101

6. TAX EXPENDITURES 

The Congressional Budget Act of 1974 (Public Law 

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

included in the budget. Tax expenditures are defined 

in the law as ‘‘revenue losses attributable to provisions 

of the Federal tax laws which allow a special exclusion, 

exemption, or deduction from gross income or which 

provide a special credit, a preferential rate of tax, or 

a deferral of liability.’’ These exceptions may be viewed 

as alternatives to other policy instruments, such as 

spending or regulatory programs. Identification and 

measurement of tax expenditures depends importantly 

on the baseline tax system against which the actual 

tax system is compared. 

The largest reported tax expenditures tend to be associated with the individual income tax. For example, 

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

contributions for medical insurance, capital gains, and 

payments of State and local individual income and 

property taxes. Reported tax expenditures under the 

corporate income tax tend to be related to timing differences in the rate of cost recovery for various investments. As is discussed below, the extent to which these 

provisions are classified as tax expenditures varies according to the conceptual baseline used. 

Each tax expenditure estimate in this chapter was 

calculated assuming other parts of the tax code remained unchanged. The estimates would be different 

if all tax expenditures or major groups of tax expenditures were changed simultaneously because of potential 

interactions among provisions. For that reason, this 

chapter does not present a grand total for the estimated 

tax expenditures. Moreover, past tax changes entailing 

broad elimination of tax expenditures were generally 

accompanied by changes in tax rates or other basic 

provisions, so that the net effects on Federal revenues 

were considerably (if not totally) offset. 

Tax expenditures relating to the individual and corporate income taxes are estimated for fiscal years 

2002–2008 using three methods of accounting: revenue 

effects, outlay equivalent, and present value. The 

present value approach provides estimates of the cumulative revenue effects for tax expenditures that involve 

deferrals of tax payments into the future or have similar long-term effects. 

The section of the chapter on performance measures 

and economic effects presents information related to 

assessment of the effect of tax expenditures on the 

achievement of program performance goals. This section 

is a complement to the government-wide performance 

plan required by the Government Performance and Results Act of 1993. 

The 2003 Budget included a discussion of important 

ambiguities in the tax expenditure concept and indicated that the Treasury Department had begun a review of the tax expenditure presentation. Particular attention of this review has focused on defining tax expenditures relative to a comprehensive income baseline, 

defining tax expenditures relative to a broad-based consumption tax baseline, and defining negative tax expenditures, i.e., provisions of current law that overtax certain items or activities. The Appendix presents 

the results from the preliminary stage of this review. 

TAX EXPENDITURES IN THE INCOME TAX 

Tax Expenditure Estimates 

All tax expenditure estimates presented here are 

based upon current tax law enacted as of December 

31, 2002. Expired or repealed provisions are not listed 

if their revenue effects result only from taxpayer activity occurring before fiscal year 2002. Due to the time 

required to estimate the large number of tax expenditures, the estimates are based on Mid-Session economic 

assumptions; exceptions are the earned income tax 

credit and child credit provisions, which involve outlay 

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

The total revenue effects for tax expenditures for fiscal years 2002–2008 are displayed according to the 

budget’s functional categories in Table 6–1. Descriptions of the specific tax expenditure provisions follow 

the tables of estimates and the 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 effects for these indicated items are zero using 

the reference tax rules. The alternative baseline concepts are discussed in detail following the tables. 

Table 6–2 reports the respective portions of the total 

revenue effects that arise under the individual and corporate income taxes separately. The placement of the 

estimates under the individual and corporate headings 

does not imply that these categories of filers benefit 

from the special tax provisions in proportion to the 

respective tax expenditure amounts shown. Rather, 

these breakdowns show the specific tax accounts 
102 ANALYTICAL PERSPECTIVES 

through which the various provisions are cleared. The 

ultimate beneficiaries of corporate tax expenditures 

could be shareholders, employees, customers, or other 

providers of capital, depending on economic forces. 

Table 6–3 ranks the major tax expenditures by the 

size of their 2004–2008 revenue effect. 

Interpreting Tax Expenditure Estimates 

The estimates shown for individual tax expenditures 

in Tables 6–1, 6–2, and 6–3 do not necessarily equal 

the increase in Federal revenues (or the change in the 

budget balance) that would result from repealing these 

special provisions, for the following reasons: 

(1) Eliminating a tax expenditure may have incentive 

effects that alter economic behavior. These incentives 

can affect the resulting magnitudes of the activity or 

of other tax provisions or Government programs. For 

example, if capital gains were taxed at ordinary rates, 

capital gain realizations would be expected to decline, 

potentially resulting in a decline in tax receipts. Such 

behavioral effects are not reflected in the estimates. 

(2) Tax expenditures are interdependent even without 

incentive effects. Repeal of a tax expenditure provision 

can increase or decrease the tax revenues associated 

with other provisions. For example, even if behavior 

does not change, repeal of an itemized deduction could 

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

brackets. Alternatively, repeal of an itemized deduction 

could lower the revenue cost from other deductions if 

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

repealed simultaneously, the increase in tax liability 

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

estimates reported in Table 6–1 are the totals of individual and corporate income tax revenue effects reported in Table 6–2 and do not reflect any possible 

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

Table 6–1 (as well as those in Table 6–5, 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 6–4. Cash-based estimates reflect the difference 

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

from prior years. Although such estimates are useful 

as a measure of cash flows into the Government, they 

do not accurately reflect the true economic cost of these 

provisions. For example, for a provision where activity 

levels have changed, so that incoming tax receipts from 

past deferrals are greater than deferred receipts from 

new activity, the cash-basis tax expenditure estimate 

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

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

deferral provision, a cash-based estimate can overstate 

the real effect on receipts to the Government because 

the newly deferred taxes will ultimately be received. 

Present-value estimates, which are a useful complement to the cash-basis estimates for provisions involving deferrals, are discussed below. 

Present-Value Estimates 

Discounted present-value estimates of revenue effects 

are presented in Table 6–4 for certain provisions that 

involve tax deferrals or other long-term revenue effects. 

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

The present-value estimates represent the revenue 

effects, net of future tax payments, that follow from 

activities undertaken during calendar year 2002 which 

cause the deferrals or other long-term revenue effects. 

For instance, a pension contribution in 2002 would 

cause a deferral of tax payments on wages in 2002 

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

the 2002 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.
6. TAX EXPENDITURES 103

Table 6–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 

(In millions of dollars) 

Total from corporations and individuals 

2002 2003 2004 2005 2006 2007 2008 2004–2008

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,190 2,210 2,240 2,260 2,290 2,310 2,330 11,430

International Affairs 

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 2,740 2,620 2,680 2,750 2,810 2,940 3,100 14,280

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 760 800 840 880 930 980 1,030 4,660

4 Extraterritorial income exclusion ............................................................................................................. 4,820 5,150 5,510 5,890 6,290 6,730 7,200 31,620

5 Inventory property sales source rules exception ................................................................................... 1,470 1,540 1,620 1,700 1,790 1,880 1,980 8,970

6 Deferral of income from controlled foreign corporations (normal tax method) .................................... 7,000 7,450 7,900 8,400 8,930 9,550 10,210 44,990

7 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,950 2,050 2,130 2,190 2,260 960 0 7,540

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,660 2,200 2,760 3,390 3,990 4,270 4,380 18,790

9 Credit for increasing research activities ................................................................................................. 6,870 5,640 4,990 2,910 1,240 520 170 9,830

Energy 

10 Expensing of exploration and development costs, fuels ....................................................................... 150 170 150 80 60 40 30 360

11 Excess of percentage over cost depletion, fuels .................................................................................. 610 670 650 610 620 640 650 3,170

12 Alternative fuel production credit ............................................................................................................ 1,560 940 520 520 520 520 210 2,290

13 Exception from passive loss limitation for working interests in oil and gas properties ....................... 10 10 10 10 10 10 10 50

14 Capital gains treatment of royalties on coal .......................................................................................... 100 110 110 120 120 130 140 620

15 Exclusion of interest on energy facility bonds ....................................................................................... 110 120 130 140 140 150 160 720

16 Enhanced oil recovery credit .................................................................................................................. 330 340 350 360 360 370 390 1,830

17 New technology credit ............................................................................................................................ 100 180 250 270 270 270 270 1,330

18 Alcohol fuel credits 1 ............................................................................................................................... 30 30 30 30 30 30 30 150

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

20 Exclusion from income of conservation subsidies provided by public utilities ..................................... 80 80 80 80 80 80 80 400

Natural Resources and Environment 

21 Expensing of exploration and development costs, nonfuel minerals .................................................... 30 30 30 30 30 40 40 170

22 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 260 260 270 280 290 290 300 1,430

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 450 480 540 580 610 650 680 3,060

24 Capital gains treatment of certain timber income ................................................................................. 100 110 110 120 120 130 140 620

25 Expensing of multiperiod timber growing costs ..................................................................................... 360 370 380 380 400 410 410 1,980

26 Tax incentives for preservation of historic structures ............................................................................ 200 210 230 240 250 260 280 1,260

Agriculture 

27 Expensing of certain capital outlays ...................................................................................................... 170 180 170 170 170 170 190 870

28 Expensing of certain multiperiod production costs ................................................................................ 130 130 120 120 120 120 120 600

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

30 Capital gains treatment of certain income ............................................................................................. 1,010 1,060 1,120 1,180 1,250 1,310 1,380 6,240

31 Income averaging for farmers ................................................................................................................ 70 70 80 80 80 90 90 420

32 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 20 60

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ..................................................................................................... 1,020 1,090 1,160 1,240 1,320 1,410 1,510 6,640

34 Excess bad debt reserves of financial institutions ............................................................................0000000 0

35 Exclusion of interest on life insurance savings ................................................................................. 17,690 19,130 20,740 22,470 24,390 26,350 28,310 122,260

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 210 220 240 250 270 280 290 1,330

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

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 870 960 1,050 1,140 1,210 1,270 1,360 6,030

40 Exclusion of interest on rental housing bonds .................................................................................. 180 200 220 240 250 260 280 1,250

41 Deductibility of mortgage interest on owner-occupied homes .......................................................... 63,590 65,540 68,440 71,870 74,790 78,160 82,650 375,910

42 Deductibility of State and local property tax on owner-occupied homes ......................................... 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310

43 Deferral of income from post 1987 installment sales ....................................................................... 1,050 1,080 1,100 1,120 1,140 1,160 1,190 5,710

44 Capital gains exclusion on home sales ............................................................................................. 19,670 20,260 20,860 21,490 22,140 22,800 23,480 110,770

45 Exception from passive loss rules for $25,000 of rental loss .......................................................... 5,690 5,270 4,920 4,600 4,290 4,020 3,790 21,620

46 Credit for low-income housing investments ....................................................................................... 3,290 3,450 3,640 3,820 3,990 4,160 4,360 19,970

47 Accelerated depreciation on rental housing (normal tax method) .................................................... 1,590 1,080 310 –520 –1,770 –3,310 –4,570 –9,860

Commerce: 

48 Cancellation of indebtedness ............................................................................................................. 0 10 30 50 60 60 50 250

49 Exceptions from imputed interest rules ............................................................................................. 50 50 50 50 50 50 50 250

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 56,060 55,010 53,930 54,550 49,870 49,760 51,450 259,560

51 Capital gains exclusion of small corporation stock ........................................................................... 100 130 160 210 250 300 350 1,270

52 Step-up basis of capital gains at death ............................................................................................ 26,890 27,390 28,500 29,630 30,490 31,370 32,390 152,380

53 Carryover basis of capital gains on gifts ........................................................................................... 640 640 450 540 640 650 630 2,910

54 Ordinary income treatment of loss from small business corporation stock sale ............................. 40 40 50 50 50 50 50 250

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... –1,800 –2,530 –1,980 –6,520 –9,200 –12,360 –15,820 –45,880

56 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 47,770 31,110 16,670 –39,310 –35,260 –33,260 –31,570 –122,730

57 Expensing of certain small investments (normal tax method) .......................................................... –360 –110 370 1,570 1,830 1,510 1,380 6,660

58 Amortization of start-up costs (normal tax method) .......................................................................... 110 130 150 160 160 170 170 810
104 ANALYTICAL PERSPECTIVES 

Table 6–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued

(In millions of dollars) 

Total from corporations and individuals 

2002 2003 2004 2005 2006 2007 2008 2004–2008

59 Graduated corporation income tax rate (normal tax method) .......................................................... 4,870 5,380 5,700 5,880 6,100 6,350 6,640 30,670

60 Exclusion of interest on small issue bonds ....................................................................................... 330 360 400 430 450 470 510 2,260

Transportation 

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

62 Exclusion of reimbursed employee parking expenses .......................................................................... 2,070 2,180 2,290 2,410 2,540 2,680 2,810 12,730

63 Exclusion for employer-provided transit passes .................................................................................... 250 320 380 450 530 600 670 2,630

Community and Regional Development 

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

65 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 690 750 830 890 950 1,000 1,060 4,730

66 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 70 70 70 70 340

67 Empowerment zones, Enterprise communities, and Renewal communities ........................................ 730 1,130 1,170 1,280 1,410 1,580 1,750 7,190

68 New markets tax credit ........................................................................................................................... 90 190 290 430 610 830 870 3,030

69 Expensing of environmental remediation costs ..................................................................................... 80 80 20 –10 –10 –10 –10 –20

Education, Training, Employment, and Social Services 

Education: 

70 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,270 1,260 1,260 1,340 1,400 1,410 1,420 6,830

71 HOPE tax credit .................................................................................................................................. 4,110 3,520 2,880 2,930 2,730 2,900 2,790 14,230

72 Lifetime Learning tax credit ................................................................................................................ 2,180 2,250 2,980 2,840 2,610 2,820 2,860 14,110

73 Education Individual Retirement Accounts ........................................................................................ 50 100 160 240 330 440 560 1,730

74 Deductibility of student-loan interest .................................................................................................. 450 640 660 680 700 720 720 3,480

75 Deduction for higher education expenses ......................................................................................... 420 2,230 2,880 3,620 2,940 0 0 9,440

76 State prepaid tuition plans ................................................................................................................. 270 340 400 470 560 660 750 2,840

77 Exclusion of interest on student-loan bonds ..................................................................................... 240 260 290 310 340 350 370 1,660

78 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 580 640 700 760 810 850 900 4,020

79 Credit for holders of zone academy bonds ....................................................................................... 50 80 90 100 100 100 100 490

80 Exclusion of interest on savings bonds redeemed to finance educational expenses ..................... 10 10 10 10 10 20 20 70

81 Parental personal exemption for students age 19 or over ............................................................... 2,480 3,310 3,230 2,690 2,020 1,670 1,470 11,080

82 Deductibility of charitable contributions (education) .......................................................................... 4,020 4,140 4,350 4,640 4,820 4,970 5,230 24,010

83 Exclusion of employer-provided educational assistance ................................................................... 400 490 520 550 580 610 650 2,910

Training, employment, and social services: 

84 Work opportunity tax credit ................................................................................................................ 380 560 430 190 80 40 20 760

85 Welfare-to-work tax credit .................................................................................................................. 80 70 80 60 40 20 10 210

86 Employer provided child care exclusion ............................................................................................ 690 720 760 810 850 890 940 4,250

87 Employer-provided child care credit .................................................................................................. 40 90 130 140 150 160 170 750

88 Assistance for adopted foster children .............................................................................................. 220 250 290 330 380 430 480 1,910

89 Adoption credit and exclusion ............................................................................................................ 140 220 450 500 540 560 570 2,620

90 Exclusion of employee meals and lodging (other than military) ...................................................... 740 780 810 850 890 930 970 4,450

91 Child credit 2 ........................................................................................................................................ 22,170 21,440 21,310 22,480 24,280 23,940 23,660 115,670

92 Credit for child and dependent care expenses ................................................................................. 2,750 2,910 3,230 2,860 2,380 2,190 2,050 12,710

93 Credit for disabled access expenditures ........................................................................................... 50 50 50 60 60 60 60 290

94 Deductibility of charitable contributions, other than education and health ....................................... 30,860 32,100 33,990 35,710 37,360 38,780 41,160 187,000

95 Exclusion of certain foster care payments ........................................................................................ 450 430 430 440 450 460 470 2,250

96 Exclusion of parsonage allowances ................................................................................................... 350 380 400 420 450 480 510 2,260

Health 

97 Exclusion of employer contributions for medical insurance premiums and medical care ............... 99,060 108,500 120,160 132,240 144,710 157,180 170,230 724,520

98 Self-employed medical insurance premiums ..................................................................................... 1,760 2,500 3,690 3,940 4,220 4,520 4,980 21,350

99 Workers’ compensation insurance premiums .................................................................................... 5,280 5,770 6,190 6,630 7,020 7,490 8,000 35,330

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

101 Deductibility of medical expenses ...................................................................................................... 5,710 6,060 6,340 6,490 6,610 6,980 7,380 33,800

102 Exclusion of interest on hospital construction bonds ........................................................................ 1,200 1,320 1,440 1,560 1,660 1,740 1,850 8,250

103 Deductibility of charitable contributions (health) ................................................................................ 4,240 4,360 4,580 4,900 5,070 5,220 5,490 25,260

104 Tax credit for orphan drug research .................................................................................................. 140 160 180 200 220 250 280 1,130

105 Special Blue Cross/Blue Shield deduction ........................................................................................ 300 340 310 300 270 300 250 1,430

106 Tax credit for health insurance purchased by certain displaced and retired individuals ................ 0 0 60 30 40 50 60 240

Income Security 

107 Exclusion of railroad retirement system benefits ................................................................................... 390 400 400 400 400 400 400 2,000

108 Exclusion of workers’ compensation benefits ........................................................................................ 5,750 6,100 6,460 6,850 7,270 7,710 8,190 36,480

109 Exclusion of public assistance benefits (normal tax method) ............................................................... 380 400 410 430 450 470 440 2,200

110 Exclusion of special benefits for disabled coal miners ......................................................................... 70 60 60 50 50 50 40 250

111 Exclusion of military disability pensions ................................................................................................. 110 110 120 120 130 130 140 640

Net exclusion of pension contributions and earnings: 0 0 0 0 0 0 0 0

112 Employer plans ................................................................................................................................... 51,260 63,480 67,870 70,540 73,200 67,500 61,440 340,550

113 401(k) plans ........................................................................................................................................ 50,830 52,920 55,290 57,830 61,490 65,060 68,030 307,700

114 Individual Retirement Accounts .......................................................................................................... 19,080 20,840 23,130 22,400 22,380 20,540 19,800 108,250

115 Low and moderate income savers credit .......................................................................................... 850 2,050 1,860 1,670 1,510 850 0 5,890

116 Keogh plans ........................................................................................................................................ 7,000 7,282 7,616 7,904 8,166 8,402 9,196 41,284

Exclusion of other employee benefits: 0 0 0 0 0 0 0 0

117 Premiums on group term life insurance ............................................................................................ 1,780 1,800 1,830 1,860 1,890 1,920 1,950 9,450
6. TAX EXPENDITURES 105

Table 6–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued

(In millions of dollars) 

Total from corporations and individuals 

2002 2003 2004 2005 2006 2007 2008 2004–2008

118 Premiums on accident and disability insurance ................................................................................ 220 230 240 250 260 270 280 1,300

119 Small business retirement plan credit .................................................................................................... 10 20 40 50 50 60 60 260

120 Income of trusts to finance supplementary unemployment benefits .................................................... 20 30 30 30 30 30 30 150

121 Special ESOP rules ................................................................................................................................ 1,630 1,710 1,790 1,890 1,990 2,090 2,200 9,960

122 Additional deduction for the blind ........................................................................................................... 40 40 40 40 40 40 40 200

123 Additional deduction for the elderly ........................................................................................................ 1,890 1,950 2,050 2,120 2,180 2,110 2,030 10,490

124 Tax credit for the elderly and disabled .................................................................................................. 20 20 20 20 10 10 10 70

125 Deductibility of casualty losses .............................................................................................................. 280 400 420 440 460 500 540 2,360

126 Earned income tax credit 3 ..................................................................................................................... 4,450 4,930 5,090 5,280 5,410 5,580 5,790 27,150

Social Security 

Exclusion of social security benefits: 

127 Social Security benefits for retired workers ....................................................................................... 18,340 18,560 18,930 19,210 20,000 21,100 21,550 100,790

128 Social Security benefits for disabled ................................................................................................. 2,910 3,210 3,570 3,950 4,360 4,870 4,390 21,140

129 Social Security benefits for dependents and survivors ..................................................................... 3,730 3,910 4,140 4,360 4,590 4,920 4,820 22,830

Veterans Benefits and Services 

130 Exclusion of veterans death benefits and disability compensation ...................................................... 3,160 3,230 3,400 3,590 3,780 3,980 4,190 18,940

131 Exclusion of veterans pensions .............................................................................................................. 70 80 80 90 90 90 100 450

132 Exclusion of GI bill benefits .................................................................................................................... 90 90 90 100 100 110 110 510

133 Exclusion of interest on veterans housing bonds ................................................................................. 40 40 50 50 50 60 60 270

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose State and local bonds ........................................................... 25,250 26,780 27,310 27,720 27,810 27,530 28,360 138,730

135 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430

136 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 2,240 2,240 2,240 2,200 1,300 0 0 5,740

Interest 

137 Deferral of interest on U.S. savings bonds ........................................................................................... 510 590 670 750 840 920 1,050 4,230

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied homes ........................................................................................ 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430

Exclusion of interest on State and local bonds for: 

Public purposes .................................................................................................................................. 25,250 26,780 27,310 27,720 27,810 27,530 28,360 138,730

Energy facilities ................................................................................................................................... 110 120 130 140 140 150 160 720

Water, sewage, and hazardous waste disposal facilities ................................................................. 450 480 540 580 610 650 680 3,060

Small-issues ........................................................................................................................................ 330 360 400 430 450 470 510 2,260

Owner-occupied mortgage subsidies ................................................................................................. 870 960 1,050 1,140 1,210 1,270 1,360 6,030

Rental housing .................................................................................................................................... 180 200 220 240 250 260 280 1,250

Airports, docks, and similar facilities ................................................................................................. 690 750 830 890 950 1,000 1,060 4,730

Student loans ...................................................................................................................................... 240 260 290 310 340 350 370 1,660

Private nonprofit educational facilities ............................................................................................... 580 640 700 760 810 850 900 4,020

Hospital construction .......................................................................................................................... 1,200 1,320 1,440 1,560 1,660 1,740 1,850 8,250

Veterans’ housing ............................................................................................................................... 40 40 50 50 50 60 60 270

Credit for holders of zone academy bonds ........................................................................................... 50 80 90 100 100 100 100 490

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: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 

$1,320; 2006 $1,370; 2007 $1,400; and 2008 $1,430. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $5,060; 2003 $5,870; 2004 $5,860; 2005 

$5,700; 2006 $7,630; 2007 $7,630; and 2008 $7,500 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 

$31,380; 2005 $32,090; 2006 $33,450; 2007 $34,480; and 2008 $35,380. 

