other than historic) ............................................................................................... 80 80 80 70 70 70 65 355

Exclusion of interest on IDBs for airports, docks, and sports and convention facilities .................................................................. 855 910 965 1,025 1,090 1,145 1,205 5,430

Exemption of certain mutuals’ and cooperatives’ income ................................................................................................................. 50 50 50 55 55 60 60 280

Empowerment zones ........................................................................................................................................................................... 250 330 385 425 450 475 490 2,225

Education, training, employment, and social services:

Education:

Exclusion of scholarship and fellowship income (normal tax method) ......................................................................................... 825 835 845 850 860 870 875 4,300

Exclusion of interest on State and local student loan bonds ....................................................................................................... 315 305 290 275 260 250 240 1,315

Exclusion of interest on State and local debt for private nonprofit educational facilities ............................................................ 770 795 830 870 910 955 990 4,555

Exclusion of interest on savings bonds transferred to educational institutions ............................................................................ 5 5 10 10 15 15 15 65

Parental personal exemption for students age 19 or over ........................................................................................................... 820 825 835 870 905 955 1,015 4,580

Deductibility of charitable contributions (education) ...................................................................................................................... 1,780 1,870 1,965 2,065 2,165 2,275 2,385 10,855

Exclusion of employer provided educational assistance ............................................................................................................... 100 ........... ........... ........... ........... ........... ........... ...................

Training, employment, and social services:

Targeted jobs credit ........................................................................................................................................................................ 395 325 60 40 20 5 ........... 125

Exclusion of employer provided child care .................................................................................................................................... 725 775 830 890 955 1,025 1,100 4,800

Exclusion of employee meals and lodging (other than military) ................................................................................................... 545 570 600 630 665 700 735 3,330

Credit for child and dependent care expenses ............................................................................................................................. 2,730 2,865 3,005 3,155 3,315 3,480 3,655 16,610

Credit for disabled access expenditures ........................................................................................................................................ 160 160 165 165 165 170 170 835

Expensing of costs of removing certain architectural barriers to the handicapped ..................................................................... 20 20 20 20 20 20 20 100

Deductibility of charitable contributions, other than education and health ................................................................................... 19,565 20,565 21,600 22,675 23,815 25,000 26,240 119,330

Exclusion of certain foster care payments ..................................................................................................................................... 30 30 35 35 35 40 40 185

Exclusion of parsonage allowances ............................................................................................................................................... 265 285 300 320 345 365 390 1,720

Health:

Exclusion of employer contributions for medical insurance premiums and medical care ............................................................... 59,440 64,520 70,490 77,040 84,125 91,620 99,925 423,200

Deductibility of medical expenses ...................................................................................................................................................... 3,495 3,785 4,125 4,510 4,930 5,395 5,895 24,855

Exclusion of interest on State and local debt for private nonprofit health facilities ......................................................................... 1,535 1,595 1,675 1,750 1,845 1,935 2,015 9,220

Deductibility of charitable contributions (health) ................................................................................................................................. 2,280 2,395 2,510 2,630 2,755 2,885 3,020 13,800

Tax credit for orphan drug research .................................................................................................................................................. 15 ........... ........... ........... ........... ........... ........... ...................

Special Blue Cross/Blue Shield deduction ......................................................................................................................................... 125 140 100 170 185 220 280 955

Income security:

Exclusion of railroad retirement system benefits ............................................................................................................................... 430 445 450 455 460 465 470 2,300

Exclusion of workmen’s compensation benefits ................................................................................................................................. 4,475 4,855 5,050 5,255 5,515 5,800 6,205 27,825

Exclusion of public assistance benefits (normal tax method) ........................................................................................................... 570 590 635 695 740 795 850 3,715

Exclusion of special benefits for disabled coal miners ...................................................................................................................... 95 90 85 85 80 75 70 395

Exclusion of military disability pensions ............................................................................................................................................. 130 130 130 130 130 130 130 650

Net exclusion of pension contributions and earnings:

Employer plans ............................................................................................................................................................................... 52,070 55,370 55,770 56,205 56,625 57,045 57,470 283,115

Individual Retirement Accounts ...................................................................................................................................................... 7,720 7,830 7,940 8,335 8,420 8,455 8,490 41,640

Keogh plans .................................................................................................................................................................................... 3,315 3,345 3,580 3,780 3,935 4,090 4,240 19,625

Exclusion of employer provided death benefits ................................................................................................................................. 30 35 35 35 40 40 45 195

Exclusion of other employee benefits:

Premiums on group term life insurance ......................................................................................................................................... 2,880 3,020 3,170 3,325 3,485 3,660 3,865 17,505

Premiums on accident and disability insurance ............................................................................................................................ 150 155 165 175 185 195 205 925

Income of trusts to finance supplementary unemployment benefits ............................................................................................ 20 20 20 20 20 20 20 100

Special ESOP rules (other than investment credit) ........................................................................................................................... 2,125 1,745 1,540 1,405 1,280 1,170 1,065 6,460

Additional deduction for the blind ....................................................................................................................................................... 25 25 25 25 25 30 30 135

Additional deduction for the elderly .................................................................................................................................................... 1,305 1,320 1,340 1,355 1,365 1,375 1,385 6,820
64 ANALYTICAL PERSPECTIVES

TABLE 5–1. TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued

(In millions of dollars)

Provision

Total Revenue Loss

1995 1996 1997 1998 1999 2000 2001 1997–2001

Tax credit for the elderly and disabled .............................................................................................................................................. 50 55 55 60 60 65 65 305

Deductibility of casualty losses ........................................................................................................................................................... 800 445 465 490 515 540 570 2,580

Earned income credit 2 ....................................................................................................................................................................... 4,920 5,670 6,250 6,460 6,820 7,105 7,510 34,145

Social Security:

Exclusion of social security benefits:

OASI benefits for retired workers ................................................................................................................................................... 16,015 16,465 17,285 18,080 18,880 19,525 20,515 94,285

Disability insurance benefits ........................................................................................................................................................... 1,975 2,180 2,375 2,580 2,800 3,030 3,265 14,050

Benefits for dependents and survivors .......................................................................................................................................... 3,630 3,820 4,030 4,245 4,470 4,695 4,935 22,375

Veterans benefits and services:

Exclusion of veterans disability compensation ................................................................................................................................... 2,665 2,820 2,985 3,160 3,335 3,515 3,720 16,715

Exclusion of veterans pensions .......................................................................................................................................................... 75 70 70 70 75 85 90 390

Exclusion of GI bill benefits ................................................................................................................................................................ 50 65 70 80 90 95 100 435

Exclusion of interest on State and local debt for veterans housing ................................................................................................. 85 80 80 80 85 85 90 420

General purpose fiscal assistance:

Exclusion of interest on public purpose State and local debt ........................................................................................................... 12,700 13,175 13,775 14,455 15,195 15,905 16,535 75,865

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ............................................................. 27,735 29,175 30,620 32,160 33,800 35,570 37,445 169,595

Tax credit for corporations receiving income from doing business in U.S. possessions ................................................................ 2,745 2,795 2,855 3,025 3,205 3,400 3,600 16,085

Interest:

Deferral of interest on savings bonds ................................................................................................................................................ 1,100 1,160 1,210 1,280 1,340 1,410 1,480 6,720

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes .................................................................................................................................... 15,275 16,070 16,860 17,710 18,615 19,590 20,620 93,395

Nonbusiness State and local taxes other than on owner-occupied homes ................................................................................. 27,735 29,175 30,620 32,160 33,800 35,570 37,445 169,595

Exclusion of interest on:

Public purpose State and local debt .............................................................................................................................................. 12,700 13,175 13,775 14,455 15,195 15,905 16,535 75,865

IDBs for certain energy facilities .................................................................................................................................................... 175 180 180 175 175 165 160 855

IDBs for pollution control and sewage and waste disposal facilities ............................................................................................ 635 630 615 605 600 575 555 2,950

Small-issue IDBs ............................................................................................................................................................................. 555 435 345 295 280 265 260 1,445

Owner-occupied mortgage revenue bonds .................................................................................................................................... 1,810 1,810 1,770 1,710 1,655 1,605 1,540 8,280

State and local debt for rental housing ......................................................................................................................................... 925 875 815 760 700 630 545 3,450

IDBs for airports, docks, and sports and convention facilities ...................................................................................................... 855 910 965 1,025 1,090 1,145 1,205 5,430

State and local student loan bonds ............................................................................................................................................... 315 305 290 275 260 250 240 1,315

State and local debt for private nonprofit educational facilities .................................................................................................... 770 795 830 870 910 955 990 4,555

State and local debt for private nonprofit health facilities ............................................................................................................. 1,535 1,595 1,675 1,750 1,845 1,935 2,015 9,220

State and local debt for veterans housing ..................................................................................................................................... 85 80 80 80 85 85 90 420

1 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: 1995: $615; 1996: $645; 1997: $665; 1998: $685;

1999: $705; 2000: $730; and 2001: $750. 2 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1995: $15,245; 1996: $18,655; 1997: $20,450; 1998:

$21,255; 1999: $22,175; 2000: $23,210; and 2001: $24,115.

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 $5 million.

Figures in table 5–1 are the arithmetic sums of corporate and individual income tax revenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.
5. TAX EXPENDITURES 65

TABLE 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES

(In millions of dollars)

Provision

Revenue Loss

Corporations Individuals

1995 1996 1997 1998 1999 2000 2001 1995 1996 1997 1998 1999 2000 2001

National defense:

Exclusion of benefits and allowances to armed forces personnel .................. ........... ........... ........... ........... ........... ........... ........... 2,000 2,060 2,080 2,095 2,120 2,140 2,160

International affairs:

Exclusion of income earned abroad by United States citizens ....................... ........... ........... ........... ........... ........... ........... ........... 1,670 1,870 2,100 2,355 2,645 2,965 3,330

Exclusion of income of foreign sales corporations .......................................... 1,400 1,500 1,600 1,700 1,800 1,900 2,000 ........... ........... ........... ........... ........... ........... ...........

Inventory property sales source rules exception .............................................. 1,300 1,400 1,500 1,600 1,700 1,800 1,900 ........... ........... ........... ........... ........... ........... ...........

Interest allocation rules exception for certain financial operations .................. 95 95 95 95 95 95 95 ........... ........... ........... ........... ........... ........... ...........

Deferral of income from controlled foreign corporations (normal tax method) 1,700 1,800 2,000 2,200 2,400 2,600 2,900 ........... ........... ........... ........... ........... ........... ...........

General science, space, and technology:

Expensing of research and experimentation expenditures (normal tax method) .................................................................................................................. 1,605 1,705 1,805 1,910 2,025 2,150 2,275 30 35 35 35 40 40 45

Credit for increasing research activities ............................................................ 1,155 665 285 120 40 5 ........... 30 10 ........... ........... ........... ........... ...........

Suspension of the allocation of research and experimentation expenditures . 325 ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

Energy:

Expensing of exploration and development costs:

Oil and gas .................................................................................................... –225 –190 –125 –55 0 70 60 –75 –65 –40 –20 0 25 20

Other fuels ..................................................................................................... 10 10 10 10 10 10 15 5 5 5 5 5 5 5

Excess of percentage over cost depletion:

Oil and gas .................................................................................................... 710 740 765 795 830 860 895 235 245 255 265 275 285 300

Other fuels ..................................................................................................... 90 90 95 105 105 115 115 30 30 30 35 35 40 40

Alternative fuel production credit ....................................................................... 820 850 840 800 750 700 650 150 150 150 140 130 120 110

Exception from passive loss limitation for working interests in oil and gas

properties ....................................................................................................... ........... ........... ........... ........... ........... ........... ........... 55 60 60 65 65 70 75

Capital gains treatment of royalties on coal ..................................................... ........... ........... ........... ........... ........... ........... ........... 15 15 15 15 15 15 15

Exclusion of interest on State and local IDBs for energy facilities ................. 70 70 70 70 70 65 65 105 110 110 105 105 100 95

New technology credit ....................................................................................... 140 140 145 155 165 175 185 0 0 0 0 0 0 0

Alcohol fuel credit 1 ........................................................................................... 5 5 5 5 5 5 5 5 5 5 5 5 5 5

Tax credit and deduction for clean-fuel burning vehicles and properties ....... 55 55 55 60 60 60 65 10 10 10 15 20 25 25

Exclusion from income of conservation subsidies provided by public utilities 80 100 105 100 90 85 75 50 55 60 65 65 70 70

Natural resources and environment:

Expensing of exploration and development costs, nonfuel minerals .............. 25 25 25 25 25 25 25 10 10 10 10 10 10 10

Excess of percentage over cost depletion, nonfuel minerals .......................... 165 170 175 180 185 185 190 55 55 60 60 60 60 65

Capital gains treatment of iron ore ................................................................... ........... ........... ........... ........... ........... ........... ........... 0 0 0 0 0 0 0

Special rules for mining reclamation reserves ................................................. 45 45 45 45 45 45 45 5 5 5 5 5 5 5

Exclusion of interest on State and local IDBs for pollution control and sewage and waste disposal facilities .................................................................. 255 250 245 240 235 230 220 380 380 370 365 365 345 335

Capital gains treatment of certain timber income ............................................ ........... ........... ........... ........... ........... ........... ........... 15 15 15 15 15 15 15

Expensing of multiperiod timber growing costs ................................................ 210 225 235 250 260 275 285 160 170 180 190 200 210 220

Investment credit and seven-year amortization for reforestation expenditures 20 20 20 20 20 20 20 25 25 30 30 30 30 30

Tax incentives for preservation of historic structures ...................................... 25 25 25 25 25 20 20 100 100 95 90 90 90 85

Agriculture:

Expensing of certain capital outlays ................................................................. 10 10 10 10 10 10 10 60 55 55 55 60 60 60

Expensing of certain multiperiod production costs ........................................... 10 10 10 10 10 10 10 75 70 70 70 75 75 75

Treatment of loans forgiven solvent farmers as if insolvent ............................ ........... ........... ........... ........... ........... ........... ........... 10 10 10 10 10 10 10

Capital gains treatment of certain income ........................................................ ........... ........... ........... ........... ........... ........... ........... 145 145 140 145 145 150 155

Commerce and housing:

Financial institutions and insurance:

Exemption of credit union income ................................................................ 630 650 710 780 860 940 1,030 ........... ........... ........... ........... ........... ........... ...........