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table. 
106 ANALYTICAL PERSPECTIVES 

Table 6–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES 

(In millions of dollars) 

Corporations Individuals 

2002 2003 2004 2005 2006 2007 2008 2004– 

2008 2002 2003 2004 2005 2006 2007 2008 2004– 2008

National Defense 

1 Exclusion of benefits and allowances to 

armed forces personnel ........................ ............ ............ ............ ................ ................ ................ ................ ................ 2,190 2,210 2,240 2,260 2,290 2,310 2,330 11,430

International Affairs 

2 Exclusion of income earned abroad by 

U.S. citizens .......................................... ............ ............ ............ ................ ................ ................ ................ ................ 2,740 2,620 2,680 2,750 2,810 2,940 3,100 14,280

3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ............ ................ ................ ................ ................ ................ 760 800 840 880 930 980 1,030 4,660

4 Extraterritorial income exclusion ............... 4,820 5,150 5,510 5,890 6,290 6,730 7,200 31,620 ................ ................ ................ ................ ................ ................ ................ ................

5 Inventory property sales source rules exception ................................................... 1,470 1,540 1,620 1,700 1,790 1,880 1,980 8,970 ................ ................ ................ ................ ................ ................ ................ ................

6 Deferral of income from controlled foreign 

corporations (normal tax method) ........ 7,000 7,450 7,900 8,400 8,930 9,550 10,210 44,990 ................ ................ ................ ................ ................ ................ ................ ................

7 Deferred taxes for financial firms on certain income earned overseas ............... 1,950 2,050 2,130 2,190 2,260 960 0 7,540 ................ ................ ................ ................ ................ ................ ................ ................

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... 1,630 2,160 2,710 3,320 3,910 4,190 4,300 18,430 30 40 50 70 80 80 80 360

9 Credit for increasing research activities ... 6,810 5,590 4,950 2,890 1,240 520 170 9,770 60 50 40 20 0 0 0 60

Energy 

10 Expensing of exploration and development costs, fuels ................................... 130 150 130 70 50 40 30 320 20 20 20 10 10 0 0 40

11 Excess of percentage over cost depletion, 

fuels ....................................................... 510 550 530 500 510 530 540 2,610 100 120 120 110 110 110 110 560

12 Alternative fuel production credit .............. 1,500 900 500 500 500 500 200 2,200 60 40 20 20 20 20 10 90

13 Exception from passive loss limitation for 

working interests in oil and gas properties ...................................................... ............ ............ ............ ................ ................ ................ ................ ................ 10 10 10 10 10 10 10 50

14 Capital gains treatment of royalties on 

coal ........................................................ ............ ............ ............ ................ ................ ................ ................ ................ 100 110 110 120 120 130 140 620

15 Exclusion of interest on energy facility 

bonds ..................................................... 30 30 30 30 30 30 30 150 80 90 100 110 110 120 130 570

16 Enhanced oil recovery credit .................... 300 310 320 330 330 340 350 1,670 30 30 30 30 30 30 40 160

17 New technology credit ............................... 100 180 250 270 270 270 270 1,330 0 0000000

18 Alcohol fuel credits 1 .................................. 20 20 20 20 20 20 20 100 10 10 10 10 10 10 10 50

19 Tax credit and deduction for clean-fuel 

burning vehicles .................................... 50 60 40 20 –10 –60 –60 –70 20 30 30 20 0 –10 –10 30

20 Exclusion from income of conservation 

subsidies provided by public utilities .... ............ ............ ............ ................ ................ ................ ................ ................ 80 80 80 80 80 80 80 400

Natural Resources and Environment 

21 Expensing of exploration and development costs, nonfuel minerals ................ 30 30 30 30 30 40 40 170 0 0 000000

22 Excess of percentage over cost depletion, 

nonfuel minerals .................................... 240 240 250 260 270 270 280 1,330 20 20 20 20 20 20 20 100

23 Exclusion of interest on bonds for water, 

sewage, and hazardous waste facilities 110 110 120 120 120 130 130 620 340 370 420 460 490 520 550 2,440

24 Capital gains treatment of certain timber 

income ................................................... ............ ............ ............ ................ ................ ................ ................ ................ 100 110 110 120 120 130 140 620

25 Expensing of multiperiod timber growing 

costs ...................................................... 240 250 260 260 270 280 280 1,350 120 120 120 120 130 130 130 630

26 Tax incentives for preservation of historic 

structures ............................................... 160 170 180 190 200 210 220 1,000 40 40 50 50 50 50 60 260

Agriculture 

27 Expensing of certain capital outlays ......... 20 20 20 20 20 20 30 110 150 160 150 150 150 150 160 760

28 Expensing of certain multiperiod production costs ............................................... 20 20 20 20 20 20 20 100 110 110 100 100 100 100 100 500

29 Treatment of loans forgiven for solvent 

farmers ................................................... ............ ............ ............ ................ ................ ................ ................ ................ 10 10 10 10 10 10 10 50

30 Capital gains treatment of certain income ............ ............ ............ ................ ................ ................ ................ ................ 1,010 1,060 1,120 1,180 1,250 1,310 1,380 6,240

31 Income averaging for farmers ................... ............ ............ ............ ................ ................ ................ ................ ................ 70 70 80 80 80 90 90 420

32 Deferral of gain on sale of farm refiners 10 10 10 10 10 10 20 60 ................ ................ ................ ................ ................ ................ ................ ................

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ........ 1,020 1,090 1,160 1,240 1,320 1,410 1,510 6,640 ................ ................ ................ ................ ................ ................ ................ ................

34 Excess bad debt reserves of financial 

institutions ......................................... 0 0 0 0 0 0 0 0 ................ ................ ................ ................ ................ ................ ................ ................

35 Exclusion of interest on life insurance 

savings .............................................. 1,770 1,800 1,830 1,860 1,890 1,920 1,950 9,450 15,920 17,330 18,910 20,610 22,500 24,430 26,360 112,810

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

37 Tax exemption of certain insurance 

companies owned by tax-exempt organizations ........................................ 210 220 240 250 270 280 290 1,330 ................ ................ ................ ................ ................ ................ ................ ................

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

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 210 220 230 230 240 250 260 1,210 660 740 820 910 970 1,020 1,100 4,820

40 Exclusion of interest on rental housing 

bonds ................................................. 40 50 50 50 50 50 50 250 140 150 170 190 200 210 230 1,000

41 Deductibility of mortgage interest on 

owner-occupied homes ..................... ............ ............ ............ ................ ................ ................ ................ ................ 63,590 65,540 68,440 71,870 74,790 78,160 82,650 375,910

42 Deductibility of State and local property 

tax on owner-occupied homes ......... ............ ............ ............ ................ ................ ................ ................ ................ 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310
6. TAX EXPENDITURES 107

Table 6–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(In millions of dollars) 

Corporations Individuals 

2002 2003 2004 2005 2006 2007 2008 2004– 

2008 2002 2003 2004 2005 2006 2007 2008 2004– 2008

43 Deferral of income from post 1987 installment sales .................................. 270 280 290 290 300 300 310 1,490 780 800 810 830 840 860 880 4,220

44 Capital gains exclusion on home sales ............ ............ ............ ................ ................ ................ ................ ................ 19,670 20,260 20,860 21,490 22,140 22,800 23,480 110,770

45 Exception from passive loss rules for 

$25,000 of rental loss ....................... ............ ............ ............ ................ ................ ................ ................ ................ 5,690 5,270 4,920 4,600 4,290 4,020 3,790 21,620

46 Credit for low-income housing investments ................................................. 2,630 2,760 2,910 3,060 3,190 3,330 3,490 15,980 660 690 730 760 800 830 870 3,990

47 Accelerated depreciation on rental 

housing (normal tax method) ........... 70 30 –20 –80 –160 –260 –330 –850 1,520 1,050 330 –440 –1,610 –3,050 –4,240 –9,010

Commerce: 

48 Cancellation of indebtedness ................ ............ ............ ............ ................ ................ ................ ................ ................ 0 10 30 50 60 60 50 250

49 Exceptions from imputed interest rules ............ ............ ............ ................ ................ ................ ................ ................ 50 50 50 50 50 50 50 250

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax 

method) ............................................. ............ ............ ............ ................ ................ ................ ................ ................ 56,060 55,010 53,930 54,550 49,870 49,760 51,450 259,560

51 Capital gains exclusion of small corporation stock ................................... ............ ............ ............ ................ ................ ................ ................ ................ 100 130 160 210 250 300 350 1,270

52 Step-up basis of capital gains at death ............ ............ ............ ................ ................ ................ ................ ................ 26,890 27,390 28,500 29,630 30,490 31,370 32,390 152,380

53 Carryover basis of capital gains on 

gifts .................................................... ............ ............ ............ ................ ................ ................ ................ ................ 640 640 450 540 640 650 630 2,910

54 Ordinary income treatment of loss from 

small business corporation stock 

sale .................................................... ............ ............ ............ ................ ................ ................ ................ ................ 40 40 50 50 50 50 50 250

55 Accelerated depreciation of buildings 

other than rental housing (normal 

tax method) ....................................... –1,710 –2,250 –1,470 –5,280 –7,440 –9,980 –12,820 –36,990 –90 –280 –510 –1,240 –1,760 –2,380 –3,000 –8,890

56 Accelerated depreciation of machinery 

and equipment (normal tax method) 40,670 26,390 14,140 –33,390 –29,330 –26,960 –25,000 –100,540 7,100 4,720 2,530 –5,920 –5,930 –6,300 –6,570 –22,190

57 Expensing of certain small investments 

(normal tax method) ......................... –140 –80 130 560 720 580 520 2,510 –220 –30 240 1,010 1,110 930 860 4,150

58 Amortization of start-up costs (normal 

tax method) ....................................... 90 110 120 130 130 140 140 660 20 20 30 30 30 30 30 150

59 Graduated corporation income tax rate 

(normal tax method) ......................... 4,870 5,380 5,700 5,880 6,100 6,350 6,640 30,670 ................ ................ ................ ................ ................ ................ ................ ................

60 Exclusion of interest on small issue 

bonds ................................................. 80 80 90 90 90 90 100 460 250 280 310 340 360 380 410 1,800

Transportation 

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

62 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ............ ................ ................ ................ ................ ................ 2,070 2,180 2,290 2,410 2,540 2,680 2,810 12,730

63 Exclusion for employer-provided transit 

passes ................................................... ............ ............ ............ ................ ................ ................ ................ ................ 250 320 380 450 530 600 670 2,630

Community and Regional Development 

64 Investment credit for rehabilitation of 

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

65 Exclusion of interest for airport, dock, and 

similar bonds ......................................... 170 170 180 180 190 200 200 950 520 580 650 710 760 800 860 3,780

66 Exemption of certain mutuals’ and cooperatives’ income ................................ 60 60 60 70 70 70 70 340 ................ ................ ................ ................ ................ ................ ................ ................

67 Empowerment zones, Enterprise communities, and Renewal communities ......... 220 300 300 320 350 390 420 1,780 510 830 870 960 1,060 1,190 1,330 5,410

68 New markets tax credit ............................. 20 50 70 110 150 210 220 760 70 140 220 320 460 620 650 2,270

69 Expensing of environmental remediation 

costs ...................................................... 70 70 20 –10 –10 –10 –10 –20 10 10 0 00000

Education, Training, Employment, and 

Social Services 

Education: 

70 Exclusion of scholarship and fellowship 

income (normal tax method) ............ ............ ............ ............ ................ ................ ................ ................ ................ 1,270 1,260 1,260 1,340 1,400 1,410 1,420 6,830

71 HOPE tax credit .................................... ............ ............ ............ ................ ................ ................ ................ ................ 4,110 3,520 2,880 2,930 2,730 2,900 2,790 14,230

72 Lifetime Learning tax credit .................. ............ ............ ............ ................ ................ ................ ................ ................ 2,180 2,250 2,980 2,840 2,610 2,820 2,860 14,110

73 Education Individual Retirement Accounts ................................................ ............ ............ ............ ................ ................ ................ ................ ................ 50 100 160 240 330 440 560 1,730

74 Deductibility of student-loan interest .... ............ ............ ............ ................ ................ ................ ................ ................ 450 640 660 680 700 720 720 3,480

75 Deduction for higher education expenses ............................................... ............ ............ ............ ................ ................ ................ ................ ................ 420 2,230 2,880 3,620 2,940 0 0 9,440

76 State prepaid tuition plans .................... ............ ............ ............ ................ ................ ................ ................ ................ 270 340 400 470 560 660 750 2,840

77 Exclusion of interest on student-loan 

bonds ................................................. 60 60 60 60 70 70 70 330 180 200 230 250 270 280 300 1,330

78 Exclusion of interest on bonds for private nonprofit educational facilities .. 140 150 150 160 160 170 170 810 440 490 550 600 650 680 730 3,210

79 Credit for holders of zone academy 

bonds ................................................. 50 80 90 100 100 100 100 490 ................ ................ ................ ................ ................ ................ ................ ................

80 Exclusion of interest on savings bonds 

redeemed to finance educational expenses ............................................... ............ ............ ............ ................ ................ ................ ................ ................ 10 10 10 10 10 20 20 70

81 Parental personal exemption for students age 19 or over ....................... ............ ............ ............ ................ ................ ................ ................ ................ 2,480 3,310 3,230 2,690 2,020 1,670 1,470 11,080

82 Deductibility of charitable contributions 

(education) ........................................ 720 700 710 830 820 810 810 3,980 3,300 3,440 3,640 3,810 4,000 4,160 4,420 20,030

83 Exclusion of employer-provided educational assistance ........................... ............ ............ ............ ................ ................ ................ ................ ................ 400 490 520 550 580 610 650 2,910

Training, employment, and social services: 

84 Work opportunity tax credit ................... 350 490 360 160 70 30 10 630 30 70 70 30 10 10 10 130

85 Welfare-to-work tax credit ..................... 70 60 70 50 30 20 10 180 10 10 10 10 10 0 0 30
108 ANALYTICAL PERSPECTIVES 

Table 6–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(In millions of dollars) 

Corporations Individuals 

2002 2003 2004 2005 2006 2007 2008 2004– 

2008 2002 2003 2004 2005 2006 2007 2008 2004– 2008

86 Employer provided child care exclusion ............ ............ ............ ................ ................ ................ ................ ................ 690 720 760 810 850 890 940 4,250

87 Employer-provided child care credit ..... ............ ............ ............ ................ ................ ................ ................ ................ 40 90 130 140 150 160 170 750

88 Assistance for adopted foster children ............ ............ ............ ................ ................ ................ ................ ................ 220 250 290 330 380 430 480 1,910

89 Adoption credit and exclusion .............. ............ ............ ............ ................ ................ ................ ................ ................ 140 220 450 500 540 560 570 2,620

90 Exclusion of employee meals and 

lodging (other than military) ............. ............ ............ ............ ................ ................ ................ ................ ................ 740 780 810 850 890 930 970 4,450

91 Child credit 2 .......................................... ............ ............ ............ ................ ................ ................ ................ ................ 22,170 21,440 21,310 22,480 24,280 23,940 23,660 115,670

92 Credit for child and dependent care 

expenses ........................................... ............ ............ ............ ................ ................ ................ ................ ................ 2,750 2,910 3,230 2,860 2,380 2,190 2,050 12,710

93 Credit for disabled access expenditures .................................................. 10 10 10 20 20 20 20 90 40 40 40 40 40 40 40 200

94 Deductibility of charitable contributions, 

other than education and health ...... 890 870 880 1,040 1,010 1,010 1,010 4,950 29,970 31,230 33,110 34,670 36,350 37,770 40,150 182,050

95 Exclusion of certain foster care payments ................................................. ............ ............ ............ ................ ................ ................ ................ ................ 450 430 430 440 450 460 470 2,250

96 Exclusion of parsonage allowances ..... ............ ............ ............ ................ ................ ................ ................ ................ 350 380 400 420 450 480 510 2,260

Health 

97 Exclusion of employer contributions for 

medical insurance premiums and medical care ................................................. ............ ............ ............ ................ ................ ................ ................ ................ 99,060 108,500 120,160 132,240 144,710 157,180 170,230 724,520

98 Self-employed medical insurance premiums .................................................... ............ ............ ............ ................ ................ ................ ................ ................ 1,760 2,500 3,690 3,940 4,220 4,520 4,980 21,350

99 Workers’ compensation insurance premiums .................................................... ............ ............ ............ ................ ................ ................ ................ ................ 5280 5770 6190 6630 7020 7490 8000 35,330

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

101 Deductibility of medical expenses ............. ............ ............ ............ ................ ................ ................ ................ ................ 5,710 6,060 6,340 6,490 6,610 6,980 7,380 33,800

102 Exclusion of interest on hospital construction bonds .............................................. 290 300 310 320 330 340 350 1,650 910 1,020 1,130 1,240 1,330 1,400 1,500 6,600

103 Deductibility of charitable contributions 

(health) ................................................... 870 850 860 1,010 990 980 980 4,820 3,370 3,510 3,720 3,890 4,080 4,240 4,510 20,440

104 Tax credit for orphan drug research ........ 140 160 180 200 220 250 280 1,130 ................ ................ ................ ................ ................ ................ ................ ................

105 Special Blue Cross/Blue Shield deduction 300 340 310 300 270 300 250 1,430 ................ ................ ................ ................ ................ ................ ................ ................

106 Tax credit for health insurance purchased 

by certain displaced and retired individuals ........................................................ ............ ............ ............ ................ ................ ................ ................ ................ 0 0 60 30 40 50 60 240

Income Security 

107 Exclusion of railroad retirement system 

benefits .................................................. ............ ............ ............ ................ ................ ................ ................ ................ 390 400 400 400 400 400 400 2,000

108 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ............ ................ ................ ................ ................ ................ 5,750 6,100 6,460 6,850 7,270 7,710 8,190 36,480

109 Exclusion of public assistance benefits 

(normal tax method) .............................. ............ ............ ............ ................ ................ ................ ................ ................ 380 400 410 430 450 470 440 2,200

110 Exclusion of special benefits for disabled 

coal miners ............................................ ............ ............ ............ ................ ................ ................ ................ ................ 70 60 60 50 50 50 40 250

111 Exclusion of military disability pensions ... ............ ............ ............ ................ ................ ................ ................ ................ 110 110 120 120 130 130 140 640

Net exclusion of pension contributions 

and earnings: 

112 Employer plans ..................................... ............ ............ ............ ................ ................ ................ ................ ................ 51,260 63,480 67,870 70,540 73,200 67,500 61,440 340,550

113 401(k) plans .......................................... ............ ............ ............ ................ ................ ................ ................ ................ 50,830 52,920 55,290 57,830 61,490 65060 68030 307,700

114 Individual Retirement Accounts ............ ............ ............ ............ ................ ................ ................ ................ ................ 19,080 20,840 23,130 22,400 22,380 20,540 19,800 108,250

115 Low and moderate income savers 

credit .................................................. ............ ............ ............ ................ ................ ................ ................ ................ 850 2,050 1,860 1,670 1,510 850 0 5,890

116 Keogh plans .......................................... ............ ............ ............ ................ ................ ................ ................ ................ 7,000 7,282 7,616 7,904 8,166 8,402 9,196 41,284

Exclusion of other employee benefits: 

117 Premiums on group term life insurance ............ ............ ............ ................ ................ ................ ................ ................ 1,780 1,800 1,830 1,860 1,890 1,920 1,950 9,450

118 Premiums on accident and disability insurance .............................................. ............ ............ ............ ................ ................ ................ ................ ................ 220 230 240 250 260 270 280 1,300

119 Small business retirement plan credit ...... ............ ............ ............ ................ ................ ................ ................ ................ 10 20 40 50 50 60 60 260

120 Income of trusts to finance supplementary 

unemployment benefits ......................... 20 30 30 30 30 30 30 150

121 Special ESOP rules ................................... 1330 1400 1470 1550 1640 1720 1810 8,190 300 310 320 340 350 370 390 1,770

122 Additional deduction for the blind ............. ............ ............ ............ ................ ................ ................ ................ ................ 40 40 40 40 40 40 40 200

123 Additional deduction for the elderly .......... ............ ............ ............ ................ ................ ................ ................ ................ 1,890 1,950 2,050 2,120 2,180 2,110 2,030 10,490

124 Tax credit for the elderly and disabled .... ............ ............ ............ ................ ................ ................ ................ ................ 20 20 20 20 10 10 10 70

125 Deductibility of casualty losses ................. ............ ............ ............ ................ ................ ................ ................ ................ 280 400 420 440 460 500 540 2,360

126 Earned income tax credit 3 ........................ ............ ............ ............ ................ ................ ................ ................ ................ 4,450 4,930 5,090 5,280 5,410 5,580 5,790 27,150

Social Security 

Exclusion of social security benefits: 

127 Social Security benefits for retired 

workers .............................................. ............ ............ ............ ................ ................ ................ ................ ................ 18,340 18,560 18,930 19,210 20,000 21,100 21,550 100,790

128 Social Security benefits for disabled .... ............ ............ ............ ................ ................ ................ ................ ................ 2,910 3,210 3,570 3,950 4,360 4,870 4,390 21,140

129 Social Security benefits for dependents 

and survivors .................................... ............ ............ ............ ................ ................ ................ ................ ................ 3,730 3,910 4,140 4,360 4,590 4,920 4,820 22,830

Veterans Benefits and Services 

130 Exclusion of veterans death benefits and 

disability compensation ......................... ............ ............ ............ ................ ................ ................ ................ ................ 3,160 3,230 3,400 3,590 3,780 3,980 4,190 18,940

131 Exclusion of veterans pensions ................ ............ ............ ............ ................ ................ ................ ................ ................ 70 80 80 90 90 90 100 450

132 Exclusion of GI bill benefits ...................... ............ ............ ............ ................ ................ ................ ................ ................ 90 90 90 100 100 110 110 510

133 Exclusion of interest on veterans housing 

bonds ..................................................... 10 10 10 10 10 10 10 50 30 30 40 40 40 50 50 220

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose 

State and local bonds ........................... 6,170 6,360 6,550 6,750 6,950 7,160 7,370 34,780 19,080 20,420 20,760 20,970 20,860 20,370 20,990 103,950

135 Deductibility of nonbusiness state and 

local taxes other than on owner-occupied homes ............................................ ............ ............ ............ ................ ................ ................ ................ ................ 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430
6. TAX EXPENDITURES 109

Table 6–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(In millions of dollars) 

Corporations Individuals 

2002 2003 2004 2005 2006 2007 2008 2004– 

2008 2002 2003 2004 2005 2006 2007 2008 2004– 2008

136 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 2,240 2,240 2,240 2,200 1,300 0 0 5,740 ................ ................ ................ ................ ................ ................ ................ ................

Interest 

137 Deferral of interest on U.S. savings 

bonds ..................................................... ............ ............ ............ ................ ................ ................ ................ ................ 510 590 670 750 840 920 1,050 4,230

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied 

homes ................................................ ............ ............ ............ ................ ................ ................ ................ ................ 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310

Nonbusiness State and local taxes 

other than on owner-occupied 

homes ................................................ ............ ............ ............ ................ ................ ................ ................ ................ 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430

Exclusion of interest on State and local 

bonds for: 

Public purposes ..................................... 6,170 6,360 6,550 6,750 6,950 7,160 7,370 34,780 19,080 20,420 20,760 20,970 20,860 20,370 20,990 103,950

Energy facilities ..................................... 30 30 30 30 30 30 30 150 80 90 100 110 110 120 130 570

Water, sewage, and hazardous waste 

disposal facilities ............................... 110 110 120 120 120 130 130 620 340 370 420 460 490 520 550 2,440

Small-issues .......................................... 80 80 90 90 90 90 100 460 250 280 310 340 360 380 410 1,800

Owner-occupied mortgage subsidies ... 210 220 230 230 240 250 260 1,210 660 740 820 910 970 1,020 1,100 4,820

Rental housing ...................................... 40 50 50 50 50 50 50 250 140 150 170 190 200 210 230 1,000

Airports, docks, and similar facilities .... 170 170 180 180 190 200 200 950 520 580 650 710 760 800 860 3,780

Student loans ........................................ 60 60 60 60 70 70 70 330 180 200 230 250 270 280 300 1,330

Private nonprofit educational facilities .. 140 150 150 160 160 170 170 810 440 490 550 600 650 680 730 3,210

Hospital construction ............................. 290 300 310 320 330 340 350 1,650 910 1,020 1,130 1,240 1,330 1,400 1,500 6,600

Veterans’ housing ................................. 10 10 10 10 10 10 10 50 30 30 40 40 40 50 50 220

Credit for holders of zone academy 

bonds ..................................................... 50 80 90 100 100 100 100 490 ................ ................ ................ ................ ................ ................ ................ ................

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: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 $1,320; 

2006 $1,370; 2007 $1,400; and 2008 $1,430. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $5,060; 2003 $5,870; 2004 $5,860; 2005 $5,700; 

2006 $7,630; 2007 $7,630; and 2008 $7,500 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 $31,380; 

2005 $32,090; 2006 $33,450; 2007 $34,480; and 2008 $35,380. 

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table. 
110 ANALYTICAL PERSPECTIVES 

Table 6–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2004–2008 PROJECTED REVENUE EFFECT 

(In millions of dollars) 

Provision 2004 2004–2008

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 120,160 724,520

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 68,440 375,910

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 67,870 340,550

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 55,290 307,700

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 53,930 259,560

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 50,910 212,430

Deductibility of charitable contributions, other than education and health ......................................................................... 33,990 187,000

Step-up basis of capital gains at death .............................................................................................................................. 28,500 152,380

Exclusion of interest on public purpose State and local bonds ......................................................................................... 27,310 138,730

Exclusion of interest on life insurance savings ................................................................................................................... 20,740 122,260

Child credit ............................................................................................................................................................................ 21,310 115,670

Capital gains exclusion on home sales ............................................................................................................................... 20,860 110,770

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 23,130 108,250

Social Security benefits for retired workers ......................................................................................................................... 18,930 100,790

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 22,160 86,310

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,900 44,990

Net exclusion of pension contributions and earnings: Keough Plans ................................................................................ 7,616 41,284

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,460 36,480

Workers’ compensation insurance premiums ...................................................................................................................... 6,190 35,330

Deductibility of medical expenses ........................................................................................................................................ 6,340 33,800

Extraterritorial income exclusion .......................................................................................................................................... 5,510 31,620

Graduated corporation income tax rate (normal tax method) ............................................................................................ 5,700 30,670

Earned income tax credit ..................................................................................................................................................... 5,090 27,150

Deductibility of charitable contributions (health) .................................................................................................................. 4,580 25,260

Deductibility of charitable contributions (education) ............................................................................................................ 4,350 24,010

Social Security benefits for dependents and survivors ....................................................................................................... 4,140 22,830

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,920 21,620

Self-employed medical insurance premiums ....................................................................................................................... 3,690 21,350

Social Security benefits for disabled ................................................................................................................................... 3,570 21,140

Credit for low-income housing investments ......................................................................................................................... 3,640 19,970

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,400 18,940

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 2,760 18,790

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,680 14,280

HOPE tax credit ................................................................................................................................................................... 2,880 14,230

Lifetime Learning tax credit .................................................................................................................................................. 2,980 14,110

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,290 12,730

Credit for child and dependent care expenses ................................................................................................................... 3,230 12,710

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,240 11,430

Parental personal exemption for students age 19 or over ................................................................................................. 3,230 11,080

Additional deduction for the elderly ..................................................................................................................................... 2,050 10,490

Special ESOP rules .............................................................................................................................................................. 1,790 9,960

Credit for increasing research activities .............................................................................................................................. 4,990 9,830

Premiums on group term life insurance .............................................................................................................................. 1,830 9,450

Deduction for higher education expenses ........................................................................................................................... 2,880 9,440

Inventory property sales source rules exception ................................................................................................................. 1,620 8,970

Exclusion of interest on hospital construction bonds .......................................................................................................... 1,440 8,250

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 2,130 7,540

Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,170 7,190

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,260 6,830

Expensing of certain small investments (normal tax method) ............................................................................................ 370 6,660

Exemption of credit union income ....................................................................................................................................... 1,160 6,640

Capital gains treatment of certain income ........................................................................................................................... 1,120 6,240

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 1,050 6,030

Low and moderate income savers credit ............................................................................................................................ 1,860 5,890

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 2,240 5,740

Deferral of income from post 1987 installment sales ......................................................................................................... 1,100 5,710

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 830 4,730

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 840 4,660

Exclusion of employee meals and lodging (other than military) ........................................................................................ 810 4,450

Employer provided child care exclusion .............................................................................................................................. 760 4,250

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 700 4,020

Deferral of interest on U.S. savings bonds ......................................................................................................................... 670 4,230

Deductibility of student-loan interest .................................................................................................................................... 660 3,480

Excess of percentage over cost depletion, fuels ................................................................................................................ 650 3,170

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 540 3,060

New markets tax credit ........................................................................................................................................................ 290 3,030

Exclusion of employer-provided educational assistance ..................................................................................................... 520 2,910

Carryover basis of capital gains on gifts ............................................................................................................................. 450 2,910

State prepaid tuition plans ................................................................................................................................................... 400 2,840
6. TAX EXPENDITURES 111

Table 6–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2004–2008 PROJECTED REVENUE EFFECT—Continued

(In millions of dollars) 

Provision 2004 2004–2008

Exclusion for employer-provided transit passes .................................................................................................................. 380 2,630

Adoption credit and exclusion .............................................................................................................................................. 450 2,620

Deductibility of casualty losses ............................................................................................................................................ 420 2,360

Alternative fuel production credit ......................................................................................................................................... 520 2,290

Exclusion of interest on small issue bonds ......................................................................................................................... 400 2,260

Exclusion of parsonage allowances ..................................................................................................................................... 400 2,260

Exclusion of certain foster care payments .......................................................................................................................... 430 2,250

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 410 2,200

Exclusion of railroad retirement system benefits ................................................................................................................ 400 2,000

Expensing of multiperiod timber growing costs ................................................................................................................... 380 1,980

Assistance for adopted foster children ................................................................................................................................ 290 1,910

Enhanced oil recovery credit ............................................................................................................................................... 350 1,830

Education Individual Retirement Accounts .......................................................................................................................... 160 1,730

Exclusion of interest on student-loan bonds ....................................................................................................................... 290 1,660

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 310 1,430

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. 270 1,430

New technology credit .......................................................................................................................................................... 250 1,330

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 240 1,330

Premiums on accident and disability insurance .................................................................................................................. 240 1,300

Capital gains exclusion of small corporation stock ............................................................................................................. 160 1,270

Tax incentives for preservation of historic structures ......................................................................................................... 230 1,260

Exclusion of interest on rental housing bonds .................................................................................................................... 220 1,250

Tax credit for orphan drug research .................................................................................................................................... 180 1,130

Expensing of certain capital outlays .................................................................................................................................... 170 870

Amortization of start-up costs (normal tax method) ............................................................................................................ 150 810

Work opportunity tax credit .................................................................................................................................................. 430 760

Employer-provided child care credit .................................................................................................................................... 130 750

Exclusion of interest on energy facility bonds .................................................................................................................... 130 720

Exclusion of military disability pensions .............................................................................................................................. 120 640

Capital gains treatment of royalties on coal ....................................................................................................................... 110 620

Capital gains treatment of certain timber income ............................................................................................................... 110 620

Expensing of certain multiperiod production costs .............................................................................................................. 120 600

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

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

Credit for holders of zone academy bonds ......................................................................................................................... 90 490

Exclusion of veterans pensions ........................................................................................................................................... 80 450

Income averaging for farmers .............................................................................................................................................. 80 420

Exclusion from income of conservation subsidies provided by public utilities ................................................................... 80 400

Expensing of exploration and development costs, fuels .................................................................................................... 150 360

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 340

Credit for disabled access expenditures ............................................................................................................................. 50 290

Exclusion of interest on veterans housing bonds ............................................................................................................... 50 270

Small business retirement plan credit ................................................................................................................................. 40 260

Exclusion of special benefits for disabled coal miners ....................................................................................................... 60 250

Exceptions from imputed interest rules ............................................................................................................................... 50 250

Ordinary income treatment of loss from small business corporation stock sale ............................................................... 50 250

Cancellation of indebtedness ............................................................................................................................................... 30 250

Tax credit for health insurance purchased by certain displaced and retired individuals .................................................. 60 240

Welfare-to-work tax credit .................................................................................................................................................... 80 210

Additional deduction for the blind ........................................................................................................................................ 40 200

Expensing of exploration and development costs, nonfuel minerals ................................................................................. 30 170

Alcohol fuel credits 1/ ........................................................................................................................................................... 30 150

Income of trusts to finance supplementary unemployment benefits .................................................................................. 30 150

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

Medical Savings Accounts ................................................................................................................................................... 30 140

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

Tax credit for the elderly and disabled ............................................................................................................................... 20 70

Exclusion of interest on savings bonds redeemed to finance educational expenses ....................................................... 10 70

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 60

Exception from passive loss limitation for working interests in oil and gas properties ..................................................... 10 50

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

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

Expensing of environmental remediation costs ................................................................................................................... 20 –20

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 70 –40

Accelerated depreciation on rental housing (normal tax method) ...................................................................................... 1,080 –4,570

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... –2,530 –15,820

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 31,110 –31,570
112 ANALYTICAL PERSPECTIVES 

Table 6–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN 

CALENDAR YEAR 2002

(In millions of dollars) 

Provision 

Present 

Value of 

Revenue 

Loss 

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 7,180 

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 1,740 

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 1,800

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

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

6 Expensing of multiperiod timber growing costs ................................................................................................... 210

7 Expensing of certain multiperiod production costs—agriculture .......................................................................... 240

8 Expensing of certain capital outlays—agriculture ................................................................................................ 270 

9 Deferral of income on life insurance and annuity contracts ................................................................................ 24,210 

10 Expensing of certain small investments (normal tax method) ............................................................................ 700 

11 Amortization of start-up costs (normal tax method) ............................................................................................. 30 

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

13 Credit for holders of zone academy bonds ......................................................................................................... 120 

14 Credit for low-income housing investments ......................................................................................................... 3,580 

15 Deferral for state prepaid tuition plans ................................................................................................................. 590 

16 Exclusion of pension contributions—employer plans ........................................................................................... 90,570 

17 Exclusion of 401(k) contributions .......................................................................................................................... 81,000 

18 Exclusion of IRA contributions and earnings ....................................................................................................... 10,650 

19 Exclusion of contributions and earnings for Keogh plans ................................................................................... 9,290 

20 Exclusion of interest on public-purpose bonds .................................................................................................... 23,560 

21 Exclusion of interest on non-public purpose bonds ............................................................................................. 6,070 

22 Deferral of interest on U.S. savings bonds .......................................................................................................... 470 

Outlay Equivalents 

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

It is the amount of budget outlays that would be required to provide the taxpayer the same after-tax income as would be received through the tax provision. 

The outlay-equivalent measure allows the cost of a tax 

expenditure to be compared with a direct Federal outlay 

on a more even footing. Outlay equivalents are reported 

in Table 6–5.