Excess bad debt reserves of financial institutions ....................................... 95 105 115 125 135 150 160 ........... ........... ........... ........... ........... ........... ...........

Exclusion of interest on life insurance savings ............................................ 275 295 320 340 375 400 415 9,630 10,375 11,150 12,000 12,885 13,855 14,535

Special alternative tax on small property and casualty insurance companies ............................................................................................................ 5 5 5 5 5 5 5 ........... ........... ........... ........... ........... ........... ...........

Tax exemption of certain insurance companies .......................................... 235 240 245 255 260 280 300 ........... ........... ........... ........... ........... ........... ...........

Small life insurance company deduction ...................................................... 110 115 120 130 135 140 145 ........... ........... ........... ........... ........... ........... ...........

Housing:

Exclusion of interest on owner-occupied mortgage subsidy bonds ............ 725 720 705 680 660 635 610 1,085 1,090 1,065 1,030 995 970 930

Exclusion of interest on State and local debt for rental housing ................ 365 345 320 300 275 245 215 560 530 495 460 425 385 330

Deductibility of mortgage interest on owner-occupied homes ..................... ........... ........... ........... ........... ........... ........... ........... 48,080 50,575 53,075 55,750 58,590 61,655 64,915

Deductibility of State and local property tax on owner-occupied homes ... ........... ........... ........... ........... ........... ........... ........... 15,275 16,070 16,860 17,710 18,615 19,590 20,620

Deferral of income from post 1987 installment sales .................................. 235 245 255 265 275 285 295 700 710 720 730 740 750 760

Deferral of capital gains on home sales ...................................................... ........... ........... ........... ........... ........... ........... ........... 14,180 14,605 15,040 15,490 15,955 16,435 16,930

Exclusion of capital gains on home sales for persons age 55 and over ... ........... ........... ........... ........... ........... ........... ........... 5,160 5,185 5,075 5,465 5,280 5,755 5,480

Exception from passive loss rules for $25,000 of rental loss ..................... ........... ........... ........... ........... ........... ........... ........... 4,515 4,235 3,985 3,745 3,520 3,305 3,070

Accelerated depreciation on rental housing (normal tax method) .............. 660 735 820 945 1,080 1,495 1,730 385 435 485 540 595 670 725
66 ANALYTICAL PERSPECTIVES

TABLE 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued

(In millions of dollars)

Provision

Revenue Loss

Corporations Individuals

1995 1996 1997 1998 1999 2000 2001 1995 1996 1997 1998 1999 2000 2001

Commerce:

Cancellation of indebtedness ........................................................................ ........... ........... ........... ........... ........... ........... ........... 105 70 40 15 0 –10 –5

Permanent exceptions from imputed interest rules ..................................... ........... ........... ........... ........... ........... ........... ........... 150 150 155 155 160 160 160

Capital gains (other than agriculture, timber, iron ore, and coal) (normal

tax method) ............................................................................................... ........... ........... ........... ........... ........... ........... ........... 7,125 7,000 6,920 7,035 7,195 7,385 7,560

Capital gains exclusion of small corporation stock ...................................... ........... ........... ........... ........... ........... ........... ........... 0 0 0 5 30 70 110

Step-up basis of capital gains at death ....................................................... ........... ........... ........... ........... ........... ........... ........... 28,305 29,480 30,265 30,710 31,160 31,615 32,075

Carryover basis of capital gains on gifts ..................................................... ........... ........... ........... ........... ........... ........... ........... 130 140 150 160 170 180 190

Ordinary income treatment of loss from small business corporation stock

sale ............................................................................................................ ........... ........... ........... ........... ........... ........... ........... 105 215 305 370 380 355 305

Accelerated depreciation of buildings other than rental housing (normal

tax method) ............................................................................................... 5,270 4,730 4,000 3,200 2,380 1,735 1,150 2,170 2,005 1,720 1,390 1,030 685 450

Accelerated depreciation of machinery and equipment (normal tax method) ............................................................................................................. 19,760 21,575 23,235 24,460 25,790 26,115 25,040 4,700 5,585 6,265 6,750 7,240 7,460 7,200

Expensing of certain small investments (normal tax method) .................... 1,120 930 685 500 385 220 135 695 590 435 295 215 100 20

Amortization of start-up costs (normal tax method) .................................... 85 90 90 95 95 95 100 100 105 110 110 115 115 120

Graduated corporation income tax rate (normal tax method) ..................... 4,105 4,435 4,730 5,015 5,345 5,710 6,085 ........... ........... ........... ........... ........... ........... ...........

Exclusion of interest on small issue IDBs ................................................... 215 165 135 115 110 105 105 340 270 210 180 170 160 155

Deferral of gains from sale of broadcasting facilities to minority owned

business .................................................................................................... 285 ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

Treatment of Alaska Native Corporations .................................................... 30 20 15 10 5 5 5 ........... ........... ........... ........... ........... ........... ...........

Transportation:

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

Exclusion of reimbursed employee parking expenses ..................................... ........... ........... ........... ........... ........... ........... ........... 1,215 1,255 1,290 1,330 1,370 1,410 1,455

Exclusion for employer-provided transit passes ............................................... ........... ........... ........... ........... ........... ........... ........... 35 50 60 70 85 100 120

Community and regional development:

Credit for low-income housing investments ...................................................... 450 520 590 655 700 720 690 1,810 2,080 2,355 2,615 2,800 2,875 2,755

Investment credit for rehabilitation of structures (other than historic) ............. 15 15 15 15 15 15 15 65 65 65 55 55 55 50

Exclusion of interest on IDBs for airports, docks, and sports and convention

facilities .......................................................................................................... 345 365 390 415 440 460 485 510 545 575 610 650 685 720

Exemption of certain mutuals’ and cooperatives’ income ................................ 50 50 50 55 55 60 60 ........... ........... ........... ........... ........... ........... ...........

Empowerment zones ......................................................................................... 75 100 120 135 140 150 150 175 230 265 290 310 325 340

Education, training, employment, and social services:

Education:

Exclusion of scholarship and fellowship income (normal tax method) ....... ........... ........... ........... ........... ........... ........... ........... 825 835 845 850 860 870 875

Exclusion of interest on State and local student loan bonds ..................... 125 120 115 110 105 100 95 190 185 175 165 155 150 145

Exclusion of interest on State and local debt for private nonprofit educational facilities ........................................................................................ 310 320 335 350 365 385 400 460 475 495 520 545 570 590

Exclusion of interest on savings bonds transferred to educational institutions ........................................................................................................... ........... ........... ........... ........... ........... ........... ........... 5 5 10 10 15 15 15

Parental personal exemption for students age 19 or over .......................... ........... ........... ........... ........... ........... ........... ........... 820 825 835 870 905 955 1,015

Deductibility of charitable contributions (education) ..................................... 170 180 190 200 210 220 230 1,610 1,690 1,775 1,865 1,955 2,055 2,155

Exclusion of employer provided educational assistance ............................. ........... ........... ........... ........... ........... ........... ........... 100 ........... ........... ........... ........... ........... ...........

Training, employment, and social services:

Targeted jobs credit ...................................................................................... 320 270 50 30 15 5 ........... 75 55 10 10 5 ........... ...........

Exclusion of employer provided child care .................................................. ........... ........... ........... ........... ........... ........... ........... 725 775 830 890 955 1,025 1,100

Exclusion of employee meals and lodging (other than military) ................. ........... ........... ........... ........... ........... ........... ........... 545 570 600 630 665 700 735

Credit for child and dependent care expenses ............................................ ........... ........... ........... ........... ........... ........... ........... 2,730 2,865 3,005 3,155 3,315 3,480 3,655

Credit for disabled access expenditures ...................................................... 130 130 130 130 130 135 135 30 30 35 35 35 35 35

Expensing of costs of removing certain architectural barriers to the

handicapped .............................................................................................. 15 15 15 15 15 15 15 5 5 5 5 5 5 5

Deductibility of charitable contributions, other than education and health . 4,895 5,160 5,425 5,695 5,985 6,280 6,580 14,670 15,405 16,175 16,980 17,830 18,720 19,660

Exclusion of certain foster care payments ................................................... ........... ........... ........... ........... ........... ........... ........... 30 30 35 35 35 40 40

Exclusion of parsonage allowances ............................................................. ........... ........... ........... ........... ........... ........... ........... 265 285 300 320 345 365 390

Health:

Exclusion of employer contributions for medical insurance premiums and

medical care .................................................................................................. ........... ........... ........... ........... ........... ........... ........... 59,440 64,520 70,490 77,040 84,125 91,620 99,925

Deductibility of medical expenses ..................................................................... ........... ........... ........... ........... ........... ........... ........... 3,495 3,785 4,125 4,510 4,930 5,395 5,895

Exclusion of interest on State and local debt for private nonprofit health facilities ............................................................................................................. 615 640 675 705 745 780 810 920 955 1,000 1,045 1,100 1,155 1,205

Deductibility of charitable contributions (health) ............................................... 640 670 700 730 760 790 820 1,640 1,725 1,810 1,900 1,995 2,095 2,200

Tax credit for orphan drug research ................................................................. 15 ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ........... ...........

Special Blue Cross/Blue Shield deduction ....................................................... 125 140 100 170 185 220 280 ........... ........... ........... ........... ........... ........... ...........

Income security:

Exclusion of railroad retirement system benefits .............................................. ........... ........... ........... ........... ........... ........... ........... 430 445 450 455 460 465 470
5. TAX EXPENDITURES 67

TABLE 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued

(In millions of dollars)

Provision

Revenue Loss

Corporations Individuals

1995 1996 1997 1998 1999 2000 2001 1995 1996 1997 1998 1999 2000 2001

Exclusion of workmen’s compensation benefits ............................................... ........... ........... ........... ........... ........... ........... ........... 4,475 4,855 5,050 5,255 5,515 5,800 6,205

Exclusion of public assistance benefits (normal tax method) .......................... ........... ........... ........... ........... ........... ........... ........... 570 590 635 695 740 795 850

Exclusion of special benefits for disabled coal miners .................................... ........... ........... ........... ........... ........... ........... ........... 95 90 85 85 80 75 70

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

Net exclusion of pension contributions and earnings:

Employer plans .............................................................................................. ........... ........... ........... ........... ........... ........... ........... 52,070 55,370 55,770 56,205 56,625 57,045 57,470

Individual Retirement Accounts .................................................................... ........... ........... ........... ........... ........... ........... ........... 7,720 7,830 7,940 8,335 8,420 8,455 8,490

Keogh plans ................................................................................................... ........... ........... ........... ........... ........... ........... ........... 3,315 3,345 3,580 3,780 3,935 4,090 4,240

Exclusion of employer provided death benefits ............................................... ........... ........... ........... ........... ........... ........... ........... 30 35 35 35 40 40 45

Exclusion of other employee benefits:

Premiums on group term life insurance ....................................................... ........... ........... ........... ........... ........... ........... ........... 2,880 3,020 3,170 3,325 3,485 3,660 3,865

Premiums on accident and disability insurance ........................................... ........... ........... ........... ........... ........... ........... ........... 150 155 165 175 185 195 205

Income of trusts to finance supplementary unemployment benefits ........... ........... ........... ........... ........... ........... ........... ........... 20 20 20 20 20 20 20

Special ESOP rules (other than investment credit) ......................................... 2,125 1,745 1,540 1,405 1,280 1,170 1,065 ........... ........... ........... ........... ........... ........... ...........