Table 6–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES 

(In millions of dollars) 

Outlay Equivalents 

2002 2003 2004 2005 2006 2007 2008 2004–2008

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,540 2,570 2,600 2,620 2,650 2,680 2,710 13,260

International affairs: 

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 3,810 3,470 3,530 3,640 3,700 3,880 4,100 18,850

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 1,000 1,060 1,110 1,170 1,220 1,290 1,360 6,150

4 Extraterritorial income exclusion ............................................................................................................. 7,410 7,920 8,480 9,060 9,680 10,350 11,080 48,650

5 Inventory property sales solurce rules exception .................................................................................. 2,260 2,370 2,490 2,620 2,750 2,890 3,050 13,800

6 Deferral of income from controlled foreign corporations (normal tax method) .................................... 7,000 7,450 7,900 8,400 8,930 9,550 10,210 44,990

7 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,950 2,050 2,130 2,190 2,260 960 0 7,540

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,660 2,200 2,760 3,390 3,990 4,270 4,380 18,790

9 Credit for increasing research activities ................................................................................................. 10,560 8,670 7,680 4,470 1,910 800 260 15,120

Energy 

10 Expensing of exploration and development costs, fuels ....................................................................... 170 180 150 80 60 50 40 380

11 Excess of percentage over cost depletion, fuels .................................................................................. 850 930 810 790 840 850 850 4,140

12 Alternative fuel production credit ............................................................................................................ 2,100 1,260 700 700 700 700 280 3,080

13 Exception from passive loss limitation for working interests in oil and gas properties ....................... 0

14 Capital gains treatment of royalties on coal .......................................................................................... 130 140 150 160 170 170 180 830

15 Exclusion of interest on energy facility bonds ....................................................................................... 160 170 180 200 200 210 230 1,020

16 Enhanced oil recovery credit .................................................................................................................. 540 560 570 590 600 620 630 3,010

17 New technology credit ............................................................................................................................ 140 240 330 350 360 360 370 1,770

18 Alcohol fuel credits 1 ............................................................................................................................... 30 30 30 30 30 30 30 150

19 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 100 120 100 60 –10 –90 –100 –40

20 Exclusion from income of conservation subsidies provided by public utilities ..................................... 100 110 110 110 110 100 100 530

Natural Resources and Environment 
6. TAX EXPENDITURES 113

Table 6–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(In millions of dollars) 

Outlay Equivalents 

2002 2003 2004 2005 2006 2007 2008 2004–2008

21 Expensing of exploration and development costs, nonfuel minerals .................................................... 40 40 40 40 50 50 50 230

22 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 330 340 350 360 370 380 390 1,850

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 640 690 780 840 880 930 980 4,410

24 Capital gains treatment of certain timber income ................................................................................. 130 140 150 160 170 170 180 830

25 Expensing of multiperiod timber growing costs ..................................................................................... 470 480 490 510 520 530 540 2,590

26 Tax incentives for preservation of historic structures ............................................................................ 200 210 220 240 250 260 270 1,240

Agriculture 

27 Expensing of certain capital outlays ...................................................................................................... 220 230 210 210 210 210 230 1,070

28 Expensing of certain multiperiod production costs ................................................................................ 160 160 150 150 140 140 140 720

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

30 Capital gains treatment of certain income ............................................................................................. 1,350 1,420 1,500 1,580 1,660 1,750 1,840 8,330

31 Income averaging for farmers ................................................................................................................ 90 90 100 100 100 100 110 510

32 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 20 60

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ..................................................................................................... 1,300 1,380 1,480 1,580 1,690 1,800 1,920 8,470

34 Excess bad debt reserves of financial institutions ............................................................................0000000 0

35 Exclusion of interest on life insurance savings ................................................................................. 19,630 21,230 23,010 24,940 27,060 29,250 31,420 135,680

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 290 310 330 350 370 390 400 1,840

38 Small life insurance company deduction ........................................................................................... 120 120 120 120 120 120 120 600

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 1,250 1,380 1,510 1,640 1,730 1,830 1,950 8,660

40 Exclusion of interest on rental housing bonds .................................................................................. 260 290 320 350 360 370 400 1,800

41 Deductibility of mortgage interest on owner-occupied homes .......................................................... 63,590 65,540 68,440 71,870 74,790 78,160 82,650 375,910

42 Deductibility of State and local property tax on owner-occupied homes ......................................... 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310

43 Deferral of income from post 1987 installment sales ....................................................................... 1,040 1,060 1,080 1,100 1,120 1,140 1,170 5,610

44 Capital gains exclusion on home sales ............................................................................................. 24,580 25,320 26,080 26,860 27,670 28,500 29,350 138,460

45 Exception from passive loss rules for $25,000 of rental loss .......................................................... 5,690 5,270 4,920 4,600 4,290 4,020 3,790 21,620

46 Credit for low-income housing investments ....................................................................................... 4,450 4,670 4,920 5,170 5,390 5,620 5,900 27,000

47 Accelerated depreciation on rental housing (normal tax method) .................................................... 1,590 1,080 310 –510 –1,770 –3,310 –4,570 –9,860

Commerce: 

48 Cancellation of indebtedness ............................................................................................................. 0 10 30 50 60 60 50 250

49 Exceptions from imputed interest rules ............................................................................................. 50 50 50 50 50 50 50 250

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 74,750 73,350 71,910 72,730 66,490 66,340 68,590 346,060

51 Capital gains exclusion of small corporation stock ........................................................................... 130 170 220 270 340 400 460 1,690

52 Step-up basis of capital gains at death ............................................................................................ 35,850 36,520 38,000 39,500 40,650 41,830 43,190 203,170

53 Carryover basis of capital gains on gifts ........................................................................................... 640 640 450 540 640 650 630 2,910

54 Ordinary income treatment of loss from small business corporation stock sale ............................. 50 50 60 60 60 60 60 300

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... –1,800 –2,530 –1,980 –6,520 –9,200 –12,360 –15,820 –45,880

56 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 47,770 31,110 16,670 –39,310 –35,260 –33,260 –31,570 –122,730

57 Expensing of certain small investments (normal tax method) .......................................................... –360 –110 370 1,570 1,830 1,510 1,380 6,660

58 Amortization of start-up costs (normal tax method) .......................................................................... 110 130 150 160 160 170 170 810

59 Graduated corporation income tax rate (normal tax method) .......................................................... 7,490 8,280 8,770 9,040 9,380 9,770 10,210 47,170

60 Exclusion of interest on small issue bonds ....................................................................................... 470 520 570 610 640 670 730 3,220

Transportation 

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

62 Exclusion of reimbursed employee parking expenses .......................................................................... 2,710 2,860 3,020 3,190 3,360 3,550 3,730 16,850

63 Exclusion for employer-provided transit passes .................................................................................... 310 400 480 560 660 750 840 3,290

Community and Regional Development 

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

65 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 30 30 30 30 30 30 30 150

66 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 70 70 70 70 340

67 Empowerment zones, Enterprise communities and Renewal communities ......................................... 730 1,120 1,170 1,280 1,410 1,580 1,750 7,190

68 New markets tax credit ........................................................................................................................... 90 190 300 420 610 830 870 3,030

69 Expensing of environmental remediation costs ..................................................................................... 110 110 40 –20 –10 –10 –10 –10

Education, Training, Employment, and Social Services 

Education: 

70 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,390 1,390 1,380 1,480 1,540 1,550 1,560 7,510

71 HOPE tax credit .................................................................................................................................. 5,270 4,510 3,690 3,760 3,500 3,720 3,580 18,250

72 Lifetime Learning tax credit ................................................................................................................ 2,790 2,880 3,820 3,640 3,340 3,610 3,660 18,070

73 Education Individual Retirement Accounts ........................................................................................ 60 120 190 280 390 520 660 2,040

74 Deductibility of student-loan interest .................................................................................................. 540 760 790 820 840 850 860 4,160

75 Deduction for higher education expenses ......................................................................................... 540 2,860 3,700 4,640 3,760 0 0 12,100

76 State prepaid tuition plans ................................................................................................................. 270 340 400 470 560 660 750 2,840
114 ANALYTICAL PERSPECTIVES 

Table 6–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(In millions of dollars) 

Outlay Equivalents 

2002 2003 2004 2005 2006 2007 2008 2004–2008

77 Exclusion of interest on student-loan bonds ..................................................................................... 340 370 410 440 490 510 530 2,380

78 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 830 920 1,010 1,090 1,160 1,220 1,300 5,780

79 Credit for holders of zone academy bonds ....................................................................................... 70 110 130 140 150 150 150 720

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

81 Parental personal exemption for students age 19 or over ............................................................... 2,750 3,670 3,570 2,980 2,240 1,850 1,630 12,270

82 Deductibility of charitable contributions (education) .......................................................................... 5,670 5,830 6,130 6,560 6,800 7,000 7,380 33,870

83 Exclusion of employer-provided educational assistance ................................................................... 500 610 650 680 720 760 800 3,610

Training, employment, and social services:.

84 Work opportunity tax credit ................................................................................................................ 380 560 430 190 80 40 20 760

85 Welfare-to-work tax credit .................................................................................................................. 80 70 80 60 40 20 10 210

86 Exclusion of employer provided child care ........................................................................................ 920 960 1,010 1,080 1,130 1,190 1,250 5,660

87 Employer-provided child care ............................................................................................................. 60 120 170 190 200 220 230 840

88 Assistance for adopted foster children .............................................................................................. 250 280 330 370 420 480 540 2,140

89 Adoption credit and exclusion ............................................................................................................ 180 280 570 640 690 710 730 3,340

90 Exclusion of employee meals and lodging (other than military) ...................................................... 910 950 990 1030 1080 1130 1180 5,410

91 Child credit 2 ........................................................................................................................................ 29,560 28,590 28,410 29,970 32,370 31,920 31,550 154,220

92 Credit for child and dependent care expenses ................................................................................. 3,670 3,880 4,310 3,810 3,170 2,920 2,730 16,940

93 Credit for disabled access expenditures ........................................................................................... 60 70 70 70 80 80 80 380

94 Deductibility of charitable contributions, other than education and health ....................................... 42,840 44,510 47,190 49,550 51,910 53,760 57,280 259,690

95 Exclusion of certain foster care payments ........................................................................................ 520 490 500 510 520 530 540 2,600

96 Exclusion of parsonage allowances ................................................................................................... 430 460 490 520 550 580 620 2,760

Health 

97 Exclusion of employer contributions for medical insurance premiums and medical care ................... 128,510 140,330 155,930 172,140 188,900 205,820 223,620 946,410

98 Self-employed medical insurance premiums ......................................................................................... 2,200 3,110 4,590 4,870 5,200 5,560 6,150 26,370

99 Workers’ compensation insurance premiums ........................................................................................ 6,580 7,200 7,710 8,250 8,720 9,300 9,950 43,930

100 Medical Savings Accounts ...................................................................................................................... 30 30 40 40 40 40 30 190

101 Deductibility of medical expenses .......................................................................................................... 6,210 6,600 6,910 7,050 7,160 7,560 7,990 36,670

102 Exclusion of interest on hospital construction bonds ............................................................................ 1,720 1,900 2,070 2,240 2,390 2,500 2,660 11,860

103 Deductibility of charitable contributions (health) .................................................................................... 5,990 6,160 6,470 6,940 7,180 7,380 7,770 35,740

104 Tax credit for orphan drug research ...................................................................................................... 210 240 270 300 330 370 420 1,690

105 Special Blue Cross/Blue Shield deduction ............................................................................................. 400 450 410 400 360 400 330 1,900

106 Tax credit for health insurance purchased by certain displaced and retired individuals ..................... 0 0 70 40 50 60 70 290

Income Security 

107 Exclusion of railroad retirement system benefits ................................................................................... 390 400 400 400 400 400 400 2,000

108 Exclusion of workers’ compensation benefits ........................................................................................ 5,750 6,100 6,460 6,850 7,270 7,710 8,190 36,480

109 Exclusion of public assistance benefits (normal tax method) ............................................................... 380 400 410 430 450 470 440 2,200

110 Exclusion of special benefits for disabled coal miners ......................................................................... 70 60 60 50 50 50 40 250

111 Exclusion of military disability pensions ................................................................................................. 110 110 120 120 130 130 140 640

Net exclusion of pension contributions and earnings:.

112 Employer plans ................................................................................................................................... 63,280 77,890 82,770 86,020 89,270 82,320 74,930 415,310

113 401(k) plans ........................................................................................................................................ 62,750 64,930 67,430 70,520 74,990 79,340 82,960 375,240

114 Individual Retirement Accounts .......................................................................................................... 25,790 28,010 30,690 29,930 29,420 27,630 26,730 144,400

115 Low and moderate income savers credit .......................................................................................... 20 30 30 30 30 30 30 150

116 Keogh plans ........................................................................................................................................ 8,943 9,272 9,661 9,976 10,259 10,521 11,516 51,933

Exclusion of other employee benefits:.

117 Premiums on group term life insurance ............................................................................................ 2360 2400 2440 2480 2520 2560 2610 12,610

118 Premiums on accident and disability insurance ................................................................................ 290 310 320 330 350 360 370 1,730

119 Small business retirement plan credit ............................................................................................... 10 20 40 50 50 60 60 260

120 Income of trusts to finance supplementary unemployment benefits ................................................ 20 30 30 30 30 30 30 150

121 Special ESOP rules ............................................................................................................................ 2,220 2,340 2,450 2,580 2,720 2,860 2,990 13,600

122 Additional deduction for the blind ...................................................................................................... 40 50 50 50 50 50 50 250

123 Additional deduction for the elderly ................................................................................................... 2,290 2,360 2,480 2,570 2,630 2,550 2,460 12,690

124 Tax credit for the elderly and disabled ............................................................................................. 30 20 20 20 20 20 10 90

125 Deductibility of casualty losses .......................................................................................................... 310 440 460 480 510 500 540 2,490

126 Earned income tax credit 3 ................................................................................................................. 4,930 5,470 5,660 5,860 6,010 6,200 6,430 30,160

Social Security 

Exclusion of social security benefits:.

127 Social Security benefits for retired workers ....................................................................................... 18,340 18,560 18,930 19,210 20,000 21,100 21,550 100,790

128 Social Security benefits for disabled ................................................................................................. 2,910 3,210 3,570 3,950 4,360 4,870 4,390 21,140

129 Social Security benefits for dependents and survivors ..................................................................... 3,730 3,910 4,140 4,360 4,590 4,920 4,820 22,830

Veterans Benefits and Services.

130 Exclusion of veterans death benefits and disability compensation .................................................. 3,160 3,230 3,400 3,590 3,780 3,980 4,190 18,940

131 Exclusion of veterans pensions ......................................................................................................... 70 80 80 90 90 90 100 450

132 Exclusion of GI bill benefits ............................................................................................................... 90 90 90 100 100 110 110 510

133 Exclusion of interest on veterans housing bonds ............................................................................. 50 50 70 70 70 80 80 370
6. TAX EXPENDITURES 115

Table 6–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(In millions of dollars) 

Outlay Equivalents 

2002 2003 2004 2005 2006 2007 2008 2004–2008

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose State and local bonds ........................................................... 36,190 38,400 39,160 39,740 39,850 39,430 40,630 198,810

135 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430

136 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 3,190 3,190 3,190 3,140 1,860 0 0 8,190

Interest 

137 Deferral of interest on U.S. savings bonds ........................................................................................... 510 590 670 750 840 920 1,050 4,230

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied homes ........................................................................................ 21,760 22,320 22,160 19,750 16,240 14,580 13,580 86,310

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 47,430 50,520 50,910 47,770 40,480 37,190 36,080 212,430

Exclusion of interest on State and local bonds for: 

Public purposes .................................................................................................................................. 36,190 38,400 39,160 39,740 39,850 39,430 40,630 198,810

Energy facilities ................................................................................................................................... 160 170 180 200 200 210 230 1,020

Water, sewage, and hazardous waste disposal facilities ................................................................. 640 690 780 840 880 930 980 4,410

Small-issues ........................................................................................................................................ 470 520 570 610 640 670 730 3,220

Owner-occupied mortgage subsidies ................................................................................................. 1,250 1,380 1,510 1,640 1,730 1,830 1,950 8,660

Rental housing .................................................................................................................................... 260 290 320 350 360 370 400 1,800

Airports, docks, and similar facilities ................................................................................................. 30 30 30 30 30 30 30 150

Student loans ...................................................................................................................................... 340 370 410 440 490 510 530 2,380

Private nonprofit educational facilities ............................................................................................... 830 920 1,010 1,090 1,160 1,220 1,300 5,780

Hospital construction .......................................................................................................................... 1,720 1,900 2,070 2,240 2,390 2,500 2,660 11,860

Veterans’ housing ............................................................................................................................... 50 50 70 70 70 80 80 370

Credit for holders of zone academy bonds ....................................................................................... 70 110 130 140 150 150 150 720

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: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 

$1,320; 2006 $1,370; 2007 $1,400; and 2008 $1,430.

2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $980; 2002 $5,060 2003 $5,870; 2004 $5,860; 

2005 $5,700; 2006 $7,630; 2007 $7,630; and 2008 $7,500

3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 

$31,380; 2005 $32,090; 2006 $33,450; 2007 $34,480; and 2008 $35,380.

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

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

Tax Expenditure Baselines 

A tax expenditure is an exception to baseline provisions of the tax structure. The 1974 Congressional 

Budget Act, which mandated the tax expenditure budget, did not specify the baseline provisions of the tax 

law. As noted previously, deciding whether provisions 

are exceptions, therefore, is a matter of judgment. As 

in prior years, this year’s tax expenditure estimates 

are presented using two baselines: the normal tax baseline and the reference tax law baseline. 

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

sum of consumption and the change in net wealth in 

a given period of time. The normal tax baseline allows 

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

is not limited to a particular structure of tax rates, 

or by a specific definition of the taxpaying unit. 

The reference tax law baseline is also patterned on 

a comprehensive income tax, but it is closer to existing 

law. Tax expenditures under the reference law baseline 

are always tax expenditures under the normal tax baseline, but the reverse is not always true. 

Both the normal and reference tax baselines allow 

several major departures from a pure comprehensive 

income tax. For example: 

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

own produce) is regarded as a tax expenditure. 

Imputed income would be taxed under a comprehensive income tax, and all income would be 

taxed as it accrued. 

• 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. (This budget proposes to eliminate the 

double taxation of corporate income.) 

• Values of assets and debt are not generally 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). 
116 ANALYTICAL PERSPECTIVES 

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

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

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

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

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

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

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

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

may be limited under the alternative minimum tax. 

3 Committee on Government Affairs, United States Senate, ‘‘Government Performance and 

Results Act of 1993’’ (Report 103-58, 1993). 

Although the reference law and normal tax baselines 

are generally similar, areas of difference include: 

(1) 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. 

(2) Income subject to the tax. Income subject to tax 

is defined as gross income less the costs of earning 

that income. The Federal income tax defines gross income to include: (1) consideration received in the exchange of goods and services, including labor services 

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

net income earned and/or reported by another entity 

(such as a partnership). Under the reference tax rules, 

therefore, gross income does not include gifts defined 

as receipts of money or property that are not consideration in an exchange—or most transfer payments, 

which can be thought of as gifts from the Government.1

The normal tax baseline also excludes gifts between 

individuals from gross income. Under the normal tax 

baseline, however, all cash transfer payments from the 

Government to private individuals are counted in gross 

income, and exemptions of such transfers from tax are 

identified as tax expenditures. The costs of earning income are generally deductible in determining taxable 

income under both the reference and normal tax baselines.2

(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 property is computed using estimates 

of economic depreciation. The latter represents a 

change in the calculation of the tax expenditure under 

normal law in the 2004 Budget. The Appendix provides 

further details on the new methodology and how it 

differs from the prior methodology. 

(4) Treatment of foreign income. Both the normal and 

reference tax baselines allow a tax credit for foreign 

income taxes paid (up to the amount of U.S. income 

taxes that would otherwise be due), which prevents 

double taxation of income earned abroad. Under the 

normal tax method, however, controlled foreign corporations (CFCs) are not regarded as entities separate from 

their controlling U.S. shareholders. Thus, the deferral 

of tax on income received by CFCs is regarded as a 

tax expenditure under this method. In contrast, except 

for tax haven activities, the reference law baseline follows current law in treating CFCs as separate taxable 

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

distributed to U.S. taxpayers. Under this baseline, deferral of tax on CFC income is not a tax expenditure 

because U.S. taxpayers generally are not taxed on accrued, but unrealized, income. 

In addition to these areas of difference, the Joint 

Committee on Taxation considers a somewhat broader 

set of tax expenditures under its normal tax baseline 

than is considered here. 

Performance Measures and the Economic 

Effects of Tax Expenditures 

The Government Performance and Results Act of 

1993 (GPRA) directs Federal agencies to develop annual 

and strategic plans for their programs and activities. 

These plans set out performance objectives to be 

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

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

Executive branch to undertake a series of analyses to 

assess the effect of specific tax expenditures on the 

achievement of agencies’ performance objectives. 

The Executive Branch is continuing to focus on the 

availability of data needed to assess the effects of the 

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

Division (IRS) have developed a new sample of individual income tax filers as one part of this effort. This 

new ‘‘panel’’ sample will follow the same taxpayers over 

a period of at least ten years. The first year of this 

panel sample was drawn from tax returns filed in 2000 

for tax year 1999. The sample will capture the changing 

demographic and economic circumstances of individuals 

and the effects of changes in tax law over an extended 

period of time. Data from the sample will therefore 

permit more extensive, and better, analyses of many 

tax provisions than can be performed using only annual 

(‘‘cross-section’’) data. In particular, data from this 

panel sample will enhance our ability to analyze the 

effect of tax expenditures designed to increase savings. 

Other efforts by OMB, Treasury, and other agencies 

to improve data available for the analysis of tax expenditures will continue over the next several years. 

Comparison of tax expenditure, spending, and 

regulatory policies. Tax expenditures by definition 

work through the tax system and, particularly, the in-
6. TAX EXPENDITURES 117

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

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

for certain types of consumption deemed meritorious. 

come tax. Thus, they may be relatively advantageous 

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

Because there is an existing public administrative and 

private compliance structure for the tax system, the 

incremental administrative and compliance costs for a 

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

some tax expenditures actually simplify the tax system, 

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

gains on home sales). 