Additional deduction for the blind ..................................................................... ........... ........... ........... ........... ........... ........... ........... 25 25 25 25 25 30 30

Additional deduction for the elderly .................................................................. ........... ........... ........... ........... ........... ........... ........... 1,305 1,320 1,340 1,355 1,365 1,375 1,385

Tax credit for the elderly and disabled ............................................................. ........... ........... ........... ........... ........... ........... ........... 50 55 55 60 60 65 65

Deductibility of casualty losses ......................................................................... ........... ........... ........... ........... ........... ........... ........... 800 445 465 490 515 540 570

Earned income credit 2 ..................................................................................... ........... ........... ........... ........... ........... ........... ........... 4,920 5,670 6,250 6,460 6,820 7,105 7,510

Social Security:

Exclusion of social security benefits:

OASI benefits for retired workers ................................................................. ........... ........... ........... ........... ........... ........... ........... 16,015 16,465 17,285 18,080 18,880 19,525 20,515

Disability insurance benefits ......................................................................... ........... ........... ........... ........... ........... ........... ........... 1,975 2,180 2,375 2,580 2,800 3,030 3,265

Benefits for dependents and survivors ......................................................... ........... ........... ........... ........... ........... ........... ........... 3,630 3,820 4,030 4,245 4,470 4,695 4,935

Veterans benefits and services:

Exclusion of veterans disability compensation ................................................. ........... ........... ........... ........... ........... ........... ........... 2,665 2,820 2,985 3,160 3,335 3,515 3,720

Exclusion of veterans pensions ........................................................................ ........... ........... ........... ........... ........... ........... ........... 75 70 70 70 75 85 90

Exclusion of GI bill benefits .............................................................................. ........... ........... ........... ........... ........... ........... ........... 50 65 70 80 90 95 100

Exclusion of interest on State and local debt for veterans housing ............... 35 30 30 30 35 35 35 50 50 50 50 50 50 55

General purpose fiscal assistance:

Exclusion of interest on public purpose State and local debt ......................... 5,100 5,300 5,545 5,820 6,120 6,395 6,645 7,600 7,875 8,230 8,635 9,075 9,510 9,890

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ................................................................................................ ........... ........... ........... ........... ........... ........... ........... 27,735 29,175 30,620 32,160 33,800 35,570 37,445

Tax credit for corporations receiving income from doing business in U.S.

possessions ................................................................................................... 2,745 2,795 2,855 3,025 3,205 3,400 3,600 ........... ........... ........... ........... ........... ........... ...........

Interest:

Deferral of interest on savings bonds .............................................................. ........... ........... ........... ........... ........... ........... ........... 1,100 1,160 1,210 1,280 1,340 1,410 1,480

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ................................................... ........... ........... ........... ........... ........... ........... ........... 15,275 16,070 16,860 17,710 18,615 19,590 20,620

Nonbusiness State and local taxes other than on owner-occupied homes ........... ........... ........... ........... ........... ........... ........... 27,735 29,175 30,620 32,160 33,800 35,570 37,445

Exclusion of interest on:

Public purpose State and local debt ............................................................ 5,100 5,300 5,545 5,820 6,120 6,395 6,645 7,600 7,875 8,230 8,635 9,075 9,510 9,890

IDBs for certain energy facilities ................................................................... 70 70 70 70 70 65 65 105 110 110 105 105 100 95

IDBs for pollution control and sewage and waste disposal facilities .......... 255 250 245 240 235 230 220 380 380 370 365 365 345 335

Small-issue IDBs ........................................................................................... 215 165 135 115 110 105 105 340 270 210 180 170 160 155

Owner-occupied mortgage revenue bonds .................................................. 725 720 705 680 660 635 610 1,085 1,090 1,065 1,030 995 970 930

State and local debt for rental housing ........................................................ 365 345 320 300 275 245 215 560 530 495 460 425 385 330

IDBs for airports, docks, and sports and convention facilities .................... 345 365 390 415 440 460 485 510 545 575 610 650 685 720

State and local student loan bonds ............................................................. 125 120 115 110 105 100 95 190 185 175 165 155 150 145

State and local debt for private nonprofit educational facilities .................. 310 320 335 350 365 385 400 460 475 495 520 545 570 590

State and local debt for private nonprofit health facilities ........................... 615 640 675 705 745 780 810 920 955 1,000 1,045 1,100 1,155 1,205

State and local debt for veterans housing ................................................... 35 30 30 30 35 35 35 50 50 50 50 50 50 55

1 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: 1995: $615; 1996: $645; 1997: $665; 1998: $685;

1999: $705; 2000: $730; and 2001: $750. 2 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1995: $15,245; 1996: $18,655; 1997: $20,450; 1998:

$21,255; 1999: $22,175; 2000: $23,210; and 2001: $24,115.

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 $5 million.
68 ANALYTICAL PERSPECTIVES

Interpreting Tax Expenditure Estimates

Tax expenditure revenue loss estimates do not necessarily equal the increase in Federal revenues (or the

reduction in budget deficits) that would result from repealing the 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

formerly subsidized activity or of other tax preferences 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 revenue losses

associated with other provisions. For example,

even if behavior does not change, repeal of an

itemized deduction could increase the revenue

losses from other deductions because some taxpayers would be moved into higher tax brackets.

Alternatively, repeal of an itemized deduction

could lower the revenue loss 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, since

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 losses reported in Table

5–2 and do not reflect any possible interactions

between the individual and corporate income tax

receipts. For this reason, the figures in Table 5–1

(as well as those in Table 5–4, which are also

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

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

table 5–3. 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. While such

estimates are useful as a measure of cash flows

into the Government, they do not always 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.

• Repeal of some provisions could affect overall levels

of income and rates of economic growth. In principle, repeal of major tax provisions may have

some impact on the budget economic assumptions.

In general, however, most changes in particular

provisions are unlikely to have significant macroeconomic effects.

Present-Value Estimates

Discounted present-value estimates of revenue losses

are presented in table 5–3 for certain provisions that

involve tax deferrals or similar 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

losses, net of future tax payments, that follow from

activities undertaken during calendar year 1996 which

cause the deferrals or related revenue effects. For instance, a pension contribution in 1996 would cause a

deferral of tax payments on wages in 1996 and on pension earnings on this contribution (e.g., interest) in

later years. In some future year, however, the 1996

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 69

1 Budget outlay figures generally reflect the pre-tax price of the resources. In some instances, however, Government purchases or subsidies are exempted from tax by a special

tax provision. When this occurs, the outlay figure understates the resource cost of the

program and is, therefore, not comparable with other outlay amounts. For example, the

outlays for certain military personnel allowances are not taxed. If this form of compensation

were treated as part of the employee’s taxable income, the Defense Department would

have to make larger cash payments to its military personnel to leave them as well off

after tax as they are now. The tax subsidy must be added to the tax-exempt budget

outlay to make this element of national defense expenditures comparable with other outlays.

TABLE 5–3. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR

ACTIVITY IN CALENDAR YEAR 1996

(In millions of dollars)

Provision

Present Value

of Revenue Loss

Deferral of income from controlled foreign corporations (normal tax method) ............................. 1,700

Expensing of research and experimentation expenditures (normal tax method) ......................... 2,035

Expensing of exploration and development costs—oil and gas .................................................... 140

Expensing of exploration and development costs—other fuels ..................................................... 10

Expensing of exploration and development costs—nonfuels ........................................................ 50

Expensing of multiperiod timber growing costs .............................................................................. 135

Expensing of certain multiperiod production costs—agriculture .................................................... 80

Expensing of certain capital outlays—agriculture ........................................................................... 65

Deferral of capital gains on home sales ........................................................................................ 14,395

Accelerated depreciation of rental housing (normal tax method) .................................................. 1,800

Accelerated depreciation of buildings other than rental housing (normal tax method) ................ 415

Accelerated depreciation of machinery and equipment (normal tax method) .............................. 23,535

Expensing of certain small investments (normal tax method) ....................................................... 1,735

Amortization of start-up costs (normal tax method) ....................................................................... 175

Deferral of tax on shipping companies ........................................................................................... 10

Credit for low-income housing investments .................................................................................... 2,850

Exclusion of pension contributions and earnings—employer plans .............................................. 50,885

Exclusion of IRA contributions and earnings ................................................................................. 2,240

Exclusions of contribution and earnings for Keogh plans ............................................................. 3,465

Exclusion of interest on State and local public-purpose bonds .................................................... 16,140

Exclusion of interest on State and local non-public purpose bonds ............................................. 8,780

Deferral of interest on U.S. savings bonds .................................................................................... 330

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

Outlay Equivalents

The concept of ‘‘outlay equivalents’’ complements

‘‘revenue losses’’ as a measure of the budget effect of

tax expenditures. It is the amount of outlay that would

be required to provide the taxpayer the same aftertax income as would be received through the tax preference. The outlay equivalent measure allows a comparison of the cost of the tax expenditure with that

of a direct Federal outlay. Outlay equivalents are reported in table 5–4.

The measure is larger than the revenue loss estimate

when the tax expenditure is judged to function as a

Government payment for service. This occurs because

an outlay program would increase the taxpayer’s pretax income. For some tax expenditures, however, the

revenue loss equals the outlay equivalent measure. This

occurs when the tax expenditure is judged to function

like a price reduction or tax deferral that does not

directly enter the taxpayer’s pre-tax income.1
70 ANALYTICAL PERSPECTIVES

TABLE 5–4. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX

(In millions of dollars)

Provision

Outlay Equivalents

1995 1996 1997 1998 1999 2000 2001 1997–2001

National defense:

Exclusion of benefits and allowances to armed forces personnel ............................................................................................ 2,335 2,405 2,425 2,445 2,470 2,495 2,520 12,355

International affairs:

Exclusion of income earned abroad by United States citizens ................................................................................................. 2,170 2,435 2,730 3,060 3,435 3,855 4,325 17,405

Exclusion of income of foreign sales corporations .................................................................................................................... 2,155 2,310 2,460 2,615 2,770 2,925 3,075 13,845

Inventory property sales source rules exception ....................................................................................................................... 2,000 2,155 2,310 2,460 2,615 2,770 2,925 13,080

Interest allocation rules exception for certain financial operations ........................................................................................... 140 140 140 140 140 140 140 700

Deferral of income from controlled foreign corporations (normal tax method) ......................................................................... 1,700 1,800 2,000 2,200 2,400 2,600 2,900 12,100

General science, space, and technology:

Expensing of research and experimentation expenditures (normal tax method) ..................................................................... 1,635 1,740 1,840 1,945 2,065 2,190 2,320 10,360

Credit for increasing research activities ..................................................................................................................................... 1,820 1,040 440 185 60 10 ............. 695

Suspension of the allocation of research and experimentation expenditures .......................................................................... 465 ........... ........... ............. ............. ............. ............. ...................

Energy:

Expensing of exploration and development costs:

Oil and gas .............................................................................................................................................................................. –300 –255 –165 –75 0 95 80 –65

Other fuels ............................................................................................................................................................................... 15 15 15 15 15 15 20 80

Excess of percentage over cost depletion:

Oil and gas .............................................................................................................................................................................. 1,335 1,385 1,440 1,495 1,560 1,615 1,680 7,790

Other fuels ............................................................................................................................................................................... 165 175 180 195 200 215 220 1,010

Alternative fuel production credit ................................................................................................................................................ 1,370 1,400 1,390 1,330 1,240 1,160 1,080 6,200

Exception from passive loss limitation for working interests in oil and gas properties ........................................................... 55 60 60 65 65 70 75 335

Capital gains treatment of royalties on coal .............................................................................................................................. 20 20 20 20 20 20 20 100

Exclusion of interest on State and local IDBs for energy facilities ........................................................................................... 255 260 260 255 250 245 230 1,240

New technology credit ................................................................................................................................................................. 195 195 205 220 230 245 260 1,160

Alcohol fuel credit 1 ..................................................................................................................................................................... 10 10 10 10 10 10 10 50

Tax credit and deduction for clean-fuel burning vehicles and properties ................................................................................. 90 90 95 105 110 120 125 555

Exclusion from income of conservation subsidies provided by public utilities ......................................................................... 175 210 225 220 210 205 195 1,055

Natural resources and environment:

Expensing of exploration and development costs, nonfuel minerals ........................................................................................ 35 35 35 35 35 35 35 175

Excess of percentage over cost depletion, nonfuel minerals .................................................................................................... 295 320 325 335 345 345 355 1,705

Capital gains treatment of iron ore ............................................................................................................................................. 0 0 0 0 0 0 0 0

Special rules for mining reclamation reserves ........................................................................................................................... 50 50 50 50 50 50 50 250

Exclusion of interest on State and local IDBs for pollution control and sewage and waste disposal facilities ...................... 910 905 890 875 850 830 800 4,245

Capital gains treatment of certain timber income ...................................................................................................................... 20 20 20 20 20 20 20 100

Expensing of multiperiod timber growing costs ......................................................................................................................... 370 395 415 440 460 485 505 2,305

Investment credit and seven-year amortization for reforestation expenditures ........................................................................ 65 65 65 75 75 75 75 365

Tax incentives for preservation of historic structures ................................................................................................................ 125 125 120 115 115 110 105 565

Agriculture:

Expensing of certain capital outlays ........................................................................................................................................... 70 65 65 65 70 70 70 340

Expensing of certain multiperiod production costs .................................................................................................................... 85 80 80 80 85 85 85 415

Treatment of loans forgiven solvent farmers as if insolvent ..................................................................................................... 10 10 10 10 10 10 10 50

Capital gains treatment of certain income ................................................................................................................................. 195 195 185 195 195 200 205 980

Commerce and housing:

Financial institutions and insurance:

Exemption of credit union income .......................................................................................................................................... 805 825 905 995 1,090 1,195 1,310 5,495

Excess bad debt reserves of financial institutions ................................................................................................................ 145 160 175 190 205 225 240 1,035

Exclusion of interest on life insurance savings ..................................................................................................................... 13,010 14,015 15,065 16,210 17,415 18,725 19,645 87,060

Special alternative tax on small property and casualty insurance companies ..................................................................... 5 5 5 5 5 5 5 25

Tax exemption of certain insurance companies .................................................................................................................... 330 340 345 365 380 395 420 1,905

Small life insurance company deduction ............................................................................................................................... 155 160 170 185 190 200 205 950

Housing:

Exclusion of interest on owner-occupied mortgage subsidy bonds ...................................................................................... 2,610 2,600 2,540 2,455 2,380 2,305 2,215 11,895

Exclusion of interest on State and local debt for rental housing ......................................................................................... 1,330 1,250 1,170 1,085 1,005 900 780 4,940

Deductibility of mortgage interest on owner-occupied homes .............................................................................................. 48,080 50,575 53,075 55,750 58,590 61,655 64,915 293,985

Deductibility of State and local property tax on owner-occupied homes ............................................................................. 15,275 16,070 16,860 17,710 18,615 19,590 20,620 93,395

Deferral of income from post 1987 installment sales ........................................................................................................... 935 955 975 995 1,015 1,035 1,055 5,075

Deferral of capital gains on home sales ................................................................................................................................ 14,180 14,605 15,040 15,490 15,955 16,435 16,930 79,850

Exclusion of capital gains on home sales for persons age 55 and over ............................................................................ 6,880 6,915 6,765 7,285 7,040 7,675 7,305 36,070

Exception from passive loss rules for $25,000 of rental loss ............................................................................................... 4,515 4,235 3,985 3,745 3,520 3,305 3,070 17,625

Accelerated depreciation on rental housing (normal tax method) ........................................................................................ 1,045 1,170 1,305 1,485 1,675 2,165 2,455 9,085

Commerce:

Cancellation of indebtedness .................................................................................................................................................. 140 90 50 20 0 –15 –10 45

Permanent exceptions from imputed interest rules ............................................................................................................... 150 150 155 155 160 160 160 790

Capital gains (other than agriculture, timber, iron ore, and coal) ......................................................................................... 9,500 9,335 9,215 9,380 9,595 9,845 10,080 48,115

Capital gain exclusion of small corporation stock ................................................................................................................. 0 0 0 5 40 95 145 285
5. TAX EXPENDITURES 71

TABLE 5–4. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued

(In millions of dollars)

Provision

Outlay Equivalents

1995 1996 1997 1998 1999 2000 2001 1997–2001

Step-up basis of capital gains at death ................................................................................................................................. 37,740 39,305 40,355 40,945 41,545 42,155 42,765 207,765

Carryover basis of capital gains on gifts ............................................................................................................................... 130 140 150 160 170 180 190 850

Ordinary income treatment of loss from small business corporation stock sale ................................................................. 40 45 50 50 50 55 55 260

Accelerated depreciation of buildings other than rental housing (normal tax method) ....................................................... 7,440 6,735 5,720 4,590 3,410 2,420 1,600 17,740

Accelerated depreciation of machinery and equipment (normal tax method) ...................................................................... 24,460 27,160 29,500 31,210 33,030 33,575 32,240 159,555

Expensing of certain small investments (normal tax method) .............................................................................................. 1,815 1,520 1,120 795 600 320 155 2,990

Amortization of start-up costs (normal tax method) .............................................................................................................. 185 195 200 205 210 210 220 1,045

Graduated corporation income tax rate (normal tax method) ............................................................................................... 5,865 6,335 6,760 7,165 7,635 8,155 8,690 38,405

Exclusion of interest on small issue IDBs ............................................................................................................................. 785 615 490 425 400 385 375 2,075

Deferral of gains from sale of broadcasting facilities to minority owned business .............................................................. 285 ........... ........... ............. ............. ............. ............. ...................

Treatment of Alaska Native Corporations .............................................................................................................................. 30 20 15 10 5 5 5 40

Transportation:

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

Exclusion of reimbursed employee parking expenses ............................................................................................................... 1,585 1,630 1,680 1,730 1,780 1,835 1,895 8,920

Exclusion for employer-provided transit passes ......................................................................................................................... 50 65 80 100 115 135 165 595

Community and regional development:

Credit for low-income housing investments ............................................................................................................................... 2,260 2,600 2,945 3,270 3,500 3,595 3,445 16,755

Investment credit for rehabilitation of structures (other than historic) ....................................................................................... 80 80 80 70 70 70 65 355

Exclusion of interest on IDBs for airports, docks, and sports and convention facilities .......................................................... 1,240 1,315 1,395 1,480 1,570 1,655 1,735 7,835

Exemption of certain mutuals’ and cooperatives’ income ......................................................................................................... 50 50 50 55 55 60 60 280

Empowerment zones ................................................................................................................................................................... 250 330 385 425 450 475 490 2,225

Education, training, employment, and social services:

Education:

Exclusion of scholarship and fellowship income (normal tax method) ................................................................................. 910 915 925 935 945 955 965 4,725

Exclusion of interest on State and local student loan bonds ............................................................................................... 455 440 415 395 375 360 345 1,890

Exclusion of interest on State and local debt for private nonprofit educational facilities .................................................... 1,110 1,150 1,200 1,255 1,315 1,375 1,430 6,575

Exclusion of interest on savings bonds transferred to educational institutions .................................................................... 5 10 10 15 20 20 20 85

Parental personal exemption for students age 19 or over ................................................................................................... 910 915 925 960 1,000 1,060 1,125 5,070

Deductibility of charitable contributions (education) .............................................................................................................. 2,370 2,485 2,610 2,735 2,870 3,005 3,155 14,375

Exclusion of employer provided educational assistance ....................................................................................................... 125 ........... ........... ............. ............. ............. ............. ...................

Training, employment, and social services:

Targeted jobs credit ................................................................................................................................................................ 395 325 60 40 20 5 ............. 125

Exclusion of employer provided child care ............................................................................................................................ 965 1,035 1,105 1,185 1,275 1,365 1,465 6,395

Exclusion of employee meals and lodging (other than military) ........................................................................................... 665 695 730 770 810 855 900 4,065

Credit for child and dependent care expenses ..................................................................................................................... 3,640 3,820 4,005 4,205 4,420 4,640 4,875 22,145

Credit for disabled access expenditures ................................................................................................................................ 240 240 250 250 250 255 255 1,260

Expensing of costs of removing certain architectural barriers to the handicapped ............................................................. 20 20 20 20 20 20 20 100

Deductibility of charitable contributions, other than education and health ........................................................................... 26,085 27,395 28,770 30,215 31,735 33,325 35,000 159,045

Exclusion of certain foster care payments ............................................................................................................................. 35 40 40 45 45 50 50 230

Exclusion of parsonage allowances ....................................................................................................................................... 325 350 375 400 425 455 485 2,140

Health:

Exclusion of employer contributions for medical insurance premiums and medical care ....................................................... 75,630 82,230 89,985 98,510 107,755 117,545 128,420 542,215

Deductibility of medical expenses .............................................................................................................................................. 3,495 3,785 4,125 4,510 4,930 5,395 5,895 24,855

Exclusion of interest on State and local debt for private nonprofit health facilities ................................................................. 2,215 2,305 2,410 2,530 2,665 2,795 2,915 13,315

Deductibility of charitable contributions (health) ......................................................................................................................... 3,040 3,190 3,350 3,520 3,695 3,880 4,075 18,520

Tax credit for orphan drug research .......................................................................................................................................... 25 ........... ........... ............. ............. ............. ............. ...................

Special Blue Cross/Blue Shield deduction ................................................................................................................................. 175 185 140 240 260 310 395 1,345

Income security:

Exclusion of railroad retirement system benefits ....................................................................................................................... 430 445 450 455 460 465 470 2,300

Exclusion of workmen’s compensation benefits ......................................................................................................................... 4,475 4,855 5,050 5,255 5,515 5,800 6,205 27,825

Exclusion of public assistance benefits (normal tax method) ................................................................................................... 570 590 635 695 740 795 850 3,715

Exclusion of special benefits for disabled coal miners .............................................................................................................. 95 90 85 85 80 75 70 395

Exclusion of military disability pensions ..................................................................................................................................... 130 130 130 130 130 130 130 650

Net exclusion of pension contributions and earnings:

Employer plans ....................................................................................................................................................................... 72,145 76,390 76,990 77,570 78,120 78,705 79,295 390,680

Individual Retirement Accounts .............................................................................................................................................. 10,600 10,895 11,190 11,765 11,945 12,105 12,225 59,230

Keogh plans ............................................................................................................................................................................ 4,365 4,405 4,715 4,980 5,180 5,385 5,590 25,850

Exclusion of employer provided death benefits ......................................................................................................................... 40 40 45 50 50 55 60 260

Exclusion of other employee benefits:

Premiums on group term life insurance ................................................................................................................................. 3,745 3,925 4,120 4,320 4,530 4,755 5,020 22,745

Premiums on accident and disability insurance .................................................................................................................... 190 200 210 225 235 250 260 1,180

Income of trusts to finance supplementary unemployment benefits .................................................................................... 20 20 20 20 20 20 20 100

Special ESOP rules (other than investment credit) ................................................................................................................... 3,035 2,490 2,200 2,005 1,830 1,675 1,525 9,235

Additional deduction for the blind ............................................................................................................................................... 30 30 30 30 35 35 35 165

Additional deduction for the elderly ............................................................................................................................................ 1,575 1,600 1,620 1,635 1,650 1,660 1,675 8,240
72 ANALYTICAL PERSPECTIVES

TABLE 5–4. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued

(In millions of dollars)

Provision

Outlay Equivalents

1995 1996 1997 1998 1999 2000 2001 1997–2001

Tax credit for the elderly and disabled ...................................................................................................................................... 65 65 70 75 75 80 80 380

Deductibility of casualty losses ................................................................................................................................................... 1,040 580 605 635 670 705 740 3,355

Earned income credit 2 ............................................................................................................................................................... 5,470 6,300 6,945 7,180 7,580 7,895 8,345 37,945

Social Security:

Exclusion of social security benefits:

OASI benefits for retired workers ........................................................................................................................................... 16,015 16,465 17,285 18,080 18,880 19,525 20,515 94,285

Disability insurance benefits ................................................................................................................................................... 1,975 2,180 2,375 2,580 2,800 3,030 3,265 14,050

Benefits for dependents and survivors .................................................................................................................................. 3,630 3,820 4,030 4,245 4,470 4,695 4,935 22,375

Veterans benefits and services:

Exclusion of veterans disability compensation ........................................................................................................................... 2,665 2,820 2,985 3,160 3,335 3,515 3,720 16,715

Exclusion of veterans pensions .................................................................................................................................................. 75 70 70 70 75 85 90 390

Exclusion of GI bill benefits ........................................................................................................................................................ 50 65 70 80 90 95 100 435

Exclusion of interest on State and local debt for veterans housing ......................................................................................... 125 115 115 115 115 120 125 590

General purpose fiscal assistance:

Exclusion of interest on public purpose State and local debt .................................................................................................. 18,315 19,010 19,885 20,870 21,940 22,955 23,855 109,505

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ..................................................... 27,735 29,175 30,620 32,160 33,800 35,570 37,445 169,595