Tax expenditures also have important limitations. In 

many cases they add to the complexity of the tax system, which raises both administrative and compliance 

costs. For example, targeting personal exemptions and 

credits can complicate filing and decisionmaking. The 

income tax system may have little or no contact with 

persons who have no or very low incomes, and does 

not require information on certain characteristics of individuals used in some spending programs, such as 

wealth. Verifying eligibility criteria can be costly. The 

tax system also operates on the basis of annual income 

and it may be poorly targeted when taxpayer characteristics change within the course of a year. These features 

may reduce the effectiveness of tax expenditures for 

addressing certain income-transfer objectives. Tax expenditures also generally do not enable the same degree 

of agency discretion as an outlay program. For example, 

grant or direct Federal service delivery programs can 

prioritize activities to be addressed with specific resources in a way that is difficult to emulate with tax 

expenditures. Tax expenditures may not receive the 

same level of scrutiny afforded to other programs. 

Outlay programs have advantages where direct government service provision is particularly warranted--

such as equipping and providing the armed forces or 

administering the system of justice. Outlay programs 

may also be specifically designed to meet the needs 

of low-income families who would not otherwise be subject to income taxes or need to file a tax return. Outlay 

programs may also receive more year-to-year oversight 

and fine tuning, through the legislative and executive 

budget process. In addition, many different types of 

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

governments, the private sector, or individuals in the 

form of grants or contracts—provide flexibility for policy 

design. On the other hand, certain outlay programs—

such as direct government service provision—may rely 

less directly on economic incentives and private-market 

provision than tax incentives, which may reduce the 

relative efficiency of spending programs for some goals. 

Spending programs require resources to be raised via 

taxes, user charges, or government borrowing, which 

can impose further costs by diverting resources from 

their most efficient uses, but tax expenditures can have 

similar effects by requiring government to make up 

for lost revenue. Finally, spending programs, particularly on the discretionary side, may respond less readily 

to changing activity levels and economic conditions than 

tax expenditures. 

Regulations have more direct and immediate effects 

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

private sector. Regulations can also be fine-tuned more 

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

largely upon voluntary compliance, rather than detailed 

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

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

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

this feature can also promote full compliance where 

(as in certain safety-related cases) policymakers believe 

that trade-offs with economic considerations are not of 

paramount importance. Also, regulations generally do 

not directly affect Federal outlays or receipts. Thus, 

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

that goes well beyond the analysis required for outlays 

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

lack of formal analysis. 

Some policy objectives are achieved using multiple 

approaches. For example, minimum wage legislation, 

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

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

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

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

saving for retirement or investing in certain sectors); 

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

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

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

Also, many tax expenditures, including those cited 

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

accelerated depreciation may encourage investment. In 

addition, the economic effects of particular provisions 

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

incomes may have positive or negative effects on tax 

neutrality). 

Performance measurement is generally concerned 

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

expenditures, the principal input is usually the revenue 

effect. Outputs are quantitative or qualitative measures 
118 ANALYTICAL PERSPECTIVES 

of goods and services, or changes in income and investment, directly produced by these inputs. Outcomes, in 

turn, represent the changes in the economy, society, 

or environment that are the ultimate goals of programs. 

Thus, for a provision that reduces taxes on certain 

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

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

inequity or unintended consequence in the tax code, 

an important performance measure might be how they 

change effective tax rates (the discounted present-value 

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

distortions caused by taxes). Effects on the incomes of 

members of particular groups may be an important 

measure for certain provisions. 

An overview of evaluation issues by budget function. 

The discussion below considers the types of measures 

that might be useful for some major programmatic 

groups of tax expenditures. The discussion is intended 

to be illustrative and not all encompassing. However, 

it is premised on the assumption that the data needed 

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

major challenge, and data constraints may limit the 

assessment of the effectiveness of many provisions. In 

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

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

tax preferences for military benefits reflect, among 

other things, the view that benefits such as housing, 

subsistence, and moving expenses are intrinsic aspects 

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

benefit of the employer, the U.S. Government. Tax benefits for combat service are intended to reduce tax burdens on military personnel undertaking hazardous service for the Nation. A portion of the tax expenditure 

associated with foreign earnings is targeted to benefit 

U.S. Government civilian personnel working abroad by 

offsetting the living costs that can be higher than those 

in the United States. These tax expenditures should 

be considered together with direct agency budget costs 

in making programmatic decisions. 

International affairs.—Tax expenditures are also 

aimed at goals such as tax neutrality. These include 

the exclusion for income earned abroad by nongovernmental employees and exclusions for income of U.S.-

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

General science, space and technology; energy; 

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

tax expenditures reduces the cost of investment, both 

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

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

incentives by measuring their effects on the cost of 

capital (the interest rate which investments must yield 

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

of these provisions on the amounts of corresponding 

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

some cases, such as research, there is evidence that 

the investment can provide significant positive 

externalities—that is, economic benefits that are not 

reflected in the market transactions between private 

parties. It could be useful to quantify these externalities 

and compare them with the size of tax expenditures. 

Measures could also indicate the effects on production 

from these investments—such as numbers or values 

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

extent to which the preferences increase production (as 

opposed to benefitting existing output) and their costeffectiveness relative to other policies. Analysis could 

also consider objectives that are more difficult to measure but still are ultimate goals, such as promoting the 

Nation’s technological base, energy security, environmental quality, or economic growth. Such an assessment is likely to involve tax analysis as well as consideration of non-tax matters such as market structure, 

scientific, and other information (such as the effects 

of increased domestic fuel production on imports from 

various regions, or the effects of various energy sources 

on the environment). 

Housing investment also benefits from tax expenditures. The mortgage interest deduction on personal residences is reported as a tax expenditure because the 

value of owner-occupied housing services is not included 

in a taxpayer’s taxable income. Taxpayers also may 

exclude up to $500,000 of the capital gains from the 

sale of personal residences. Measures of the effectiveness of these provisions could include their effects on 

increasing the extent of home ownership and the quality of housing.. Similarly, analysis of the extent of accumulated inflationary gains is likely to be relevant to 

evaluation of the capital gains for home sales. Deductibility of State and local property taxes assists with 

making housing more affordable as well as easing the 

cost of providing community services through these 

taxes. Provisions intended to promote investment in 

rental housing could be evaluated for their effects on 

making such housing more available and affordable. 

These provisions should then be compared with alternative programs that address housing supply and demand. 

Transportation.—Employer-provided parking is a 

fringe benefit that, for the most part, is excluded from 

taxation. The tax expenditure estimates reflect the cost 

of parking that is leased by employers for employees; 

an estimate is not currently available for the value 
6. TAX EXPENDITURES 119

of parking owned by employers and provided to their 

employees. The exclusion for employer-provided transit 

passes is intended to promote use of this mode of transportation, which has environmental and congestion benefits. The tax treatments of these different benefits 

could be compared with alternative transportation policies. 

Community and regional development.—A series 

of tax expenditures is intended to promote community 

and regional development by reducing the costs of financing specialized infrastructure, such as airports, 

docks, and stadiums. Empowerment zone and enterprise community provisions are designed to promote 

activity in disadvantaged areas. These provisions can 

be compared with grants and other policies designed 

to spur economic development. 

Education, training, employment, and social 

services.—Major provisions in this function are intended to promote post-secondary education, to offset 

costs of raising children, and to promote a variety of 

charitable activities. The education incentives can be 

compared with loans, grants, and other programs designed to promote higher education and training. The 

child credits are intended to adjust the tax system for 

the costs of raising children; as such, they could be 

compared to other Federal tax and spending policies, 

including related features of the tax system, such as 

personal exemptions (which are not defined as a tax 

expenditure). Evaluation of charitable activities requires consideration of the beneficiaries of these activities, who are generally not the parties receiving the 

tax reduction. 

Health.—Individuals also benefit from favorable 

treatment of employer-provided health insurance. Measures of these benefits could include increased coverage 

and pooling of risks. The effects of insurance coverage 

on final outcome measures of actual health (e.g., infant 

mortality, days of work lost due to illness, or life expectancy) or intermediate outcomes (e.g., use of preventive 

health care or health care costs) could also be investigated. A potentially negative outcome of this tax expenditure is that the subsidy may lead to excessive 

health care spending for these who are covered. 

Income security, Social Security, and veterans 

benefits and services.—Major tax expenditures in the 

income security function benefit retirement savings, 

through employer-provided pensions, individual retirement accounts, and Keogh plans. These provisions 

might be evaluated in terms of their effects on boosting 

retirement incomes, private savings, and national savings (which would include the effect on private savings 

as well as public savings or deficits). Interactions with 

other programs, including Social Security, also may 

merit analysis. As in the case of employer-provided 

health insurance, analysis of employer-provided pension 

programs requires imputing the value of benefits funded at the firm level to individuals. 

Other provisions principally affect the incomes of 

members of certain groups, rather than affecting incentives. For example, tax-favored treatment of Social Security benefits, certain veterans benefits, and deductions for the blind and elderly provide increased incomes to eligible parties. The earned-income tax credit, 

in contrast, should be evaluated for its effects on labor 

force participation as well as the income it provides 

lower-income workers. 

General purpose fiscal assistance and interest.—

The tax-exemption for public purpose State and local 

bonds reduces the costs of borrowing for a variety of 

purposes (borrowing for non-public purposes is reflected 

under other budget functions). The deductibility of certain State and local taxes reflected under this function 

primarily relates to personal income taxes (property tax 

deductibility is reflected under the commerce and housing function). Tax preferences for Puerto Rico and other 

U.S. possessions are also included here. These provisions can be compared with other tax and spending 

policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings 

bonds benefits savers who invest in these instruments. 

The extent of these benefits and any effects on Federal 

borrowing costs could be evaluated. 

The above illustrative discussion, although broad, is 

nevertheless incomplete, omitting important details 

both for the provisions mentioned and the many that 

are not explicitly cited. Developing a framework that 

is sufficiently comprehensive, accurate, and flexible to 

reflect the objectives and effects of the wide range of 

tax expenditures will be a significant challenge. OMB, 

Treasury, and other agencies will work together, as 

appropriate, to address this challenge. As indicated 

above, over the next few years the Executive Branch’s 

focus will be on the availability of the data needed 

to assess the effects of the tax expenditures designed 

to increase savings. 

Descriptions of Income Tax Provisions 

Descriptions of the individual and corporate income 

tax expenditures reported upon in this chapter follow. 

These descriptions relate to current law as of December 

31, 2002, and do not reflect proposals made elsewhere 

in the Budget. 

National Defense 

1. Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, as well as certain 

amounts of pay related to combat service, are excluded 

from income subject to tax. 

International Affairs 

2. Income earned abroad.—U.S. citizens who lived 

abroad, worked in the private sector, and satisfied a 

foreign residency requirement in 2002 may exclude up 

to $80,000 in foreign earned income from U.S. taxes. 
120 ANALYTICAL PERSPECTIVES 

5The determination of whether a provision is a tax expenditure is made on the basis 

of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under 

general U.S. income tax principles. For that reason, the tax expenditure estimates include, 

for example, estimates related to the exclusion of extraterritorial income, as well as other 

exclusions, notwithstanding that such exclusions define income under the general rule of 

U.S. income taxation. 

In addition, if these taxpayers receive a specific allowance for foreign housing from their employers, they may 

also exclude the value of that allowance. If they do 

not receive a specific allowance for housing expenses, 

they may deduct against their U.S. taxes that portion 

of such expenses that exceeds one-sixth the salary of 

a civil servant at grade GS-14, step 1 ($67,765 in 2002). 

3. Exclusion of certain allowances for Federal 

employees abroad.—U.S. Federal civilian employees 

and Peace Corps members who work outside the continental United States are allowed to exclude from U.S. 

taxable income certain special allowances they receive 

to compensate them for the relatively high costs associated with living overseas. The allowances supplement 

wage income and cover expenses like rent, education, 

and the cost of travel to and from the United States. 

4. Extraterritorial income exclusion5.—For purposes of calculating U.S. tax liability, a taxpayer may 

exclude from gross income the qualifying foreign trade 

income attributable to foreign trading gross receipts. 

The exclusion generally applies to income from the sale 

or lease of qualifying foreign trade property and certain 

types of services income. The FSC Repeal and 

Extraterritorial Income Exclusion Act of 2000 created 

the extraterritorial income exclusion to replace the foreign sales corporation provisions, which the Act repealed. The exclusion is generally available for transactions entered into after September 30, 2000. 

5. Sales source rule exceptions.—The worldwide 

income of U.S. persons is taxable by the United States 

and a credit for foreign taxes paid is allowed. The 

amount of foreign taxes that can be credited is limited 

to the pre-credit U.S. tax on the foreign source income. 

The sales source rules for inventory property allow U.S. 

exporters to use more foreign tax credits by allowing 

the exporters to attribute a larger portion of their earnings abroad than would be the case if the allocation 

of earnings was based on actual economic activity. 

6. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled 

by U.S. shareholders is not subject to U.S. taxation. 

The income becomes taxable only when the controlling 

U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal 

tax method, the currently attributable foreign source 

pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not 

distributed. Thus, the normal tax method considers the 

amount of controlled foreign corporation income not distributed to a U.S. shareholder as tax-deferred income. 

7. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. Taxes on 

income earned through December 31, 2006 can be deferred. 

General Science, Space, and Technology 

8. Expensing R&E expenditures.—Research and 

experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue 

for several years. It is often difficult, however, to identify whether a specific R&E project is successful and, 

if successful, what its expected life will be. Under the 

normal tax method, the expensing of R&E expenditures 

is viewed as a tax expenditure. The baseline assumed 

for the normal tax method is that all R&E expenditures 

are successful and have an expected life of five years. 

9. R&E credit.—The research and experimentation 

(R&E) credit is 20 percent of qualified research expenditures in excess of a base amount. The base amount 

is generally determined by multiplying a ‘‘fixed-base 

percentage’’ by the average amount of the company’s 

gross receipts for the prior four years. The taxpayer’s 

fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through 

1988. Taxpayers may also elect an alternative credit 

regime. Under the alternative credit regime the taxpayer is assigned a three-tiered fixed-base percentage 

that is lower than the fixed-base percentage that would 

otherwise apply, and the credit rate is reduced (the 

rates range from 2.65 percent to 3.75 percent). A 20-

percent credit with a separate threshold is provided 

for a taxpayer’s payments to universities for basic research. The credit applies to research conducted before 

July 1, 2004 and extends to research conducted in Puerto Rico and the U.S. possessions. 

Energy 

10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of 

unsalvageable materials used in constructing wells) 

may be expensed rather than amortized over the productive life of the property. Integrated oil companies 

may deduct only 70 percent of such costs and must 

amortize the remaining 30 percent over five years. The 

same rule applies to the exploration and development 

costs of surface stripping and the construction of shafts 

and tunnels for other fuel minerals. 

11. 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 
6. TAX EXPENDITURES 121

producers. Unlike depreciation or cost depletion, percentage depletion deductions can exceed the cost of the 

investment. 

12. Alternative fuel production credit.—A nontaxable credit of $3 per oil-equivalent barrel of production (in 1979 dollars) is provided for several forms of 

alternative fuels. The credit is generally available if 

the price of oil stays below $29.50 (in 1979 dollars). 

The credit generally expires on December 31, 2002. 

13. Oil and gas exception to passive loss limitation.—Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations. 

As a result, the working interest-holder, who manages 

on behalf of himself and all other owners the development of wells and incurs all the costs of their operation, 

may aggregate negative taxable income from such interests with his income from all other sources. 

14. Capital gains treatment of royalties on 

coal.—Sales of certain coal under royalty contracts can 

be treated as capital gains rather than ordinary income. 

15. Energy facility bonds.—Interest earned on 

State and local bonds used to finance construction of 

certain energy facilities is tax-exempt. These bonds are 

generally subject to the State private-activity bond annual volume cap. 

16. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for 

tertiary oil recovery on U.S. projects. Qualifying costs 

include tertiary injectant expenses, intangible drilling 

and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property. 

17. New technology credits.—A credit of 10 percent 

is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from 

renewable resources such as wind, biomass, and poultry 

waste facilities. The renewable resources credit applies 

only to electricity produced by a facility placed in service on or before December 31, 2004. 

18. Alcohol fuel credits.—An income tax credit is 

provided for ethanol that is derived from renewable 

sources and used as fuel. The credit equals 53 cents 

per gallon in 2001 and 2002; 52 cents per gallon in 

2003 and 2004; and 51 cents per gallon in 2005, 2006, 

and 2007. To the extent that ethanol is mixed with 

taxable motor fuel to create gasohol, taxpayers may 

claim an exemption of the Federal excise tax rather 

than the income tax credit. In addition, small ethanol 

producers are eligible for a separate 10 cents per gallon 

credit. 

19. Credit and deduction for clean-fuel vehicles 

and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles 

and owners of clean-fuel refueling property may deduct 

part of their expenditures. The credit and deduction 

are phased out from 2004 through 2007,. 

20. Exclusion of utility conservation subsidies.—

Non-business customers can exclude from gross income 

subsidies received from public utilities for expenditures 

on energy conservation measures. 

Natural Resources and Environment 

21. Exploration and development costs.—Certain 

capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than 

depreciated over the life of the asset. 

22. Percentage depletion.—Most nonfuel mineral 

extractors may use percentage depletion rather than 

cost depletion, with percentage depletion rates ranging 

from 22 percent for sulfur to 5 percent for sand and 

gravel. 

23. Sewage, water, solid and hazardous waste 

facility bonds.—Interest earned on State and local 

bonds used to finance the construction of sewage, water, 

or hazardous waste facilities is tax-exempt. These bonds 

are generally subject to the State private-activity bond 

annual volume cap. 

24. Capital gains treatment of certain timber.—

Certain timber sold under a royalty contract can be 

treated as a capital gain rather than ordinary income. 

25. Expensing multiperiod timber growing 

costs.—Most of the production costs of growing timber 

may be expensed rather than capitalized and deducted 

when the timber is sold. In most other industries, these 

costs are capitalized under the uniform capitalization 

rules. 

26. 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 

27. Expensing certain capital outlays.—Farmers, 

except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for 

feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though 

these expenditures are for inventories held beyond the 

end of the year, or for capital improvements that would 

otherwise be capitalized. 

28. Expensing multiperiod livestock and crop 

production costs.—The production of livestock and 

crops with a production period of less than two years 

is exempt from the uniform cost capitalization rules. 

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale 

with a production period of two years or more may 

elect not to capitalize costs. If they do, they must apply 

straight-line depreciation to all depreciable property 

they use in farming. 

29. Loans forgiven solvent farmers.—Farmers are 

forgiven the tax liability on certain forgiven debt. Normally, a debtor must include the amount of loan forgiveness as income or reduce his recoverable basis in 

the property to which the loan relates. If the debtor 

elects to reduce basis and the amount of forgiveness 

exceeds his basis in the property, the excess forgiveness 

is taxable. For insolvent (bankrupt) debtors, however, 
122 ANALYTICAL PERSPECTIVES 

the amount of loan forgiveness reduces carryover losses, 

then unused credits, and then basis; any remainder 

of the forgiven debt is excluded from tax. Farmers with 

forgiven debt are considered insolvent for tax purposes, 

and thus qualify for income tax forgiveness. 

30. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops, 

can be treated as capital gains rather than ordinary 

income. 

31. Income averaging for farmers.—Taxpayers can 

lower their tax liability by averaging, over the prior 

three-year period, their taxable income from farming. 

32. Deferral of gain on sales of farm refiners.—

A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement 

property. 

Commerce and Housing 

This category includes a number of tax expenditure 

provisions that also affect economic activity in other 

functional categories. For example, provisions related 

to investment, such as accelerated depreciation, could 

be classified under the energy, natural resources and 

environment, agriculture, or transportation categories. 

33. Credit union income.—The earnings of credit 

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

34. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings 

banks, and savings and loan associations may deduct 

additions to bad debt reserves in excess of actually 

experienced losses. 

35. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided 

for investment income within qualified life insurance 

and annuity contracts. Investment income earned on 

qualified life insurance contracts held until death is 

permanently exempt from income tax. Investment income distributed prior to the death of the insured is 

tax-deferred, if not tax-exempt. Investment income 

earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits 

from tax deferral without annual contribution or income 

limits generally applicable to other tax-favored retirement income plans. 