Tax credit for corporations receiving income from doing business in U.S. possessions ........................................................ 3,920 3,995 4,075 4,320 4,580 4,855 5,145 22,975

Interest:

Deferral of interest on savings bonds ........................................................................................................................................ 1,100 1,160 1,210 1,280 1,340 1,410 1,480 6,720

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ............................................................................................................................ 15,275 16,070 16,860 17,710 18,615 19,590 20,620 93,395

Nonbusiness State and local taxes other than on owner-occupied homes ......................................................................... 27,735 29,175 30,620 32,160 33,800 35,570 37,445 169,595

Exclusion of interest on:

Public purpose State and local debt ...................................................................................................................................... 18,315 19,010 19,885 20,870 21,940 22,955 23,855 109,505

IDBs for certain energy facilities ............................................................................................................................................ 255 260 260 255 250 245 230 1,240

IDBs for pollution control and sewage and waste disposal facilities .................................................................................... 910 905 890 875 850 830 800 4,245

Small-issue IDBs ..................................................................................................................................................................... 785 615 490 425 400 385 375 2,075

Owner-occupied mortgage revenue bonds ............................................................................................................................ 2,610 2,600 2,540 2,455 2,380 2,305 2,215 11,895

State and local debt for rental housing ................................................................................................................................. 1,330 1,250 1,170 1,085 1,005 900 780 4,940

IDBs for airports, docks, and sports and convention facilities .............................................................................................. 1,240 1,315 1,395 1,480 1,570 1,655 1,735 7,835

State and local student loan bonds ....................................................................................................................................... 455 440 415 395 375 360 345 1,890

State and local debt for private nonprofit educational facilities ............................................................................................ 1,110 1,150 1,200 1,255 1,315 1,375 1,430 6,575

State and local debt for private nonprofit health facilities ..................................................................................................... 2,215 2,305 2,410 2,530 2,665 2,795 2,915 13,315

State and local debt for veterans housing ............................................................................................................................ 125 115 115 115 115 120 125 590

1 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: 1995: $615; 1996: $645; 1997: $665; 1998: $685;

1999: $705; 2000: $730; and 2001: $750. 2 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1995: $15,245; 1996: $18,655; 1997: $20,450; 1998:

$21,255; 1999: $22,175; 2000: $23,210; and 2001: $24,115.

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 $5 million.

Tax Expenditure Baselines

A tax expenditure is a preferential exception to the

baseline provisions of the tax structure. The 1974 Congressional Budget Act does not, however, specify the

baseline provisions of the tax law. Deciding whether

provisions are preferential 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 used 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 pattered on

a comprehensive income tax, but in practice is closer

to existing law. Reference law tax expenditures are limited to special exceptions in the tax code that serve

programmatic functions. These functions correspond to

specific budget categories such as national defense, agriculture, or health care. While tax expenditures under

the reference law baseline are generally tax expenditures under the normal tax baseline, 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 when 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 owner-occupied hous-
5. TAX EXPENDITURES 73

2Gross income does, however, include transfer payments associated with past employment,

such as social security benefits.

3In the cases 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.

ing 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 measuring interest costs would be regarded as a positive

tax expenditure (i.e., a tax subsidy).

While 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.2 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.3

• 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

Under the Government Performance and Results Act

of 1993 (GPRA), Federal agencies, in conjunction with

the Office of Management and Budget, are directed to

develop performance goals, performance measures, and

strategic plans for their functions and programs. Consistent with this effort, OMB and the Department of

the Treasury have started to develop a framework for

evaluating the performance and economic effects of tax

expenditures; the discussion here summarizes the initial work on this issue. This framework is expected

to evolve over coming years based on additional work

within the Executive branch and consultation with Con-
74 ANALYTICAL PERSPECTIVES

gressional units, including the Joint Committee on Taxation and the General Accounting Office.

Tax expenditures have a variety of objectives and

effects. These include promoting certain types of activities (e.g., investment in low-income housing); influencing individual behavior (e.g., encouraging saving for retirement); and reducing the tax burden on individuals

in adverse situations (e.g., those claiming casualty

losses or large medical expenses).

Performance measurement is generally concerned

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

expenditures, the principal input is likely to be the

tax revenue loss. Outputs are quantitative or qualitative measures of goods and services, or changes in

income and investment, directly attributable to 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 investment in a certain activity, an increase in the amount of investment in that activity

would likely be a key output. The resulting production

from that investment, and, in turn, the associated net

changes (positive or negative) in national income, economic welfare, or security, could be the outcomes of

interest.

Estimation of these performance indicators and economic effects may be pursued using economic modeling

and quantitative analysis. It is anticipated that OMB,

Treasury, and other agencies will work together, as

appropriate, on determining a set of useful measures

and quantifying the effects of tax expenditures, as well

as on conceptual issues such as the identification and

measurement of tax expenditures.

The discussion below considers the types of measures

that might be useful for some major programmatic

groups of tax expenditures. The discussion is merely

intended to be illustrative.

A major set of tax expenditures benefits 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 savings.

Individuals also benefit from favorable treatment of

employer-provided health insurance. These benefits

could be evaluated in terms of their impact on health

insurance coverage and the corresponding improvements in health status.

Other provisions principally have income distribution,

rather than incentive, effects. For example, tax-favored

treatment of social security benefits provides increased

incomes to low-income retirees. This provision could be

evaluated by measuring the effects on the income of

the elderly and their well-being. The earned-income tax

credit, in contrast, should probably be evaluated both

for its effects on labor force participation as well as

its income redistribution properties.

Housing investment also benefits from tax expenditures such as the mortgage interest deduction and preferential treatment of capital gains on housing. Measures of the effectiveness of these provisions could include consideration of their effects on increasing home

ownership and the quality of housing. Deductibility of

State and local property taxes might be evaluated in

terms of its effect on making housing more affordable

as well as easing the cost of providing community services.

The above illustrative discussion, while broad, is nevertheless incomplete, both for the provisions mentioned

and the many that are not explicitly cited. Developing

a framework which is appropriately comprehensive, accurate, and flexible to reflect the objectives and effects

of the wide range of tax expenditures will be a significant challenge. It is expected that this framework will

evolve and improve over the next several years with

the objective of eventually producing appropriate quantitative analyses.

Other Considerations

The tax expenditure analysis could be extended beyond the income and transfer taxes to include payroll

and excise taxes. The exclusion of certain forms of compensation from the wage base, for instance, reduces

payroll taxes, as well as income taxes. Payroll tax exclusions are complex to analyze, however, because they

also affect social insurance benefits. Certain targeted

excise tax provisions might also be considered tax expenditures. In this case challenges include determining

an appropriate baseline.

Descriptions of Income Tax Provisions

Descriptions of the individual and corporate income

tax expenditures reported upon in this chapter follow.

NATIONAL DEFENSE

Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, are excluded from income

subject to tax.

INTERNATIONAL AFFAIRS

Income earned abroad.—A U.S. citizen or resident

alien who resides in a foreign country or who stays

in one or more foreign countries for a minimum of

11 out of the past 12 months may exclude $70,000

per year of foreign-earned income. Eligible taxpayers

also may exclude or deduct reasonable housing costs

in excess of one-sixth of the salary of a civil servant

at grade GS–14, step 1. These provisions do not apply

to Federal employees working abroad; however, the tax

expenditure estimate does reflect certain allowances

that are excluded from their taxable income.

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. These provisions conform to the General Agreement on Tariffs and Trade.
5. TAX EXPENDITURES 75

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. Two

exceptions give rise to tax expenditures: sales of inventory property that reduces the U.S. tax of exporters;

and, for financial institutions and certain financing operations of nonfinancial enterprises, an exception from

the rules that require allocation of interest expenses

between domestic and foreign activities of a U.S. taxpayer.

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 subject to U.S.

taxation, whether or not distributed. Thus, under the

normal tax baseline the excess of controlled foreign corporation income over the amount distributed to a U.S.

shareholder gives rise to a tax expenditure in the form

of a tax deferral.

GENERAL SCIENCE, SPACE, AND TECHNOLOGY

Expensing R&E expenditures.—Research and experimentation (R&E) projects can be viewed as investments because their benefits accrue for several years

when they are successful. It is difficult, however, to

identify whether a specific R&E project is completed

and successful and, if it is successful, what its expected

life will be. For these reasons, the statutory provision

that these expenditures may be expensed is considered

part of the reference law. Under the normal tax method, however, 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.

R&E credit.—Under legislation that expired on July

1, 1995, the tax credit was 20 percent of the qualified

expenditures in excess of each year’s base amount. This

threshold was determined by multiplying a ‘‘fixed-base

percentage’’ (limited to a maximum of .16 for existing

companies) by the average amount of the company’s

gross receipts for the four preceding years. The ‘‘fixedbase percentage’’ was the ratio of R&E expenses to

gross receipts for the 1984 to 1988 period. Start-up

companies that did not both incur qualified expenses

and had gross receipts in at least three of the base

years were assigned a ‘‘fixed-base percentage’’ of .03.

A similar credit with its own separate threshold was

provided for taxpayers’ basic research grants to universities. Beginning in 1989, the otherwise deductible

qualified R&E expenditures were reduced by the

amount of the credit.

Allocation of R&E expenditures.—Regulations issued in 1977 were designed to achieve a reasonable

allocation of R&E expenses between corporations’ domestic and foreign activities, but successive legislative

and administrative actions suspended this requirement.

Under legislation that expired on July 31, 1995, 50

percent of both U.S.- and foreign-based R&E expenses

were allocated to their respective income sources. The

remaining R&E expenses then had to be allocated on

the basis of gross sales or gross income.

ENERGY

Exploration and development costs.—In the case

of successful investments in domestic oil and gas wells,

intangible drilling costs, such as wages, the costs of

using machinery for grading and drilling, and 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 may currently deduct only

70 percent of such costs and 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.

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.

Alternative fuel production credit.—A nontaxable

credit of $3 per barrel (in 1979 dollars) of oil-equivalent

production is provided for several forms of alternative

fuels. It is generally available as long as the price of

oil stays below $29.50 (in 1979 dollars).

Oil and gas exception to passive loss limitation.—Although owners of working interests in oil and

gas properties are subject to the alternative minimum

tax, they are exempted from the ‘‘passive income’’ limitations. This means that 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
76 ANALYTICAL PERSPECTIVES

from such interests with his income from all other

sources. Thus, he will be relieved of the minimum tax

rules limit on tax deferrals.

Capital gains treatment of royalties on coal.—

Sales of certain coal under royalty contracts can be

treated as capital gains. While the top statutory rate

on ordinary income is 39.6 percent, the rates on capital

gains are limited to 28 percent.

Tax-exempt bonds for energy facilities.—Certain

energy facilities, such as municipal electric and gas utilities, may benefit from tax-exempt financing.

Enhanced oil recovery credit.—A credit is provided

equal to 15 percent of the taxpayer’s costs for tertiary

oil recovery on projects in the United States. 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.

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 and biomass. The renewable

resources credit applies only to electricity produced by

a facility placed in service before July 1, 1999.

Alcohol fuel credit.—Gasohol, a motor fuel composed of at least 10 percent alcohol, is exempt from

5.4 of the 18.4 cents per gallon Federal excise tax on

gasoline. Smaller exemptions are allowed for motor fuel

with lower alcohol content. There is a corresponding

income tax credit for alcohol used as a fuel in applications where the excise tax is not assessed. This credit,

equal to a subsidy of 54 cents per gallon for alcohol

used as a motor fuel, is intended to encourage substitution of alcohol for petroleum-based gasoline. In addition, small producers of ethanol are eligible for a 10

cent per gallon credit.

Credit and deduction for clean-fuel vehicles and

property.—A tax credit of 10 percent is provided for

electric vehicles. In addition, a deduction is provided

for other clean-fuel burning vehicles as well as refueling

property.

Exclusion of utility conservation subsidies.—Subsidies by public utilities for customer expenditures on

energy conservation measures are excluded from the

gross income of the customer.

NATURAL RESOURCES AND ENVIRONMENT

Exploration and development costs.—As is true

for fuel minerals, certain capital outlays associated with

exploration and development of nonfuel minerals may

be expensed rather than depreciated over the life of

the asset.

Percentage depletion.—Most nonfuel mineral extractors also make use of percentage depletion rather

than cost depletion, with percentage depletion rates

ranging from 22 percent for sulphur down to 5 percent

for sand and gravel.

Capital gains treatment of iron ore and of certain timber income.—Iron ore and certain timber sold

under a royalty contract can be treated as capital gains.

Mining reclamation reserves.—Taxpayers are allowed to establish reserves to cover certain costs of

mine reclamation and of closing solid waste disposal

properties. Net increases in reserves may be taken as

a deduction against taxable income.

Tax-exempt bonds for pollution control and

waste disposal.—Interest on State and local government debt issued to finance private pollution control

and waste disposal facilities was excludable from income subject to tax. This authorization was repealed

for pollution control equipment and limits placed on

the amount of debt that can be issued for private waste

disposal facilities by the Tax Reform Act of 1986.

Expensing multiperiod timber growing costs.—

Generally, costs must be capitalized when goods are

produced for inventory used in one’s own trade or business, or under contract to another party. Timber production, however, was specifically exempted from these

multiperiod cost capitalization rules, creating a special

benefit derived from this deferral of taxable income.

Credit and seven-year amortization for reforestation.—A special 10 percent investment tax credit is

allowed for up to $10,000 invested annually in clearing

land and planting trees for the ultimate production of

timber. The same amount of forestation investment

may also be amortized over a seven-year period. Without this preference, the amount would have to be capitalized and could be recovered (deducted) only when

the trees were sold or harvested 20 or more years later.

Moreover, the amount of forestation investment that

is amortizable is not reduced by any of the investment

credit that is allowed.

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

Expensing certain capital outlays.—Farmers, except for certain agricultural corporations and partnerships, are allowed to deduct 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.
5. TAX EXPENDITURES 77

4The insolvent taxpayer’s carryover losses and unused credits are extinguished first, and

then his basis in assets reduced to no less than amounts still owed creditors. Finally,

the remainder of the forgiven debt is excluded from tax.

Expensing multiperiod livestock and crop production costs.—The production of livestock and crops

with a production period of less than two years is exempted 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.

Loans forgiven solvent farmers.—Farmers are

granted special tax treatment by being forgiven the

tax liability on certain forgiven debt. Normally, the

amount of loan forgiveness is accounted for as a gain

(income) of the debtor and he must either report the

gain, 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. However, in the case of insolvent (bankrupt) debtors, the

amount of loan forgiveness never results in an income

tax liability.4 Farmers with forgiven debt are considered

insolvent for tax purposes, and thus qualify for income

tax forgiveness.

Capital gains treatment of certain income.—Certain agricultural income, such as unharvested crops,

can be treated as capital gains.

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

also have been classified under the energy, natural resources and environment, agriculture, or transportation

categories.

Credit union income.—The earnings of credit

unions not distributed to members as interest or dividends are exempt from income tax.

Bad debt reserves.—Only commercial banks with

less than $500 million in assets, mutual savings banks,

and savings and loan associations are permitted to deduct additions to bad debt reserves in excess of actually

experienced losses. The deduction for additions to loss

reserves allowed qualifying mutual savings banks and

savings and loan associations is 8 percent of otherwise

taxable income. To qualify, the thrift institutions must

maintain a specified fraction of their assets in the form

of mortgages, primarily residential.

Interest on life insurance savings.—Savings in the

form of policyholder reserves are accumulated from premium payments and interest is earned on the reserves.

Such interest income is not taxed as it accrues nor

when received by beneficiaries upon the death of the

insured.

Small property and casualty insurance companies.— Insurance companies that have annual net premium incomes of less than $350,000 are exempted from

tax; those with $350,000 to $2,100,000 of net premium

incomes may elect to pay tax only on the income earned

by their investment portfolio.

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 exempted from tax.

Mortgage housing bonds.—Interest on all mortgage

revenue bonds issued by State and local governments

is exempt from taxation. Proceeds are used to finance

homes purchased by first-time buyers—with low to

moderate incomes—of dwellings with prices under 90

percent of the average area purchase price.

There are limits imposed on the amount of tax-exempt State and local government bonds that could be

issued to fund private activity. The volume cap for single-family mortgage revenue bonds and multifamily

rental housing bonds is combined with the cap for student loans and industrial development bonds (IDBs).

The cap is set at $50 per capita or a minimum of

$150 million for each State.

States are authorized to issue mortgage credit certificates (MCCs) in lieu of qualified mortgage revenue

bonds because the bonds are relatively inefficient subsidies to first-time home buyers. MCCs entitle home

buyers to income tax credits for a specified percentage

of interest on qualified mortgage loans. In this way,

the entire amount of the subsidy flows directly to the

home buyer without being partly diverted to financial

middlemen or bondholders. A State cannot issue an

aggregate annual amount of MCCs greater than 25 percent of its annual ceiling for qualified mortgage bonds.

Because of the relationship between MCCs and qualified mortgage bonds, their estimates are presented as

one line item in the tables.

Rental housing bonds.—State and local government

issues of IDBs are restricted to multifamily rental housing projects in which 20 percent (15 percent in targeted

areas) of the units are 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.
78 ANALYTICAL PERSPECTIVES

5Thus, when a borrower on December 31, 1995, issues a promise to pay $1,000 plus

interest at 10 percent on December 30, 1996, for a total repayment of $1,100, and accepts

$900 from a lender in exchange for the contract, the rules require that both parties: (a)

recognize that $900 is the amount lent, so that the effective loan interest rate is not

the nominal 10 percent rate but is 22.2 percent; and (b) both report $200 as interest

paid or received in 1996, as the case may be.

Interest and taxes on owner-occupied homes.—

Owner-occupants of homes may deduct mortgage interest and property taxes 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.

Real property installment sales.—Dealers in real

and personal property, i.e., sellers that regularly hold

property for sale or resale, cannot defer taxable income

from installment sales until the receipt of the loan repayment. Nondealers, defined as sellers of real property

used in their business, are required to pay interest

to the Federal Government 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 $5,000,000 is,

therefore, a tax expenditure.

Capital gains on home sales.—When a primary

residence is sold, the homeowner can defer paying a

capital gains tax on the proceeds by purchasing or constructing a home of value at least equal to that of

the prior home (net of sales and qualified fix-up expenses) within two years. This deferral is a tax expenditure.

Capital gains on sales by owners aged 55 or

older.—A taxpayer who is 55 years of age or older

at the time of the sale of his residence may elect to

exclude from tax up to $125,000 of the gain from its

sale. This is a once-in-a-lifetime election. In effect, this

provision converts some prior deferrals of tax into forgiveness of tax.

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 exempted from this rule.

Accelerated depreciation of real property, machinery and equipment.—As previously noted, the tax

depreciation allowance provisions are part of the reference law rules, and thus do not cause tax expenditures under the reference method. Under the normal

tax method, however, a 40-year tax life for depreciable

real property is the norm. So, the statutory depreciation

period in effect from 1987 to 1993 for nonresidential

properties of 31.5 years, and the 39-year period for

property placed in service after February 25, 1993, give

rise to tax expenditures. The statutory depreciation period for residential property is 27.5 years, which also

results in tax expenditures. Statutory depreciation of

machinery and equipment also is somewhat accelerated

relative to the normal tax baseline. In addition, tax

expenditures arise from pre-1987 tax allowances for

real and personal property.

Cancellation of indebtedness.—Individuals are not

required to report the cancellation of certain indebtedness as current income. However, if they do not, it

would be included as an adjustment in the basis of

the underlying property.

Imputed interest rules.—Under reference law rules

commonly referred to as original issue discount (OID),

both the holder and seller of a financial contract are

generally required to report interest earned in the period it accrues, not when the contract payments are

made. Moreover, the amount of interest accruable is

determined by the actual price paid for the contract,

not by the stated or nominal principal and interest

stipulated in the contract.5

Exceptions to the general rules for accounting for

interest expense or income include the following: (a)

permission for the mortgagor of his personal residence

to treat the discount from the nominal principal of his

mortgage loan, commonly called ‘‘points,’’ as prepaid

interest which is deductible in the year paid, not the

year accrued; and (b) sellers of farms and small businesses worth less than $1 million, in exchange for the

purchaser’s debt obligation, are exempted from the OID

rules. This is $750,000 more than the $250,000 exemption that the reference tax law generally allows for

such transactions.

Capital gains (other than agriculture, timber,

iron ore and coal).—While the top statutory rate on

ordinary income is 39.6 percent, the rates on capital

gains are limited to 28 percent. This treatment is considered a tax expenditure under the normal tax method

but not under the reference law method.

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. Certain activities such as personal services and

banking are ineligible for the exclusion.

Step-up in basis of capital gains at death.—Capital gains on assets held at the owner’s death are not
5. TAX EXPENDITURES 79

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 capital gain

is forgiven.

Carryover basis of capital gains on gifts.—When

a gift is made, the transferred property carries to the

donee the donor’s basis—the cost that was incurred

when the property was first acquired. The carryover

of the donor’s basis allows a continued deferral of unrealized capital gains.

Ordinary income treatment of losses from sale

of small business corporate stock shares.—Up to

$100,000 in losses from the sale of such stock may

be treated as ordinary losses, and therefore not be subject to the $3,000 annual capital loss write-off limit

if the corporation’s capitalization is less than $1 million.

Expensing of certain small investments.—Qualifying investments in tangible property up to $17,500

($10,000 prior to 1993) can be expensed rather than

depreciated over time. To the extent that qualifying

investment during the year exceeds $200,000, the

amount eligible for expensing is decreased. The amount

expensed is completely phased out when qualifying investments exceed $217,500.

Business start-up costs.—When an individual or

corporation acquires or otherwise enters into a new

business, certain start-up expenses, such as the costs

of investigating opportunities and legal services, are

normally incurred. The taxpayer may elect to amortize

these outlays over 60 months although they are similar

to other payments he makes for nondepreciable intangible assets that are not recoverable until the business

is sold. Under the normal tax method this gives rise

to a tax expenditure, while under the reference method

it does not.

Graduated corporation income tax rate schedule.—The schedule is graduated, with rates of 15 percent on the first $50,000 of taxable income, 25 percent

on the next $25,000, 34 percent on the next $9.925

million, and a rate of 35 percent on income over $10

million. As compared with a flat 35 percent tax rate,

the lower rates provide a $111,000 reduction in tax

liability for corporations with taxable incomes of $10

million. This benefit is recaptured in the cases of corporations with taxable incomes exceeding $100,000.

This is accomplished by (1) a 5 percent additional tax

on corporate incomes in excess of $100,000, but less

than $335,000 and (2) a 3 percent additional tax on

income over $15 million but less than $18.33 million.

At this point the $111,000 is fully recaptured. Since

this rate schedule is part of the reference tax law, it

does not give rise to 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 do yield a tax expenditure

under this concept.

Small issue industrial development bonds.—The

interest on small issue industrial development bonds

(IDBs) issued by State and local governments to finance

private business property is excluded from income subject to tax. Depreciable property financed with small

issue IDBs must be depreciated, however, using the

straight-line method. The tax exemption of small issue

bonds expired in 1986, except for small issue IDBs exclusively issued to finance manufacturing facilities for

which the tax exemption is permanent. The annual volume of small issue IDBs is subject to the unified volume cap discussed in the mortgage housing bond section above.

Deferral of gains from sale of broadcasting facility to minority owned business.—The voluntary

sale of assets generally requires the seller to pay tax

on the gain that has accrued over the period of ownership. However, in the case of an involuntary sale, as

when an owner’s property must be sold in a condemnation preceding, or to implement a change in a government’s regulatory policy, the owner is permitted to

defer payment of tax, provided the proceeds are reinvested in similar property within a specified period.

In 1979, the Federal Communications Commission instituted a policy of encouraging minority group ownership of broadcast licenses. Since that time, the tax laws

have been interpreted to permit voluntary sellers of

licensed broadcasting facilities to defer payment of capital gains tax when the buyer has been certified as

a ‘‘minority business,’’ in effect treating the sale as

‘‘involuntary.’’

Treatment of Alaskan Native Corporations

losses.—Tax law restricts the ability of profitable corporations to reduce their tax liabilities by merging or

buying corporations with accumulated net operating

losses (NOLs) and as yet unrefunded claims to investment credits. Alaska Native Corporations have a limited exemption (fifteen years after the NOL or credit

claim was first experienced) from these restrictions that

includes NOLs and credits claimable prior to April 26,

1988.

TRANSPORTATION

Shipping companies that are U.S. flag carriers.—Certain companies that operate U.S. flag vessels receive a deferral of 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 qualified investments. Once indefinite, the deferral has been limited to 25 years since January 1, 1987.

Exclusion of reimbursed employee parking expenses.—Parking at or near an employer’s business

premises that is paid for by the employer is excludable
80 ANALYTICAL PERSPECTIVES

from the income of the employee as a working condition

fringe benefit. The maximum amount of the parking

exclusion is $155 month (in 1993 dollars), indexed in

$5 increments. The tax expenditure estimate does not

include parking at facilities owned by the employer.

Exclusion of employer-provided transit passes.—

Transit passes, tokens, and fare cards provided by an

employer to defray an employee’s commuting costs are

excludable from the employee’s income as a de minimis

fringe benefit, if the total value of the benefit does

not exceed $60 per month (in 1993 dollars), indexed

in $5 increments.