36. Small property and casualty insurance companies.—Insurance companies that have annual net 

premium incomes of less than $350,000 are exempt 

from tax; those with $350,000 to $2.1 million of net 

premium incomes may elect to pay tax only on the 

income earned by their investment portfolio. 

37. Insurance companies owned by exempt organizations.—Generally, the income generated by life 

and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations 

conducted by such exempt organizations as fraternal 

societies and voluntary employee benefit associations, 

however, are exempt from tax. 

38. Small life insurance company deduction.—

Small life insurance companies (gross assets of less 

than $500 million) can deduct 60 percent of the first 

$3 million of otherwise taxable income. The deduction 

phases out for otherwise taxable income between $3 

million and $15 million. 

39. Mortgage housing bonds.—Interest earned on 

State and local bonds used to finance homes purchased 

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds 

that can be issued to finance these and other private 

activity is limited. The combined volume cap for private 

activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial 

development bonds is $62.50 per capita ($187.5 million 

minimum) per State in 2001, and $75 per capita ($225 

million minimum) in 2002. The Community Renewal 

Tax Relief Act of 2000 accelerated the scheduled increase in the state volume cap and indexed the cap 

for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax 

credits for a specified percentage of interest on qualified 

mortgages. The total amount of MCCs issued by a State 

cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds. 

40. Rental housing bonds.—Interest earned on 

State and local government bonds used to finance multifamily rental housing projects is tax-exempt. At least 

20 percent (15 percent in targeted areas) of the units 

must be reserved for families whose income does not 

exceed 50 percent of the area’s median income; or 40 

percent for families with incomes of no more than 60 

percent of the area median income. Other tax-exempt 

bonds for multifamily rental projects are generally 

issued with the requirement that all tenants must be 

low or moderate income families. Rental housing bonds 

are subject to the volume cap discussed in the mortgage 

housing bond section above. 

41. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on 

their primary and secondary residences as itemized 

nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the 

owner’s basis in the residence and, for debt incurred 

after October 13, 1987, it is limited to no more than 

$1 million. Interest on up to $100,000 of other debt 

secured by a lien on a principal or second residence 

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions 

on personal residences are tax expenditures because 

the value of owner-occupied housing services is not included in a taxpayer’s taxable income. The Appendix 

provides an alternative calculation of the tax expenditure based on the implicit rental income on owner-occupied housing, which is generally viewed as a more accurate measure of the tax expenditure relative to a comprehensive income tax base. 
6. TAX EXPENDITURES 123

42. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their 

primary and secondary residences even though they are 

not required to report the value of owner-occupied housing services as gross income. 

43. Installment sales.—Dealers in real and personal 

property (i.e., sellers who regularly hold property for 

sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment. 

Nondealers (i.e., sellers of real property used in their 

business) are required to pay interest on deferred taxes 

attributable to their total installment obligations in excess of $5 million. Only properties with sales prices 

exceeding $150,000 are includable in the total. The payment of a market rate of interest eliminates the benefit 

of the tax deferral. The tax exemption for nondealers 

with total installment obligations of less than $5 million 

is, therefore, a tax expenditure. 

44. Capital gains exclusion on home sales.—A 

homeowner can exclude from tax up to $500,000 

($250,000 for singles) of the capital gains from the sale 

of a principal residence. The exclusion may not be used 

more than once every two years. 

45. Passive loss real estate exemption.—In general, passive losses may not offset income from other 

sources. Losses up to $25,000 attributable to certain 

rental real estate activity, however, are exempt from 

this rule. 

46. Low-income housing credit.—Taxpayers who 

invest in certain low-income housing are eligible for 

a tax credit. The credit rate is set so that the present 

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other 

Federal benefits (such as tax-exempt bond financing), 

or (2) substantially rehabilitated existing housing. The 

credit is allowed in equal amounts over 10 years. State 

agencies determine who receives the credit; States are 

limited in the amount of credit they may authorize 

annually. The Community Renewal Tax Relief Act of 

2000 increased the per-resident limit to $1.50 in 2001 

and to $1.75 in 2002 and indexed the limit for inflation, 

beginning in 2003. The Act also created a $2 million 

minimum annual cap for small States beginning in 

2002; the cap is indexed for inflation, beginning in 

2003. 

47. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of 

the reference law rules, and thus do not give rise to 

tax expenditures under the reference method. Under 

the normal tax method, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

48. Cancellation of indebtedness.—Individuals are 

not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not 

reported as current income, however, the basis of the 

underlying property must be reduced by the amount 

canceled. 

49. Imputed interest rules.—Holders (issuers) of 

debt instruments are generally required to report interest earned (paid) in the period it accrues, not when 

paid. In addition, the amount of interest accrued is 

determined by the actual price paid, not by the stated 

principal and interest stipulated in the instrument. In 

general, any debt associated with the sale of property 

worth less than $250,000 is excepted from the general 

interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but 

is under normal law. Exceptions above $250,000 are 

a tax expenditure under reference law; these exceptions 

include the following: (1) sales of personal residences 

worth more than $250,000, and (2) sales of farms and 

small businesses worth between $250,000 and $1 million. 

50. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held 

for more than 1 year are taxed at a lower rate than 

ordinary income. The lower rate on capital gains is 

considered a tax expenditure under the normal tax 

method but not under the reference law method. 

For most assets held for more than 1 year, the top 

capital gains tax rate is 20 percent. For assets acquired 

after December 31, 2000, the top capital gains tax rate 

for assets held for more than 5 years is 18 percent. 

On January 1, 2001, taxpayers were permitted to markto-market existing assets to start the 5-year holding 

period. Losses from the mark-to-market are not recognized. For assets held for more than 1 year by taxpayers in the 15–percent ordinary tax bracket, the top 

capital gains tax rate is 10 percent. After December 

31, 2000, the top capital gains tax rate for assets held 

by these taxpayers for more than 5 years is 8 percent. 

51. 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. 

52. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are 

not subject to capital gains taxes. The cost basis of 

the appreciated assets is adjusted upward to the market value at the owner’s date of death. After repeal 

of the estate tax under EGTRRA for 2010, the basis 

for property acquired from a decedent will be the lesser 

of fair market value or the decedent’s basis. Certain 

types of additions to basis will be allowed so that assets 

in most estates that are not currently subject to estate 

tax will not be subject to capital gains tax in the hands 

of the heirs. 

53. Carryover basis of capital gains on gifts.—

When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the 

transferred property was first acquired) carries-over to 

the donee. The carryover of the donor’s basis allows 

a continued deferral of unrealized capital gains. Even 

though the estate tax is repealed for 2010 under 

EGTRRA, the gift tax is retained with a lifetime exemption of $1 million. 
124 ANALYTICAL PERSPECTIVES 

54. Ordinary income treatment of losses from 

sale of small business corporate stock shares.—

Up to $100,000 in losses from the sale of small business 

corporate stock (capitalization less than $1 million) may 

be treated as ordinary losses. Such losses would, thus, 

not be subject to the $3,000 annual capital loss writeoff limit. 

55. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus 

do not give rise to tax expenditures under reference 

law. Under normal law, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

56. Accelerated depreciation of machinery and 

equipment.—The tax depreciation allowance provisions 

are part of the reference law rules, and thus do not 

give rise to tax expenditures under reference law. 

Under the normal tax baseline, this tax depreciation 

allowance is measured relative to economic depreciation. This calculation is described in more detail in 

the Appendix. 

57. Expensing of certain small investments.—In 

2002, qualifying investments in tangible property up 

to $24,000 can be expensed rather than depreciated 

over time. The expensing limit increases to $25,000 

in 2003. To the extent that qualifying investment during the year exceeds $200,000, the amount eligible for 

expensing is decreased. In 2002, the amount expensed 

is completely phased out when qualifying investments 

exceed $224,000. 

58. Business start-up costs.—When taxpayers enter 

into a new business, certain start-up expenses, such 

as the cost of legal services, are normally incurred. 

Taxpayers may elect to amortize these outlays over 60 

months even though they are similar to other payments 

made for nondepreciable intangible assets that are not 

recoverable until the business is sold. The normal tax 

method treats this amortization as a tax expenditure; 

the reference tax method does not. 

59. Graduated corporation income tax rate 

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000 

of taxable income, 25 percent on the next $25,000, and 

34 percent on the next $9.925 million. Compared with 

a flat 34-percent rate, the lower rates provide an 

$11,750 reduction in tax liability for corporations with 

taxable income of $75,000. This benefit is recaptured 

for corporations with taxable incomes exceeding 

$100,000 by a 5-percent additional tax on corporate 

incomes in excess of $100,000 but less than $335,000. 

The corporate tax rate is 35 percent on income over 

$10 million. Compared with a flat 35-percent tax rate, 

the 34-percent rate provides a $100,000 reduction in 

tax liability for corporations with taxable incomes of 

$10 million. This benefit is recaptured for corporations 

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but 

less than $18.33 million. Because the corporate rate 

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method. 

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower 

rates is considered a tax expenditure under this concept. 

60. Small issue industrial development bonds.—

Interest earned on small issue industrial development 

bonds (IDBs) issued by State and local governments 

to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must 

be depreciated, however, using the straight-line method. 

The annual volume of small issue IDBs is subject to 

the unified volume cap discussed in the mortgage housing bond section above. 

Transportation 

61. Deferral of tax on U.S. shipping companies.—

Certain companies that operate U.S. flag vessels can 

defer income taxes on that portion of their income used 

for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment 

of loans to finance these investments. Once indefinite, 

the deferral has been limited to 25 years since January 

1, 1987. 

62. Exclusion of employee parking expenses.—

Employee parking expenses that are paid for by the 

employer or that are received in lieu of wages are excludable from the income of the employee. In 2002, 

the maximum amount of the parking exclusion is $185 

(indexed) per month. The tax expenditure estimate does 

not include parking at facilities owned by the employer. 

63. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in 

lieu of wages to defray an employee’s commuting costs 

are excludable from the employee’s income. In 2002, 

the maximum amount of the exclusion is $100 (indexed) 

per month. 

Community and Regional Development 

64. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation 

of buildings that are used for business or productive 

activities and that were erected before 1936 for other 

than residential purposes. The taxpayer’s recoverable 

basis must be reduced by the amount of the credit. 

65. Airport, dock, and similar facility bonds.—

Interest earned on State and local bonds issued to finance high-speed rail facilities and government-owned 

airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to 

a volume cap. 

66. Exemption of income of mutuals and cooperatives.—The incomes of mutual and cooperative telephone and electric companies are exempt from tax if 

at least 85 percent of their revenues are derived from 

patron service charges. 

67. Empowerment zones, enterprise communities, 

and renewal communities.—Qualifying businesses in 

designated economically depressed areas can receive tax 
6. TAX EXPENDITURES 125

benefits such as an employer wage credit, increased 

expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain 

capital gains incentives. The Job Creation and Worker 

Assistance Act of 2002 expanded the existing provisions 

by adding the ‘‘New York City Liberty Zone.’’ In addition, certain first-time buyers of a principal residence 

in the District of Columbia can receive a tax credit 

on homes purchased on or before December 31, 2003, 

and investors in certain D.C. property can receive a 

capital gains break. The Community Renewal Tax Relief Act of 2000 created the renewal communities tax 

benefits, which begin on January 1, 2002 and expire 

on December 31, 2009. The Act also created additional 

empowerment zones, increased the tax benefits for empowerment zones, and extended the expiration date of 

(1) empowerment zones from December 31, 2004 to December 31, 2009, and (2) the D.C. home-buyer credit 

from December 31, 2001 to December 31, 2003. 

68. New markets tax credit.—Taxpayers who invest 

in a community development entity (CDE) after December 31, 2000 are eligible for a tax credit. The total 

equity investment available for the credit across all 

CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and 

2003, $2.0 billion in 2004 and 2005, and $3.5 billion 

in 2006 and 2007. The amount of the credit equals 

(1) 5 percent in the year of purchase and the following 

2 years, and (2) 6 percent in the following 4 years. 

A CDE is any domestic firm whose primary mission 

is to serve or provide investment capital for low-income 

communities/individuals; a CDE must be accountable 

to residents of low-income communities. The Community Renewal Tax Relief Act of 2000 created the new 

markets tax credit. 

69. Expensing of environmental remediation 

costs.—Taxpayers who clean up certain hazardous substances at a qualified site may expense the clean-up 

costs, rather than capitalize the costs, even though the 

expenses will generally increase the value of the property significantly or appreciably prolong the life of the 

property. The expensing only applies to clean-up costs 

incurred on or before December 31, 2003. The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2001 to December 31, 

2003. The Act also expanded the number of qualified 

sites. 

Education, Training, Employment, and Social 

Services 

70. Scholarship and fellowship income.—Scholarships and fellowships are excluded from taxable income 

to the extent they pay for tuition and course-related 

expenses of the grantee. Similarly, tuition reductions 

for employees of educational institutions and their families are not included in taxable income. From an economic point of view, scholarships and fellowships are 

either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus, 

under the reference law method, this exclusion is not 

a tax expenditure because this method does not include 

either gifts or price reductions in a taxpayer’s gross 

income. The exclusion, however, is considered a tax expenditure under the normal tax method, which includes 

gift-like transfers of government funds in gross income 

(many scholarships are derived directly or indirectly 

from government funding). 

71. HOPE tax credit.—The non-refundable HOPE 

tax credit allows a credit for 100 percent of an eligible 

student’s first $1,000 of tuition and fees and 50 percent 

of the next $1,000 of tuition and fees. The credit only 

covers tuition and fees paid during the first two years 

of a student’s post-secondary education. In 2002, the 

credit is phased out ratably for taxpayers with modified 

AGI between $82,000 and $102,000 ($41,000 and 

$51,000 for singles) (indexed beginning in 2002). 

72. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for 

20 percent of an eligible student’s tuition and fees. For 

tuition and fees paid before January 1, 2003, the maximum credit per return is $1,000. For tuition and fees 

paid after December 31, 2002, the maximum credit per 

return is $2,000. The credit is phased out ratably for 

taxpayers with modified AGI between $82,000 and 

$102,000 ($41,000 and $51,000 for singles) (indexed beginning in 2002). The credit applies to both undergraduate and graduate students. 

73. Deduction for Higher Education Expenses.—

The tax code provides a new above-the-line deduction 

for qualified higher education expenses. The maximum 

annual deduction is $3,000 beginning in 2002 for taxpayers with adjusted gross income up to $130,000 on 

a joint return ($65,000 for singles). The maximum deduction increases to $4,000 in 2004. Taxpayers with 

adjusted gross income up to $160,000 on a joint return 

($80,000 for singles) may deduct up to $2,000 beginning 

in 2004. No deduction is allowed for expenses paid after 

December 31, 2005. 

74. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is 

not taxed when earned, and investment income from 

an education IRA is tax-exempt when withdrawn to 

pay for a student’s tuition and fees. The maximum contribution is $2,000 and the phase-out range for joint 

filers is $190,000 through $220,000 of modified AGI, 

double the range of singles. Elementary and secondary 

school expenses may also be paid tax-free from such 

accounts. 

75. Student-loan interest.—Taxpayers may claim 

an above-the-line deduction of up to $2,500 on interest 

paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. 

76. State prepaid tuition plans.—Some States 

have adopted prepaid tuition plans and prepaid room 

and board plans, which allow persons to pay in advance 

for college expenses for designated beneficiaries. Beginning in 2002, investment income is not taxed when 

earned, and is tax-exempt when withdrawn to pay for 

qualified expenses. 
126 ANALYTICAL PERSPECTIVES 

77. Student-loan bonds.—Interest earned on State 

and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds 

that each State may issue annually is limited. 

78. Bonds for private nonprofit educational institutions.—Interest earned on State and local government bonds issued to finance the construction of facilities used by private nonprofit educational institutions 

is not taxed. 

79. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds 

receive a non-refundable tax credit (at a rate set by 

the Treasury Department) rather than interest. The 

credit is included in gross income. Proceeds from zone 

academy bonds may only be used to renovate, but not 

construct, qualifying schools and for certain other 

school purposes. The total amount of zone academy 

bonds that may be issued is limited to $1.6 billion—

$400 million in each year from 1998 to 2003. 

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

earned on U.S. savings bonds issued after December 

31, 1989 is tax-exempt if the bonds are transferred 

to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers 

with AGI between $86,400 and $116,400 ($57,600 and 

$72,600 for singles) in 2002. 

81. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent 

children age 19 or over who (1) receive parental support 

payments of $1,000 or more per year, (2) are full-time 

students, and (3) do not claim a personal exemption 

on their own tax returns. 

82. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to 

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the assets’ current value without being taxed on 

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent 

of adjusted gross income; a corporation’s total charitable 

contributions generally may not exceed 10 percent of 

pre-tax income. 

83. Employer-provided educational assistance.—

Employer-provided educational assistance is excluded 

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. 

84. Work opportunity tax credit.—Employers can 

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2004 

and who are certified as members of various targeted 

groups. The amount of the credit that can be claimed 

is 25 percent for employment of less than 400 hours 

and 40 percent for employment of 400 hours or more. 

The maximum credit per employee is $2,400 and can 

only be claimed on the first year of wages an individual 

earns from an employer. Employers must reduce their 

deduction for wages paid by the amount of the credit 

claimed. 

85. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible 

wages paid to qualified long-term family assistance recipients during the first two years of employment. The 

credit is 35 percent of the first $10,000 of wages in 

the first year of employment and 50 percent of the 

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The 

credit applies to wages paid to employees who are hired 

on or before December 31, 2004. 

86. Employer-provided child care exclusion.—

Employer-provided child care is excluded from an employee’s gross income even though the employer’s costs 

for the child care are a deductible business expense. 

87. Employer-provided child care credit.—Employers can deduct expenses for supporting child care 

or child care resource and referral services. A tax credit 

to employers for qualified expenses began in 2002. The 

credit is equal to 25 percent of qualified expenses for 

employee child care and 10 percent of qualified expenses for child care resource and referral services. Employer deductions for such expenses are reduced by the 

amount of the credit. The maximum total credit is limited to $150,000 per taxable year. 

88. Assistance for adopted foster children.—Taxpayers who adopt eligible children from the public foster care system can receive monthly payments for the 

children’s significant and varied needs and a reimbursement of up to $2,000 for nonrecurring adoption expenses. These payments are excluded from gross income. 

89. Adoption credit and exclusion.—Taxpayers can 

receive a nonrefundable tax credit for qualified adoption 

expenses. The maximum credit is $5,000 per child 

($6,000 for special needs adoptions) for 2001. The credit 

is phased-out ratably for taxpayers with modified AGI 

between $150,000 and $190,000 in 2002. EGTRRA increased the maximum credit for non-special needs children to $10,000, set a flat credit amount of $10,000 

for special needs children, and increased the start point 

of the phase-out to $150,000 beginning in 2002. The 

credit amounts and the phase-out thresholds are indexed for inflation beginning in 2003. Unused credits 

may be carried forward and used during the five subsequent years. Taxpayers may also exclude qualified 

adoption expenses from income, subject to the same 

maximum amounts and phase-out as the credit. The 

same expenses cannot qualify for tax benefits under 

both programs; however, a taxpayer may use the benefits of the exclusion and the tax credit for different 

expenses. Stepchild adoptions are not eligible for either 

benefit. Both the credit and the exclusion were made 

permanent by EGTRRA. 

90. Employer-provided meals and lodging.—Employer-provided meals and lodging are excluded from 

an employee’s gross income even though the employer’s 

costs for these items are a deductible business expense. 

91. Child credit.—Taxpayers with children under 

age 17 can qualify for a $600 refundable per child credit. The maximum credit is increased to $700 in 2005, 
6. TAX EXPENDITURES 127

$800 in 2009, and $1,000 in 2010. The credit is phased 

out for taxpayers at the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 for singles). 

92. Child and dependent care expenses.—Married 

couples with child and dependent care expenses may 

claim a tax credit when one spouse works full time 

and the other works at least part time or goes to school. 

The credit may also be claimed by single parents and 

by divorced or separated parents who have custody of 

children. Expenditures up to a maximum $2,400 for 

one dependent and $4,800 for two or more dependents 

are eligible for the credit. EGTRRA increased the maximum expenditure limit to $3,000 for one dependent 

and $6,000 for two or more dependents beginning in 

2003. The credit is equal to 30 percent of qualified 

expenditures (35 percent beginning in 2003) for taxpayers with incomes of $10,000 or less ($15,000 or less 

beginning in 2003). The credit is reduced to a minimum 

of 20 percent by one percentage point for each $2,000 

of income in excess of $10,000 ($15,000 beginning in 

2003). 