COMMUNITY AND REGIONAL DEVELOPMENT

Low-income housing investment.—Through 1989,

a tax credit for investment in new, substantially rehabilitated, and certain unrehabilitated low-income housing was structured to have a present value of 70 percent of construction or rehabilitation costs incurred and

was allowed over 10 years. For Federally subsidized

projects and those involving unrehabilitated existing

low income housing, the credit was structured to have

a present value of 30 percent. Beginning on January

1, 1990, the credit was extended at a present value

of 70 percent, including projects financed with other

Federal subsidies, but only if substantial rehabilitation

was done. Notwithstanding the capital grant character

of this subsidy, the investor’s recoverable basis is not

reduced by the substantial credit allowed.

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. A full reduction by the

amount of the credit is required in the taxpayer’s recoverable basis.

Tax-exempt bonds for airports and similar facilities.—Government-owned airports, docks and

wharves, as well as high-speed rail facilities that need

not be government-owned, may be financed with taxexempt bonds. These bonds are not covered by a volume

cap.

Exemption of certain mutuals’ and cooperatives’

income.—The incomes of mutual and cooperative telephone and electric companies are exempted from tax

if at least 85 percent of their revenues are derived

from patron service charges.

Empowerment zones.—Qualifying businesses in designated economically depressed areas can receive tax

benefits such as an employer wage credit, increasing

expensing of investment in equipment, tax-exempt financing, and accelerated depreciation. In addition, a

tax credit for contributions to certain community development corporations can be available.

EDUCATION, TRAINING, EMPLOYMENT, AND SOCIAL

SERVICES

Scholarship and fellowship income.—Scholarships and fellowships are not excluded from taxable

income to the extent they exceed tuition and courserelated expenses of the grantee. 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, the exclusion is not a tax

expenditure because this method does not include either

gifts or price reductions in a taxpayer’s gross income.

Under the normal tax method, however, the exclusion

is considered a tax expenditure because under this

method gift-like transfers of government funds—and

many scholarships are derived directly or indirectly

from government funding—are included in gross income.

Tax-exempt bonds for educational purposes.—Interest on State and local government debt issued to

finance student loans or the construction of facilities

used by private nonprofit educational institutions is excluded from income subject to tax. The aggregate volume of such private activity bonds that each State may

issue during any calendar year is limited.

U.S. savings bonds for education.—Interest on

U.S. savings bonds, issued after December 31, 1989,

may be excluded from tax if the bonds, plus accrued

interest, are transferred to an educational institution

as payment for educational expenses. The exclusion

from tax is phased out for joint returns with adjusted

gross incomes of $65,250 to $95,250 and $43,500 to

$58,500 for single and head of household returns in

1995.

Dependent students age 19 or older.—Taxpayers

can claim personal exemptions for dependent children

age 19 or over who receive parental support payments

of $1,000 or more per year, are full-time students, and

do not claim a personal exemption on their own tax

returns. This preferential arrangement usually generates tax savings because the students’ marginal tax

rates are more often than not lower than their parents’

marginal tax rates.

Charitable contributions.—Contributions to charitable, religious, and certain other nonprofit organizations are allowed as an itemized deduction for individuals, generally up to 50 percent of adjusted gross income. Taxpayers who donate capital assets to charitable

or educational organizations can deduct the assets’ current value without the taxation of any appreciation in

value. Corporations can also deduct charitable contributions up to 10 percent of their pre-tax income. Tax

expenditures resulting from the deductibility of contributions are shown separately for educational and

other institutions. Contributions to health institutions

are reported under the health function.
5. TAX EXPENDITURES 81

Employer provided benefits.—Many employers provide employee benefits that are not counted in employee

income. The employers’ costs for these benefits are deductible business expenses. The exclusion from an employee’s income of the value of educational assistance,

child care, meals and lodging, as well as ministers’

housing allowances and the rental value of parsonages

are tax expenditures. The exclusion for educational assistance expired on December 31, 1994. Health and

other insurance benefits are reported under the health

and income security functions. Certain parking and

transit benefits are reported under the transportation

function.

Targeted jobs credit.—Employers could claim a tax

credit for qualified wages paid to individuals who began

work before January 1, 1995, and who were certified

as members of various targeted groups. The amount

of the credit that could be claimed was 40 percent of

the first $3,000 paid during the first year of employment. The 40 percent credit also applied to the summer

employment wages paid to 16 and 17 year old youths

who were members of low income families. Employers

had to reduce their deduction for wages paid by the

amount of the credit claimed.

Child and dependent care expenses.—A tax credit

may be claimed by married couples for child and dependent care expenses incurred 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 divorced or separated parents who have custody of children, and by single parents. 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.

Disabled access expenditures.—A credit is provided of 50 percent of eligible disabled access expenditures in excess of $250. The credit is limited to $5,000.

Costs of removing architectural barriers to the

handicapped.—The investment cost of making any

business accessible to persons suffering physical or

mental disabilities may be deducted, rather than capitalized as part of the taxpayer’s basis in such property

and recovered by subsequent depreciation allowances,

as is generally required.

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 explicitly excluded from the gross

incomes of foster parents, making the expenses they

incur nondeductible. This activity is, in effect, tax-exempt.

HEALTH

Employer paid medical insurance and expenses.—Employee compensation, in the form of payments by employers for health insurance premiums and

other medical expenses, is deducted as a business expense by employers, but it is not included in employee

gross income.

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.

Tax-exempt bonds for hospital construction.—Interest earned on State and local government debt issued to finance hospital construction is excluded from

income subject to tax.

Charitable contributions to health institutions.—Contributions to nonprofit health institutions

are allowed as a deduction for individuals and corporations. Tax expenditures resulting from the deductibility

of contributions to other charitable institutions are listed under the education, training, employment, and social services function.

Orphan drugs.—To encourage the development of

drugs for the treatment of rare diseases or physical

conditions, a tax credit was granted equal to 50 percent

of the costs for clinical testing that must be completed

before manufacture and distribution are approved by

the Food and Drug Administration. Because the drug

firm was not required to reduce its deduction for testing

expenses (an R&D expenditure) by the amount of this

credit, the private cost of clinically testing orphan drugs

was reduced substantially. This tax expenditure expired

December 31, 1994.

Blue Cross and Blue Shield.—Although these organizations are not qualified as exempt, they are provided

exceptions from otherwise applicable insurance company income tax accounting rules that effectively eliminate their tax liabilities.

INCOME SECURITY

Railroad retirement benefits.—These benefits are

not generally subject to the income tax unless the recipient’s gross income reaches a certain threshold discussed more fully under the social security function.

Workmen’s compensation benefits.—Workmen’s

compensation provides payments to disabled workers.

These benefits, although income to the recipients, are

a tax preference because they are not subject to the

income tax.

Public assistance benefits.—The exclusion from

taxable income of public assistance benefits received

by individuals is listed as a tax expenditure under the

normal tax method because, under this method, cash
82 ANALYTICAL PERSPECTIVES

transfers from government are included in gross income. In contrast, gifts not conditioned on the performance of services, including transfers from government,

are not taxable under the reference law. Therefore,

under the reference tax method, the tax exclusion for

public assistance benefits is not shown as a tax expenditure.

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.

Military disability pensions.—Most of the military

pension income received by current disabled retired veterans is excluded from their income subject to tax.

Pension contributions and earnings.—Certain

employer contributions to pension plans, along with individual contributions to individual retirement accounts

(IRAs) and amounts set aside by the self-employed, are

excluded from adjusted gross income in the year of

contribution. The investment income earned by pension

funds and other qualifying retirement plans is not taxable when earned, and this deferral is, therefore, also

a tax expenditure.

Limited amounts ($9,500 in 1996) can be excluded

from an employee’s compensation under a qualified

cash or deferred arrangement with the employer (401(k)

plan) or tax-sheltered annuity (403(b) plan).

Employees may deduct annual contributions to an

IRA of $2,000 (or 100 percent of compensation, if less),

or $2,250 on a joint return with only one spouse earning income, if: (a) neither the individual or spouse is

an active participant in an employer-provided retirement plan; or (b) their adjusted gross income falls below

$40,000 ($25,000 for a single taxpayer). The allowable

IRA deduction is phased out between $40,000 and

$50,000 for a joint return and $25,000 and $35,000

for a single return. Beyond these income limits, nondeductible contributions to IRAs are available to taxpayers who are active participants in employer-provided

retirement plans. Self-employed persons 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.

Employer provided insurance benefits.—Many

employers cover part or all the cost of premiums or

payments for: (a) employees’ life insurance benefits; (b)

accident and disability benefits; (c) death benefits; and

(d) supplementary unemployment benefits. The

amounts are deductible by the employers and are excluded as well from employees’ gross incomes for tax

purposes.

Employer Stock Ownership Plan (ESOP) provisions.—A special type of employee benefit plan, organized as a trust, is tax-exempt. 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

(percentages of employees’ cash compensation); (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) ESOPs’ lenders may exclude

half the interest from their gross income; (4) employees

who sell appreciated company stock to the ESOP may

defer any taxes due until they withdraw benefits; and

(5) dividends paid to ESOP-held stock are deductible

by the employer.

Support of the aged and the blind.—Taxpayers

who are blind or 65 years of age or older may take

an additional $1,000 standard deduction if single, or

$800 if married. In addition, 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 income. Qualified income

is limited to no more than $2,500 for single individuals

or married couples filing a joint return where only one

spouse is 65 years of age or older, and up to $3,750

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.

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. However, a special provision

permits relief for taxpayers suffering an uninsured loss.

They may deduct casualty and theft losses of more than

$100 each, but only to the extent that total losses during the year exceed 10 percent of adjusted gross income.

Earned income credit.—This credit may be claimed

by low income workers. For a family with one qualifying child, the credit is 34 percent of the first $6,330

of earned income in 1996. The credit is 40 percent

of the first $8,890 of income for a family with two

or more qualifying children. When the taxpayer’s income exceeds $11,610, 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 $25,078 of adjusted gross income ($28,495 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 1996,

the credit is 7.65 percent of the first $4,220 of earned
5. TAX EXPENDITURES 83

income. When the taxpayer’s income exceeds $5,280,

the credit is phased out at the rate of 7.65 percent.

It is completely phased out at $9,500 of 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 are refundable to individuals, and as such are paid by the Federal Government. This portion of the credit is included in outlays,

while the amount that offsets tax liabilities is shown

as a tax expenditure.

SOCIAL SECURITY

Old Age and Survivors Insurance (OASI) 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.

Social Security benefits for the disabled, dependents and survivors.—Benefit payments from the Social Security Trust Fund, for disability and for dependents and survivors, are excluded from the beneficiaries’

gross incomes, and thus give rise to tax expenditures.

VETERANS BENEFITS AND SERVICES

Veterans benefits.—All compensation due to death

or disability and pensions paid by the Veterans Administration are excluded from taxable income.

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

Public purpose State and local debt.—Interest on

State and local government debt, issued to finance government activities, is excluded from Federal taxation.

State and local governments, therefore, can sell debt

obligations at a lower interest cost than would be possible if such interest were subject to tax. Only the excluded interest on bonds for public purposes, such as

schools, roads, and sewers, is included here.

Nonbusiness State and local taxes excluding

home-owner property taxes.—The deductibility of

nonbusiness State and local income and personal property taxes gives indirect assistance to these governments by reducing the costs of the services they provide.

Business income earned in U.S. possessions.—

Under certain conditions, U.S. corporations receiving

income from an active trade or business, or from investments located in a U.S. possession, can claim a special

credit against U.S. tax otherwise due.

INTEREST

U.S. savings bonds.—The interest on U.S. savings

bonds is not taxable until the bonds are redeemed,

thereby deferring tax liability. The deferral is equivalent to an interest-free loan and, therefore, it is a tax

expenditure.

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
84 ANALYTICAL PERSPECTIVES

TABLE 5–5. REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED

TRANSFER TAX

(In millions of dollars)

Description

Fiscal Years

1995 1996 1997 1998 1999 2000 2001 1997–2001

Natural Resources and Environment:

Deductions for donations of conservation easements .................. 0 0 0 0 0 0 0 0

Agriculture:

Special use valuation of farm real property .................................. 70 75 80 85 90 95 100 450

Tax deferral of closely held farms ................................................. 55 60 65 70 75 80 85 375

Commerce:

Special use valuation of real property used in closely held businesses ........................................................................................ 20 20 20 25 25 25 25 120

Tax deferral of closely held business ........................................... 10 10 10 10 15 15 15 65

Education, training, employment, and social services:

Deduction for charitable contributions (education) ........................ 515 565 600 640 680 730 775 3,425

Deduction for charitable contributions (other than education and

health) ........................................................................................ 1,520 1,650 1,765 1,885 2,005 2,135 2,280 10,070

Health:

Deduction for charitable contributions (health) ............................. 465 510 550 590 630 680 730 3,180

General government:

Credit for State death taxes .......................................................... 2,885 3,175 3,420 3,685 3,965 4,250 4,555 19,875

Note: All estimates have been rounded to the nearest $5 million.