93. Disabled access expenditure credit.—Small 

businesses (less than $1 million in gross receipts or 

fewer than 31 full-time employees) can claim a 50-percent credit for expenditures in excess of $250 to remove 

access barriers for disabled persons. The credit is limited to $5,000. 

94. Charitable contributions, other than education and health.—Taxpayers may deduct contributions to charitable, religious, and certain other nonprofit organizations. Taxpayers who donate capital assets to charitable organizations can deduct the assets’ 

current value without being taxed on any appreciation 

in value. An individual’s total charitable contribution 

generally may not exceed 50 percent of adjusted gross 

income; a corporation’s total charitable contributions 

generally may not exceed 10 percent of pre-tax income. 

95. Foster care payments.—Foster parents provide 

a home and care for children who are wards of the 

State, under contract with the State. Compensation received for this service is excluded from the gross incomes of foster parents; the expenses they incur are 

nondeductible. 

96. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income. 

Health 

97. Employer-paid medical insurance and expenses.—Employer-paid health insurance premiums 

and other medical expenses (including long-term care) 

are deducted as a business expense by employers, but 

they are not included in employee gross income. The 

self-employed also may deduct part of their family 

health insurance premiums. 

98. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums. 

Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 2001, 70 percent in 

2002, and 100 percent in 2003 and thereafter. 

99. Workers compensation insurance premiums.—Workers compensation insurance premiums 

are paid by employers and deducted as a business expense, but the premiums are not included in employee 

gross income. 

100. Medical savings accounts.—Some employees 

may deduct annual contributions to a medical savings 

account (MSA); employer contributions to MSAs (except 

those made through cafeteria plans) for qualified employees are also excluded from income. An employee 

may contribute to an MSA in a given year only if the 

employer does not contribute to the MSA in that year. 

MSAs are only available to self-employed individuals 

or employees covered under an employer-sponsored high 

deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the 

deductible under the high deductible plan for family 

coverage (65 percent for individual coverage). Earnings 

from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No 

new MSAs may be established after December 31, 2003. 

101. Medical care expenses.—Personal expenditures for medical care (including the costs of prescription drugs) exceeding 7.5 percent of the taxpayer’s adjusted gross income are deductible. 

102. Hospital construction bonds.—Interest earned 

on State and local government debt issued to finance 

hospital construction is excluded from income subject 

to tax. 

103. Charitable contributions to health institutions.—Individuals and corporations may deduct contributions to nonprofit health institutions. Tax expenditures resulting from the deductibility of contributions 

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

104. Orphan drugs.—Drug firms can claim a tax 

credit of 50 percent of the costs for clinical testing required by the Food and Drug Administration for drugs 

that treat rare physical conditions or rare diseases. 

105. Blue Cross and Blue Shield.—Blue Cross and 

Blue Shield health insurance providers in existence on 

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that 

substantially reduce (or even eliminate) their tax liabilities. 

106. Tax credit for health insurance purchased 

by ceratin displaced and retired individuals.—The 

Trade Act of 2002 provided a refundable tax credit of 

65 percent for the purchase of health insurance 

covergae by individuals eligible for Trade Adjustment 

Assitance and certain PBGC pension recipients. 
128 ANALYTICAL PERSPECTIVES 

Income Security 

107. Railroad retirement benefits.—Railroad retirement benefits are not generally subject to the income tax unless the recipient’s gross income reaches 

a certain threshold. The threshold is discussed more 

fully under the Social Security function. 

108. Workers’ compensation benefits.—Workers 

compensation provides payments to disabled workers. 

These benefits, although income to the recipients, are 

not subject to the income tax. 

109. Public assistance benefits.—Public assistance 

benefits are excluded from tax. The normal tax method 

considers cash transfers from the government as taxable and, thus, treats the exclusion for public assistance 

benefits as a tax expenditure. 

110. 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. 

111. Military disability pensions.—Most of the 

military pension income received by current disabled 

retired veterans is excluded from their income subject 

to tax. 

112. Employer-provided pension contributions 

and earnings.—Certain employer contributions to pension plans are excluded from an employee’s gross income even though the employer can deduct the contributions. In addition, the tax on the investment income earned by the pension plans is deferred until the 

money is withdrawn. 

113. 401(k) plans.—Individual taxpayers can make 

tax-preferred contributions to certain types of employerprovided 401(k) plans (and 401(k)-type plans like 403(b) 

plans and the Federal government’s Thrift Savings 

Plan). In 2001, an employee could exclude up to $10,500 

(indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k) plan. EGTRRA increases the exclusion amount to $11,000 in 2002, 

$12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and 

$15,000 in 2006 (indexed thereafter). The tax on the 

investment income earned by 401(k)-type plans is deferred until withdrawn. 

EGTRRA also allows employees to make after-tax 

contributions to 401(k) and 401(k)-type plans beginning 

in 2002. These contributions are not excluded from AGI, 

but the investment income of such after-tax contributions is not taxed when earned or withdrawn. 

114. Individual Retirement Accounts.—Individual 

taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs, 

non-deductible IRAs, and Roth IRAs. Employees can 

make annual contributions to an IRA up to $3,000 (or 

100 percent of compensation, if less). The annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. 

The IRA contribution limit increases to $4,000 in 2005, 

and $5,000 in 2008 (indexed thereafter) and allows taxpayers over age 50 to make additional ‘‘catch-up’’ contributions of $1,000 (by 2006). 

Taxpayers whose AGI is below $54,000 ($34,000 for 

non-joint filers) in 2002 can claim a deduction for IRA 

contributions. In 2002, the IRA deduction is phased 

out for taxpayers with AGI between $54,000 and 

$64,000 ($34,000 and $44,000 for non-joint). The phaseout range increases annually until it reaches $80,000 

to $100,000 in 2007 ($50,000 to $60,000 in 2005 for 

non-joint filers). Taxpayers whose AGI is above the 

phase-out range can also claim a deduction for their 

IRA contributions depending on whether they (or their 

spouse) are an active participant in an employer-provided retirement plan. The tax on the investment income earned by 401(k) plans, non-deductible IRAs, and 

deductible IRAs is deferred until the money is withdrawn. 

Taxpayers with incomes below $150,000 ($95,000 for 

nonjoint filers) can make contributions to Roth IRAs. 

The maximum contribution to a Roth IRA is phased 

out for taxpayers with AGI between $150,000 and 

$160,000 ($95,000 and $110,000 for singles). Investment 

income of a Roth IRA is not taxed when earned nor 

when withdrawn. Withdrawals from a Roth IRA are 

penalty free if: (1) the Roth IRA was opened at least 

5 years before the withdrawal, and (2) the taxpayer 

either (a) is at least 59-1/2, (b) dies, (c) is disabled, 

or (d) purchases a first-time house. 

Taxpayers can contribute to a non-deductible IRA regardless of their income and whether they are an active 

participant in an employer-provided retirement plan. 

The tax on investment income earned by non-deductible 

IRAs is deferred until the money is withdrawn. 

115. Low and moderate income savers’ credit.—

EGTRRA provides an additional incentive for lowerincome taxpayers to save through a nonrefundable credit of up to 50 percent on IRA contributions. This credit 

is in addition to any deduction or exclusion. The credit 

is completely phased out by $50,000 for joint filers and 

$25,000 for single filers. This temporary credit is in 

effect from 2002 through 2006. 

116. Keogh plans.—Self-employed individuals can 

make deductible contributions to their own retirement 

(Keogh) plans equal to 25 percent of their income, up 

to a maximum of $40,000 in 2002. The tax on the 

investment income earned by Keogh plans is deferred 

until withdrawn. 

117. Employer-provided life insurance benefits.—

Employer-provided life insurance benefits are excluded 

from an employee’s gross income even though the employer’s costs for the insurance are a deductible business expense. 

118. Small business retirement plan credit.—

Businesses with 100 or fewer employees may receive 

a credit for 50 percent of the qualified startup costs 

associated with a new qualified retirement plan. The 

credit is limited to $500 annually and may only be 

claimed for expenses incurred during the first three 

years from the start of the qualified plan. Qualified 

startup expenses include expenses related to the establishment and administration of the plan, and the retirement-related education of employees. 
6. TAX EXPENDITURES 129

119. Employer-provided accident and disability 

benefits.—Employer-provided accident and disability 

benefits are excluded from an employee’s gross income 

even though the employer’s costs for the benefits are 

a deductible business expense. 

120. Employer-provided supplementary unemployment benefits.—Employers may establish trusts 

to pay supplemental unemployment benefits to employees separated from employment. Interest payments to 

such trusts are exempt from taxation. 

121. Employer Stock Ownership Plan (ESOP) 

provisions.—ESOPs are a special type of tax-exempt 

employee benefit plan. Employer-paid contributions (the 

value of stock issued to the ESOP) are deductible by 

the employer as part of employee compensation costs. 

They are not included in the employees’ gross income 

for tax purposes, however, until they are paid out as 

benefits. The following special income tax provisions 

for ESOPs are intended to increase ownership of corporations by their employees: (1) annual employer contributions are subject to less restrictive limitations; (2) 

ESOPs may borrow to purchase employer stock, guaranteed by their agreement with the employer that the 

debt will be serviced by his payment (deductible by 

him) of a portion of wages (excludable by the employees) to service the loan; (3) employees who sell appreciated company stock to the ESOP may defer any taxes 

due until they withdraw benefits; and (4) dividends 

paid to ESOP-held stock are deductible by the employer. 

122. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,150 

standard deduction if single, or $900 if married in 2002. 

123. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,150 standard deduction if single, or $900 if 

married in 2002. 

124. Tax credit for the elderly and disabled.—

Individuals who are 65 years of age or older, or who 

are permanently disabled, can take a tax credit equal 

to 15 percent of the sum of their earned and retirement 

income. Income is limited to no more than $5,000 for 

single individuals or married couples filing a joint return where only one spouse is 65 years of age or older, 

and up to $7,500 for joint returns where both spouses 

are 65 years of age or older. These limits are reduced 

by one-half of the taxpayer’s adjusted gross income over 

$7,500 for single individuals and $10,000 for married 

couples filing a joint return. 

125. Casualty losses.—Neither the purchase of property nor insurance premiums to protect its value are 

deductible as costs of earning income; therefore, reimbursement for insured loss of such property is not reportable as a part of gross income. Taxpayers, however, 

may deduct uninsured casualty and theft losses of more 

than $100 each, but only to the extent that total losses 

during the year exceed 10 percent of AGI. 

126. Earned income tax credit (EITC).—The EITC 

may be claimed by low income workers. For a family 

with one qualifying child, the credit is 34 percent of 

the first $7,370 of earned income in 2002. The credit 

is 40 percent of the first $10,350 of income for a family 

with two or more qualifying children. The credit is 

phased out beginning when the taxpayer’s income exceeds $13,520 at the rate of 15.98 percent (21.06 percent if two or more qualifying children are present). 

It is completely phased out when the taxpayer’s modified adjusted gross income reaches $29,201 ($33,178 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 2002, 

the credit is 7.65 percent of the first $4,910 of earned 

income. When the taxpayer’s income exceeds $6,150, 

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

It is completely phased out at $11,060 of modified adjusted gross income. 

For workers with or without children, the income 

levels at which the credit begins to phase-out and the 

maximum amounts of income on which the credit can 

be taken are adjusted for inflation. For married taxpayers filing a joint return, EGTRRA increases the base 

amount for the phase-out by $1,000 in 2002 through 

2004, $2,000 in 2005 through 2007, and $3,000 in 2008 

(indexed thereafter). 

Earned income tax credits in excess of tax liabilities 

owed through the individual income tax system are refundable to individuals. This portion of the credit is 

shown as an outlay, while the amount that offsets tax 

liabilities is shown as a tax expenditure. 

Social Security 

127. Social Security benefits for retired workers.—Social Security benefits that exceed the beneficiary’s contributions out of taxed income are deferred 

employee compensation and the deferral of tax on that 

compensation is a tax expenditure. These additional 

retirement benefits are paid for partly by employers’ 

contributions that were not included in employees’ taxable compensation. Portions (reaching as much as 85 

percent) of recipients’ Social Security and Tier 1 Railroad Retirement benefits are included in the income 

tax base, however, if the recipient’s provisional income 

exceeds certain base amounts. Provisional income is 

equal to adjusted gross income plus foreign or U.S. 

possession income and tax-exempt interest, and one 

half of Social Security and tier 1 railroad retirement 

benefits. The tax expenditure is limited to the portion 

of the benefits received by taxpayers who are below 

the base amounts at which 85 percent of the benefits 

are taxable. 

128. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund, 

for disability and for dependents and survivors, are partially excluded from a beneficiary’s gross incomes. 

129. Social Security benefits for dependents and 

survivors.—Benefit payments from the Social Security 
130 ANALYTICAL PERSPECTIVES 

Trust Fund for dependents and survivors are partially 

excluded from a beneficiary’s gross income. 

Veterans Benefits and Services 

130. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded 

from taxable income. 

131. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income. 

132. G.I. Bill benefits.—G.I. Bill benefits paid by 

the Veterans Administration are excluded from gross 

income. 

133. 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 

134. Public purpose State and local bonds.—Interest earned on State and local government bonds 

issued to finance public-purpose construction (e.g., 

schools, roads, sewers), equipment acquisition, and 

other public purposes is tax-exempt. Interest on bonds 

issued by Indian tribal governments for essential governmental purposes is also tax-exempt. 

135. Deductibility of certain nonbusiness State 

and local taxes.—Taxpayers may deduct State and 

local income taxes and property taxes even though 

these taxes primarily pay for services that, if purchased 

directly by taxpayers, would not be deductible. 

136. Business income earned in U.S. possessions.—U.S. corporations operating in a U.S. possession 

(e.g., Puerto Rico) can claim a credit against some or 

all of their U.S. tax liability on possession business 

income. The credit expires December 31, 2005. 

Interest 

137. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until 

the bonds are redeemed. 

Appendix: 

TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION 

This appendix provides an initial presentation of the 

Treasury Department review of the tax expenditure 

budget first described in the 2003 Budget. As previously 

described, the review focuses in particular on three 

issues: (1) using comprehensive income as a baseline 

tax system, (2) using a consumption tax as a baseline 

tax system, and (3) defining negative tax expenditures 

(provisions that cause taxpayers to pay too much tax). 

The first section of this appendix compares major 

tax expenditures in the current budget to those implied 

by a comprehensive income baseline. This comparison 

includes a discussion of negative tax expenditures. The 

second section compares the major tax expenditures in 

the current budget to those implied by a consumption 

tax baseline, and also discusses negative tax expenditures. The final section addresses concerns that have 

been raised over the measurement of some current tax 

expenditures by describing a new estimate of the tax 

expenditure caused by accelerated depreciation and an 

alternative estimate of the tax expenditure resulting 

from the tax exemption of the return earned on owneroccupied housing. The final section also provides an 

estimate of the negative tax expenditure caused by the 

double tax on corporate profits. 

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON 

COMPREHENSIVE INCOME 

As discussed in the main body of this chapter, traditional tax expenditures are measured relative to normal 

law or reference law baselines that deviate from a comprehensive concept of income. Consequently, tax expenditures identified in the budget can differ from those 

that would be identified if comprehensive income were 

chosen as the baseline tax system. This appendix addresses this issue by comparing major tax expenditures 

listed in the current tax expenditure budget with those 

implied by a comprehensive income baseline. Most large 

tax expenditures would continue to be tax expenditures 

were the baseline taken to be comprehensive income, 

although some would not. A comprehensive income 

baseline would also result in a number of additional 

tax provisions being counted as tax expenditures. 

Current budgetary practice excludes from the list of 

official tax expenditures those provisions that over-tax 

certain items of income. This exclusion conforms to the 

view that tax expenditures are substitutes for direct 

government spending programs. However, it gives a 

one-sided picture of the ways in which current law deviates from the baseline tax system. Relative to a comprehensive income baseline, a number of current tax 

provisions would be negative tax expenditures. Some 

of these might also be negative tax expenditures under 

the reference law or normal law baselines, expanded 

to admit negative tax expenditures. 
6. TAX EXPENDITURES 131

6See, e.g., David F. Bradford, Untangling the Income Tax (Cambridge, MA: Harvard 

University Press, 1986), pp. 15–31, and Richard Goode, ‘‘The Economic Definition of Income’’ 

in Joseph Pechman, ed., Comprehensive Income Taxation (Washington, D.C.: The Brookings 

Institution, 1977), pp. 1–29. 7 Not all of the items are properly specified and measured if the intent is to compare 

current law with a comprehensive income tax. Nonetheless, they all deal with items whose 

treatment differs fundamentally from that required by a comprehensive income tax. 

8Fiscal Year 2003 Budget of the United States Government, Analytical Perspectives (Washington, D.C.: U.S. Government Printing Office, 2002) p. 127 9 U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: U.S. Government 

Printing Office, 1977) p. 92. 10 Home mortgage interest and property taxes on owner-occupied housing raise the same 

ambiguity. Classifying them as probably not tax expenditures arguably is inconsistent. It 

reflects the judgment that no comprehensive tax is likely to tax the value of State and 

local services, while it appears somewhat easier to impute and tax the rental income from 

owner-occupied housing. 11 Under the normal tax method employed by the Joint Committee on Taxation, the 

value of some public assistance benefits provided by state governments is included as a 

tax expenditure, thereby raising a potential double counting issue. 12 As a practical matter, this may be impossible to do. Valuing claims subject to future 

contingencies is very difficult, as discussed in Bradford, Untangling the Income Tax, pp. 

23–24. 

Treatment of Major Tax Expenditures From the 

Current Budget Under a Comprehensive Income Baseline 

Comprehensive income, also called Haig-Simons income, is the real, inflation adjusted, accretion to one’s 

economic power arising between two points in time, 

e.g., the beginning and ending of the year. It includes 

all accretions to wealth, whether or not realized, whether or not related to a market transaction, and whether 

a return to capital or labor. Inflation adjusted capital 

gains would be included in comprehensive income as 

they accrue. Business, investment, and casualty losses, 

including losses caused by depreciation, would be deducted. Implicit returns, such as those accruing to 

homeowners, also would be included in comprehensive 

income. While comprehensive income can be defined 

on the sources side of the consumer’s balance sheet, 

it sometimes is instructive to use the identity between 

the sources of wealth and the uses of wealth to redefine 

it as the sum of consumption during the period plus 

the change in net worth between the beginning and 

the end of the period. 

Comprehensive income is widely held to be the idealized base for an income tax even though it is not a 

perfectly defined concept. 6 It suffers from conceptual 

ambiguities, some of which are discussed below, as well 

as practical problems in measurement and tax administration, e.g., how to implement a practicable deduction 

for economic depreciation or include in income the return earned on housing or consumer durable goods, 

including automobiles and major appliances. 

Furthermore, comprehensive income represents an 

ideal tax base only in the tautological sense that the 

base of an income tax is, or should be, income. Comprehensive income does not necessarily represent the 

economically most desirable tax base; efficiency or equity might be improved by deviating from comprehensive income as a tax base, e.g., by reducing the taxation 

of capital income in order to spur economic growth or 

by subsidizing certain types of activities in order to 

correct for market failures or to improve the after-tax 

distribution of income. In addition, some elements of 

comprehensive income would be difficult or impossible 

to include in a tax system that is administrable. 

Table 1 shows the thirty largest tax expenditures 

from the 2004 Budget classified according to whether 

they would be considered a tax expenditure under a 

comprehensive income tax. Thirteen of the thirty items 

would be tax expenditures under a comprehensive tax 

base (those in panel A). 7 Most of these give preferential 

tax treatment to the return on certain types of savings 

or investment. They are a result of the explicitly hybrid 

nature of the existing tax system, and arise out of policy decisions that reflect discomfort with the high tax 

rate on capital income that would otherwise arise under 

the current structure of the income tax, especially in 

consideration of the potential for capital income to be 

subject to two layers of tax given the absence of integration between the corporate and individual income tax 

systems. 