6An additional tax, at a flat rate of 55 percent, is imposed on lifetime, generation-skipping

transfers in excess of $1 million. 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.

gifts made plus the net estate at death. Gifts in

the tax base are all annual transfers in excess

of $10,000 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 $192,800 lifetime credit is provided against the

tax in determining the final amount of transfer

taxes that are due and payable. This allows each

taxpayer to make a $600,000 tax-free transfer of

assets that otherwise would be liable to the unified transfer tax.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 1995–2001 are displayed by functional category in table 5–5. 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

Donations of conservation easements.—Bequests

for conservation are excluded from taxable estates. A

conservation bequest is the value of property and easements (in perpetuity) to such property the use of which

is restricted to any one or more of the following: the

public for outdoor recreation; protection of the natural

habitats of fish, wildlife, plants, etc.; scenic enjoyment

of the public; and preservation of historic land areas

and structures. Similar conservation gifts are excluded

from the gift tax base and are also deductible from

the donor’s otherwise taxable income in the year of

the gift.

AGRICULTURE

Special use valuation of farms.—Farmland owned

and operated by a decedent and/or a member of the

family may be valued for estate tax purposes on the
5. TAX EXPENDITURES 85

basis of its ‘‘continued use’’ as a farm if: the farmland

is at least 25 percent of the decedent’s gross estate;

the entire value of all farm property is at least 50

percent of the gross estate; and family heirs to the

farm agree to continue to operate the property as a

farm for at least 10 years. Since continued use valuation of farmland is frequently substantially less than

the fair market value, the resulting reduction in tax

liability serves as a subsidy to the continued operation

of family farms.

Tax deferral of closely held farms.—Decedents’ estates may use a preferential, extended installment payment period of five to 15 years to discharge estate tax

liabilities if the value of the farm properties exceeds

35 percent of the net estates. The interest charged is

only 4 percent for the first five years, rather than the

standard Federal short-term borrowing rate plus three

percentage points, which applies during the last 10

years of the repayment period.

COMMERCE AND HOUSING CREDIT

Special use valuation of closely held businesses.—The two estate tax incentives to family farming are also available to the estates of owners of nonfarm family businesses. If the same three conditions

previously described are met, the real property in their

estates is eligible for continued use valuation.

Tax deferral of closely held businesses.—Nonfarm

family businesses that satisfy the net estate requirements qualify for preferential 15 year deferred estate

tax payment. To be eligible for this special provision,

the value of stock in closely held corporations must

exceed 35 percent of the decedent’s gross estate, less

debt and funeral expenses.

EDUCATION, TRAINING, EMPLOYMENT, AND SOCIAL

SERVICES

Bequests to tax-exempt organizations.—These bequests are deductible from decedent’s otherwise taxable

lifetime transfers.

HEALTH

Bequests to health providers.—Such bequests, that

are exempt from the income tax, are deductible from

otherwise taxable lifetime transfers of decedents.

GENERAL GOVERNMENT

State and local death taxes.—A credit is allowed

for state death taxes against any Federal estate tax

that otherwise would be due. The amount of the state

death tax credit is determined by a rate schedule that

reaches a limit of 16 percent of the taxable estate in

excess of $60,000.
86 ANALYTICAL PERSPECTIVES

TABLE 5–6. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 1997 REVENUE LOSS

(In millions of dollars)

Provision 1997 1997–2001

Exclusion of employer contributions for medical insurance premiums and medical care ................................................................................... 70,490 423,200

Net exclusion of employer pension plan contributions and earnings .................................................................................................................. 55,770 283,115

Deductibility of mortgage interest on owner-occupied homes .............................................................................................................................. 53,075 293,985

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ................................................................................ 30,620 169,595

Step-up basis of capital gains at death ................................................................................................................................................................ 30,265 155,825

Accelerated depreciation of machinery and equipment (normal tax method) ..................................................................................................... 29,500 159,555

Deductibility of charitable contributions (all types) ................................................................................................................................................ 26,075 143,985

Exclusion of OASI benefits for retired workers ..................................................................................................................................................... 17,285 94,285

Deductibility of State and local property tax on owner-occupied homes ............................................................................................................. 16,860 93,395

Deferral of capital gains on home sales ............................................................................................................................................................... 15,040 79,850

Exclusion of interest on public purpose State and local debt .............................................................................................................................. 13,775 75,865

Exclusion of interest on life insurance savings ..................................................................................................................................................... 11,470 66,275

Net exclusion of Individual Retirement Account contributions and earnings ....................................................................................................... 7,940 41,640

Exclusion of interest on State and local debt for various non-public purposes .................................................................................................. 7,565 37,920

Capital gains (other than agriculture, timber, iron ore, and coal) (normal tax method) ..................................................................................... 6,920 36,095

Earned income credit 1 .......................................................................................................................................................................................... 6,250 34,145

Accelerated depreciation of buildings other than rental housing (normal tax method) ....................................................................................... 5,720 17,740

Exclusion of capital gains on home sales for persons age 55 and over ............................................................................................................ 5,075 27,055

Exclusion of workmen’s compensation benefits .................................................................................................................................................... 5,050 27,825

Graduated corporation income tax rate (normal tax method) .............................................................................................................................. 4,730 26,885

Deductibility of medical expenses .......................................................................................................................................................................... 4,125 24,855

Exclusion of social security benefits for dependents and survivors .................................................................................................................... 4,030 22,375

Exception from passive loss rules for $25,000 of rental loss .............................................................................................................................. 3,985 17,625

Net exclusion of Keogh plan contributions and earnings ..................................................................................................................................... 3,580 19,625

Premiums on employer-provided group term life insurance ................................................................................................................................. 3,170 17,505

Credit for child and dependent care expenses ..................................................................................................................................................... 3,005 16,610

Exclusion of veterans disability compensation ...................................................................................................................................................... 2,985 16,715

Credit for low-income housing investments ........................................................................................................................................................... 2,945 16,755

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................................................... 2,855 16,085

Exclusion of social security disability insurance benefits ..................................................................................................................................... 2,375 14,050

Exclusion of income earned abroad by United States citizens ............................................................................................................................ 2,100 13,395

Exclusion of benefits and allowances to armed forces personnel ....................................................................................................................... 2,080 10,595

Deferral of income from controlled foreign corporations (normal tax method) .................................................................................................... 2,000 12,100

Expensing of research and experimentation expenditures (normal tax method) ................................................................................................ 1,840 10,360

Exclusion of income of foreign sales corporations ............................................................................................................................................... 1,600 9,000

Special ESOP rules (other than investment credit) .............................................................................................................................................. 1,540 6,460

Inventory property sales source rules exception .................................................................................................................................................. 1,500 8,500

Additional deduction for the elderly ....................................................................................................................................................................... 1,340 6,820

Accelerated depreciation on rental housing (normal tax method) ........................................................................................................................ 1,305 9,085

Exclusion of reimbursed employee parking expenses .......................................................................................................................................... 1,290 6,855

Deferral of interest on savings bonds ................................................................................................................................................................... 1,210 6,720

Excess of percentage over cost depletion (oil, gas, and other fuels) ................................................................................................................. 1,145 6,240

Expensing of certain small investments (normal tax method) .............................................................................................................................. 1,120 2,990

Alternative fuel production credit ........................................................................................................................................................................... 990 4,390

Deferral of income from post 1987 installment sales ........................................................................................................................................... 975 5,075

Exclusion of scholarship and fellowship income (normal tax method) ................................................................................................................ 845 4,300

Parental personal exemption for students age 19 or over ................................................................................................................................... 835 4,580

Exclusion of employer provided child care ........................................................................................................................................................... 830 4,800

Exemption of credit union income ......................................................................................................................................................................... 710 4,320

Exclusion of public assistance benefits (normal tax method) .............................................................................................................................. 635 3,715

Exclusion of employee meals and lodging (other than military) .......................................................................................................................... 600 3,330

Deductibility of casualty losses .............................................................................................................................................................................. 465 2,580

Exclusion of railroad retirement system benefits .................................................................................................................................................. 450 2,300

Expensing of multiperiod timber growing costs .................................................................................................................................................... 415 2,305

Empowerment zones .............................................................................................................................................................................................. 385 2,225

Ordinary income treatment of loss from small business corporation stock sale ................................................................................................. 305 1,715

Exclusion of parsonage allowances ....................................................................................................................................................................... 300 1,720

Credit for increasing research activities ................................................................................................................................................................ 285 450

Tax exemption of certain insurance companies ................................................................................................................................................... 245 1,340

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................................................... 235 1,220

Amortization of start-up costs (normal tax method) .............................................................................................................................................. 200 1,045

Exclusion from income of conservation subsidies provided by public utilities .................................................................................................... 165 785

Premiums on employer-provided accident and disability insurance ..................................................................................................................... 165 925

Credit for disabled access expenditures ............................................................................................................................................................... 165 835

Permanent exceptions from imputed interest rules .............................................................................................................................................. 155 790

Carryover basis of capital gains on gifts ............................................................................................................................................................... 150 850

New technology credit ............................................................................................................................................................................................ 145 825

Capital gains treatment of certain income ............................................................................................................................................................ 140 735

Exclusion of military disability pensions ................................................................................................................................................................ 130 650
5. TAX EXPENDITURES 87

TABLE 5–6. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 1997 REVENUE LOSS—Continued

(In millions of dollars)

Provision 1997 1997–2001

Small life insurance company deduction ............................................................................................................................................................... 120 670

Tax incentives for preservation of historic structures ........................................................................................................................................... 120 565

Excess bad debt reserves of financial institutions ................................................................................................................................................ 115 685

Enhanced oil recovery credit ................................................................................................................................................................................. 100 520

Special Blue Cross/Blue Shield deduction ............................................................................................................................................................ 100 955

Interest allocation rules exception for certain financial operations ....................................................................................................................... 95 475

Exclusion of special benefits for disabled coal miners ......................................................................................................................................... 85 395

Expensing of certain multiperiod production costs ............................................................................................................................................... 80 415

Investment credit for rehabilitation of structures (other than historic) .................................................................................................................. 80 355

Exclusion of veterans pensions ............................................................................................................................................................................. 70 390

Exclusion of GI bill benefits ................................................................................................................................................................................... 70 435

Expensing of certain capital outlays ...................................................................................................................................................................... 65 340

Tax credit and deduction for clean-fuel burning vehicles and properties ............................................................................................................ 65 395

Exclusion for employer-provided transit passes .................................................................................................................................................... 60 435

Targeted jobs credit ............................................................................................................................................................................................... 60 125

Exception from passive loss limitation for working interests in oil and gas properties ...................................................................................... 60 335

Tax credit for the elderly and disabled ................................................................................................................................................................. 55 305

Investment credit and seven-year amortization for reforestation expenditures ................................................................................................... 50 250

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................................................... 50 280

Special rules for mining reclamation reserves ...................................................................................................................................................... 50 250

Cancellation of indebtedness ................................................................................................................................................................................. 40 40

Exclusion of certain foster care payments ............................................................................................................................................................ 35 185

Expensing of exploration and development costs, nonfuel minerals ................................................................................................................... 35 175

Exclusion of employer provided death benefits .................................................................................................................................................... 35 195

Additional deduction for the blind .......................................................................................................................................................................... 25 135

Income of trusts to finance supplementary unemployment benefits .................................................................................................................... 20 100

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

Expensing of costs of removing certain architectural barriers to the handicapped ............................................................................................ 20 100

Capital gains treatment of royalties on coal ......................................................................................................................................................... 15 75

Treatment of Alaska Native Corporations ............................................................................................................................................................. 15 40

Capital gains treatment of certain timber income ................................................................................................................................................. 15 75

Exclusion of interest on savings bonds transferred to educational institutions ................................................................................................... 10 65

Alcohol fuel credit 2 ................................................................................................................................................................................................ 10 50

Treatment of loans forgiven solvent farmers as if insolvent ................................................................................................................................ 10 50

Special alternative tax on small property and casualty insurance companies .................................................................................................... 5 25

Capital gains exclusion of small corporation stock ............................................................................................................................................... 0 215

1 The effect of the earned income tax credit on outlays is $20,450 million in 1997 and $111,205 million for 1997–2001.

2 In addition, the partial exemption from the excide tax for alcohol fuels results in a reduction in excise tax receipts for 1997 of $665 million and $3,535 million for 1997–2001.

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 $5 million.

Figures in table 5–6 are the arithmetic sums of corporate and individual income tax revenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.