Panel B deals with items that potentially are tax 

expenditures, but that raise more difficult conceptual 

issues or raise inconsistencies. The first of these is the 

deduction of nonbusiness State and local taxes other 

than on owner-occupied homes. These taxes include 

both income taxes and property taxes. The stated justification for this tax expenditure is that ‘‘Taxpayers 

may deduct State and local income taxes and property 

taxes even though these taxes primarily pay for services 

that, if purchased directly by taxpayers, would not be 

deductible.’’ 8 The idea is that these taxes represent 

consumption expenditures, and so are elements of income. 

In contrast to the view in the budget, the deduction 

for State and local taxes might not be a tax expenditure 

if the baseline were comprehensive income. Properly 

measured comprehensive income would include the imputed value of State and local government benefits received, but would allow a deduction for State and local 

taxes paid. 9 Thus, in this sense the deductibility of 

State and local taxes is consistent with comprehensive 

income principles; it should not be a tax expenditure. 

However, imputing the value of State and local services 

may be difficult and, as a rough correction, the tax 

system might disallow the deduction for State and local 

taxes. 10 So, if the value of services from State and 

local governments is excluded from the tax base, as 

it generally is under current law, a deduction for taxes 

might be viewed as a tax expenditure relative to a 

comprehensive income baseline. 11

Step-up of basis at death lowers the income tax on 

capital gains for those who inherit assets below what 

it would be otherwise. From that perspective it would 

be a tax expenditure under a comprehensive income 

baseline. Nonetheless, there are ambiguities. Under a 

comprehensive income baseline, all gains would be 

taxed as accrued, so there would be no deferred unrealized gains on assets held at death. 

The lack of full taxation of Social Security retirement 

benefits also is listed in panel B. To the extent that 

Social Security is viewed as a pension, a comprehensive 

income tax would include in income all contributions 

to Social Security retirement funds (payroll taxes) and 

tax accretions to value as they arise (inside build-up). 12

Benefits paid out of prior contributions and the inside 
132 ANALYTICAL PERSPECTIVES 

13This includes both the tax expenditure for benefits paid to workers and that for benefits 

paid to survivors and dependents. 14The current budget does not include as a tax expenditure the absence of income taxation 

on the employer’s contributions (payroll taxes) to Social Security retirement at the time 

these contributions are made. 15Private pensions allow the employee to defer tax on all inside build-up. They also 

allow the employee to defer tax on contributions made by the employer, but not on contributions made directly by the employee. Applying these tax rules to Social Security would 

require the employee to include in his taxable income benefits paid out of inside buildup and out of the employer’s contributions, but would allow the employee to exclude from 

his taxable income benefits paid out of his own contributions. 

16Suppose he buys the unemployment insurance policy at the beginning of the year. 

He exchanges one asset, cash, for another, the policy, so there is no change in net worth. 

But, at the end of the year, the policy expires and so is worthless, hence he has a reduction 

in net worth equal to the amount he paid for the policy, which of course is the premium. 

If the policy pays off (i.e., a work related injury prevents his employment), then he would 

include the proceeds in his income because they represent an increase in net worth. 17 U.S. Treasury, Blueprints for Basic Tax Reform, pp. 59–61. 18This might also be double counting under the normal and reference law baselines. 19See, for example, Goode, The Economic Definition of Income, pp. 16–17, and Bradford, 

Untangling the Income Tax, pp. 19–21, and pp.30–31. 20The item also includes gifts of appreciated property, at least part of which represents 

a tax expenditure relative to an ideal income tax, even if one assumes that charitable 

donations are not consumption. 21 If recipients tend to be in lower tax brackets, then the tax expenditure is smaller 

than when measured at the donor’s tax rates. 

build-up, however, would not be included in the tax 

base because the fall in the value of the individual’s 

Social Security account would be offset by an increase 

in cash. In contrast, to the extent that Social Security 

is viewed as a transfer program, all contributions 

should be deductible from the income tax base and 

all benefits received should be included in the income 

tax base. 

In contrast to either of these treatments, current law 

excludes one-half of contributions (employer-paid payroll taxes) from the base of the income tax, makes no 

attempt to tax accretions, and subjects some, but not 

all, benefits to taxation. The difference between the 

current law treatment of Social Security retirement 

benefits and their treatment under a comprehensive 

income tax would qualify as a tax expenditure, but 

such a tax expenditure differs in concept from that 

included in the current budget. 

The tax expenditures in the current budget 13 reflect 

exemptions for lower income beneficiaries from the tax 

on 85 percent of Social Security benefits. 14 Historically, 

payroll taxes paid by the employee represented no more 

than 15 percent of the expected value of the benefits 

received by a lower-earnings Social Security beneficiary. 

The 85 percent inclusion rate is therefore intended to 

tax the remaining amount of the benefit payment arising from the payroll tax contributions made by employers and the implicit return on the employee and employer contributions. Thus, the tax expenditure conceived and measured in the current budget is not intended to capture the deviation from a comprehensive 

income baseline, which would additionally account for 

the deferral of tax on these components (less an inflation adjustment attributable to the employee’s payroll 

tax contributions). Rather, it is intended to approximate 

the taxation of private pensions with employee contributions made from after-tax income, 15 on the assumption that Social Security is comparable to such 

pensions. Hence, the official tax expenditure understates the tax advantage accorded Social Security benefits relative to a comprehensive income baseline. 

To the extent that the personal and dependent care 

exemptions and the standard deduction properly remove from taxable income all expenditures that do not 

yield consumption value, then the child care credit and 

the earned income tax credit would be tax expenditures. 

In contrast, a competing perspective views these credits 

as appropriate modifications that account for differing 

taxpaying capacity. Since comprehensive income is 

equal to the sum of consumption and one’s change in 

wealth, expenditures on items that are viewed as not 

yielding consumption value reduce income, and, hence 

taxpaying capacity under this interpretation. 

The tax expenditures related to workers’ compensation benefits raise double counting issues. The official 

tax expenditure list counts as a tax expenditure both 

the failure to tax premiums and the failure to tax benefits. This is inappropriate treatment if the baseline is 

comprehensive income. Under comprehensive income 

tax principles, if the taxpayer were to buy the insurance 

himself, he would be able to deduct the premium (since 

it represents a reduction in net-worth) but should include the benefit when paid (since it represents an increase in net-worth). 16 If the employer paid the premium, the proper treatment would allow the employer 

a deduction and allow the employee to disregard the 

premium, but he would take the proceeds, if any, into 

income. Equivalently, the employee could be required 

to take the premium into income and ignore the proceeds, on the argument that the premium has the same 

expected value as the proceeds of the policy, as explained in Blueprints. 17 But in no circumstances should 

the employee be taxed on both the premium and the 

proceeds. One of the two current tax expenditures 

would be eliminated if the baseline were comprehensive 

income. 18

The next category (panel C) includes items whose 

treatment under a comprehensive income tax is widely 

acknowledged to be ambiguous. 19 Consider, for example, the items relating to charitable contributions. 

Under existing law, charitable contributions are deductible, and this deduction is considered on its face a tax 

expenditure in the current budget. 20

The treatment of charitable donations, however, is 

ambiguous under a comprehensive income tax. If charitable contributions are a consumption item for the 

giver, then they are properly included in his taxable 

income; a deduction for contributions would then be 

a tax expenditure relative to a comprehensive income 

tax baseline. In contrast, charitable contributions could 

represent a transfer of purchasing power from the giver 

to the receiver. As such, they would represent a reduction in the giver’s net worth, not an item of consumption, and so properly would be deductible, implying that 

current law’s treatment is not a tax expenditure. At 

the same time, the value of the charitable benefits received is income to the recipient. Under current law, 

such income generally is not taxed, and so represents 

a tax expenditure whose size might be approximated 

by the size of the donor’s contribution. 21
6. TAX EXPENDITURES 133

22Of course, the value of government services would be included in net income. 23 As discussed below, the double tax on corporate profits would be a major negative 

tax expenditure. 24 In contrast, the passive loss rules themselves, which restrict the deduction of losses, 

would be a negative tax expenditure when compared to a comprehensive tax base. 

25To the extent that premiums are deductible. 26 Current law offers favorable treatment to some education costs, thereby creating (positive) tax expenditures. Current law allows expensing of that part of the cost of education 

and career training that is related to foregone earnings and this would be a tax expenditure 

under a comprehensive income baseline. In addition, some education has consumption value, 

and under a comprehensive income definition would be taxable to that extent, but is not 

taxable under current law. 27See Bradford, Untangling the Income Tax, p. 41. 

Medical expenditures may or may not be an element 

of income (or consumption), depending on one’s point 

of view. Some argue that medical expenditures don’t 

represent discretionary spending, and so are not consumption. Instead, they are a reduction of net worth 

and should be excluded from the tax base. Others argue 

that there is no way to logically distinguish medical 

care from other consumption items. Moreover, clearly 

there is choice in health care decisions, e.g., whether 

to go to the best doctor, whether to have voluntary 

surgical procedures, and whether to exercise and eat 

nutritiously so as to improve and maintain one’s health 

and minimize medical expenditures. 

The final category (panel D) includes items that probably are not tax expenditures under a comprehensive 

income tax base. But even these raise some issues. 

Mortgage interest would be deductible from the base 

of a comprehensive income tax, because comprehensive 

income would include implicit rental income on owneroccupied housing. Similarly, property taxes on owneroccupied housing would be deductible, since they represent a reduction in net worth. 22 One could argue, 

however, that because current law fails to impute rental income, the home mortgage interest deduction and 

the deduction for property taxes constitute tax expenditures. Alternatively, they might be viewed as proxies 

for the correct tax expenditure. They are, however, extremely crude proxies for the implicit rental income 

earned on owner-occupied housing. The interest deduction proxy, for example, ignores implicit rental income 

earned on a house that is unencumbered by any mortgage. 

A comprehensive income tax would assign all income 

tax liability to individuals. There would be no separate 

corporation income tax. Hence, the issue of graduated 

corporate tax rates would not come up. 23 Under some 

views, graduated individual income tax rates might result in a tax expenditure or in a negative tax expenditure, depending on the decision regarding the general 

tax rate. 

A tax based on comprehensive income would allow 

all losses to be deducted. Hence, the exception from 

the passive loss rules would not be a tax expenditure. 24

Major Tax Expenditures Under a Comprehensive Income Tax That Are Excluded from the 

Current Budget 

While most of the major tax expenditures in the current budget also would be tax expenditures under a 

comprehensive income base, there also are tax expenditures relative to a comprehensive income base that are 

not found on the existing tax expenditure list. These 

additional tax expenditures include the imputed return 

from consumer durables and owner-occupied housing, 

the difference between capital gains as they accrue and 

capital gains as they are realized, private gifts and 

inheritances received, in-kind benefits from such government programs as food-stamps, Medicaid, and public 

housing, the value of payouts from insurance policies, 25

and benefits received from private charities. Under 

some ideas of comprehensive income, the value of leisure and of household production of goods and services 

also would be included as tax expenditures. The personal exemption and standard deduction also might be 

considered tax expenditures, although they can be 

viewed differently, e.g., as elements of the basic tax 

rate schedule or as necessary expenditures that are 

not items of voluntary consumption. The foreign tax 

credit also might be a tax expenditure, since it could 

be argued that a deduction for foreign taxes, rather 

than a credit, would seem to measure the income of 

U.S. residents properly. 

Negative Tax Expenditures 

Under current budgetary practice, negative tax expenditures, tax provisions that raise rather than lower 

taxes, are excluded from the official tax expenditure 

list. This exclusion conforms with the view that tax 

expenditures are defined to be similar to government 

spending programs. 

If attention is expanded to include any deviation from 

the baseline tax system, negative tax expenditures 

would be of interest. Relative to a comprehensive income baseline, there are a number of important negative tax expenditures, some of which also might be 

viewed as negative tax expenditures under an expanded 

interpretation of the normal or reference law baseline. 

Among the more important negative tax expenditures 

is the corporation income tax, which would be eliminated under a comprehensive income tax applied to 

individuals as discussed later in the Appendix. The passive loss rules, restrictions on the deductibility of capital losses, and NOL carry-forward requirements each 

would generate a negative tax expenditure, since a comprehensive income tax would allow full deductibility 

of losses. If human capital were considered an asset, 

then its cost (e.g., certain education and training expenses, including perhaps the cost of college and professional school) should be amortizable, but it is not under 

current law. 26 Some restricted deductions under the 

individual AMT might be negative tax expenditures as 

might the phase-out of personal exemptions and of 

itemized deductions. The inability to deduct consumer 

interest also might be a negative tax expenditure, as 

an interest deduction may be required to properly 

measure income, as seen by the equivalence between 

borrowing and reduced lending. 27

Current tax law fails to index for inflation interest 

receipts, capital gains, depreciation, and inventories. 

These provisions are negative tax expenditures because 
134 ANALYTICAL PERSPECTIVES 

28 Accelerated depreciation can be described as the equivalent of an interest free loan 

from the government to the taxpayer. Under federal budget accounting principles, such 

a loan would be treated as an outlay equal to the present value of the foregone interest. 

comprehensive income would be indexed for inflation. 

Current law, however, also fails to index for inflation 

the deduction for interest payments; this represents a 

(positive) tax expenditure. 

The issue of indexing highlights that even if one 

wished to focus only on tax policies that are similar 

to spending programs, accounting for some negative tax 

expenditures may be required. For example, the net 

subsidy created by accelerated depreciation is properly 

measured by the difference between depreciation allowances specified under existing tax law and economic 

depreciation, which is indexed for inflation. 28

Tax Expenditures and the Tax Rate Structure 

Under some views, the graduated personal income 

tax rate structure might result in a tax expenditure 

or in a negative tax expenditure. To the extent that 

one views a single tax rate as most compatible with 

a comprehensive income base, tax rates above the appropriate single rate would yield a negative tax expenditure. To the extent that one views a graduated tax 

rate structure as most desirable, then differences between the appropriate graduated tax rate structure and 

the actual tax rate structure would lead to tax expenditures or negative tax expenditures. 

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES RELATIVE 

TO A CONSUMPTION BASE 

This section compares tax expenditures listed in the 

official tax expenditure budget with those implied by 

a comprehensive consumption baseline. It first discusses some of the difficulties encountered in trying 

to compare current tax provisions to those that would 

be observed under a comprehensive consumption tax. 

Next, it discusses which of the thirty largest official 

tax expenditures would be tax expenditures under the 

consumption baseline, concluding that about one-half 

of the top thirty official tax expenditures would remain 

tax expenditures under a consumption baseline. Most 

of those that fall off the list are tax incentives for 

saving and investment. 

The section next discusses some major differences between current law and a comprehensive consumption 

baseline that are excluded from the current list of tax 

expenditures. These differences include the consumption value of owner-occupied housing and other consumer durables, benefits from in-kind government 

transfers, and gifts. It concludes with a discussion of 

negative tax expenditures relative to a consumption 

baseline 

Ambiguities in Determining Tax Expenditures 

Relative to a Consumption Baseline 

A broad-based consumption tax is a combination of 

an income tax plus a deduction for net saving. This 

follows from the definition of comprehensive income as 

consumption plus the change in net worth. It therefore 

seems straightforward to say that current law’s deviations from a consumption base are the sum of (a) 

tax expenditures on an income base associated with 

exemptions and deductions for certain types of income, 

plus (b) overpayments of tax, or negative tax expenditures, to the extent net saving is not deductible from 

the tax base. In reality, however, the situation is more 

complicated. A number of issues arise, some of which 

also are problems in defining a comprehensive income 

tax, but seem more severe, or at least more obvious, 

for the consumption tax baseline. 

It is not always clear how to treat certain items 

under a consumption tax. One problem is determining 

whether a particular expenditure is an item of consumption. Spending on medical care and charitable donations are two examples. Another problem is related 

to foreign source income. It is sometimes argued that 

a credit for foreign income taxes is inappropriate 

against the base of a consumption tax. Does that mean 

that the current foreign tax credit is a tax expenditure 

for a consumption tax base? The classification below 

includes medical spending and charitable contributions 

in the definition of consumption, but also considers an 

alternative view. It makes no judgment about the treatment of foreign taxes, but provides a brief discussion 

of the issue. 

There may be more than one way to treat various 

items under a consumption tax. For example, a consumption tax might ignore borrowing and lending by 

excluding from the borrower’s tax base the proceeds 

from loans, denying the borrower a deduction for payments of interest and principal, and excluding interest 

and principal payments received from the lender’s tax 

base. On the other hand, a consumption tax might include borrowing and lending in the tax base by requiring the borrower to add the proceeds from loans in 

his tax base, allowing the lender to deduct loans from 

his tax base, allowing the borrower to deduct payments 

of principal and interest, and requiring the lender to 

include receipt of principal and interest payments. In 

present value terms, the two approaches are equivalent 

for both the borrower and the lender; in particular both 

allow the tax base to measure consumption and both 

impose a zero effective tax rate on interest income. 

But which approach is taken obviously has different 

implications (at least on an annual flow basis) for the 

treatment of many important items of income and expense, such as the home mortgage interest deduction. 

The classification below suggests that the deduction for 

home mortgage interest probably should be a tax expenditure, but takes note of alternative views. 
6. TAX EXPENDITURES 135

Some exclusions of income are equivalent in many 

respects to consumption tax treatment that immediately deducts the cost of an investment while taxing 

the future cash-flow. For example, exempting investment income is equivalent to consumption tax treatment as far as the normal rate of return on new investment is concerned. This is because expensing generates 

a tax reduction that offsets in present value terms the 

tax paid on the investment’s future normal returns. 

Expensing gives the income from a marginal investment a zero effective tax rate. However, a yield exemption approach differs from a consumption tax as far 

as the distribution of income and government revenue 

is concerned. Pure profits in excess of the normal rate 

of return would be taxed under a consumption tax, 

because they are an element of cash-flow, but would 

not be taxed under a yield exemption tax system. 

Should exemption of certain kinds of investment income, and certain investment tax credits, be regarded 

as the equivalent of consumption tax treatment? The 

classification that follows generally takes a broad view 

of this equivalence and considers tax provisions that 

reduce or eliminate the tax on capital income to be 

consistent with a broad-based consumption tax. 

Looking at provisions one at a time can be misleading. The hybrid character of the existing tax system 

leads to many provisions that might make good sense 

in the context of a consumption tax, but that generate 

inefficiencies because of the problem of the ‘‘uneven 

playing field’’ when evaluated within the context of the 

existing tax rules. It is not clear how these should 

be classified. For example, many saving incentives are 

targeted to specific tax-favored sources of capital income, and so potentially distort economic choices in 

ways that would not occur under a broad-based consumption tax. As another example, under a consumption value added tax (VAT) based on the destination 

principle, there would be a rebate of the VAT on exports and a tax on imports. Does this mean that the 

extraterritorial income exclusion (the successor of the 

Foreign Sales Corporation provision) is not a tax expenditure? Resolution comes down to judgments about 

how broad is broad enough to be considered general, 

or whether it even matters at all that a provision is 

targeted in some way. The classification that follows 

generally views savings incentives, even if targeted, as 

consistent with a broad based consumption tax. 

Capital gains would not be a part of a comprehensive 

consumption tax base. Proceeds from asset sales and 

sometimes borrowing would be part of the cash-flow 

tax base, but, for transactions between domestic investors at a flat tax rate, would cancel out in the economy 

as a whole. How should existing tax expenditures related to capital gains be classified? The classification 

below generally views available capital gains tax breaks 

as consistent with a broad-based consumption tax because they lower the tax rate on capital income toward 

the zero rate that is consistent with a consumptionbased tax. By implication, this also means that capital 

gains taxes paid under a broad-based consumption tax 

are negative tax expenditures. 

Such considerations suggest that trying to compute 

the current tax’s deviations from ‘‘the’’ base of a consumption tax is impossible because deviations cannot 

be uniquely determined, making it very difficult to do 

a consistent accounting of the differences between the 

current tax base and a consumption tax base. Nonetheless, Table 2 attempts a classification based on the 

criteria outlined above. 

Treatment of Major Tax Expenditures Under a 

Comprehensive Consumption Baseline 

As noted above, the major difference between a comprehensive consumption tax and a comprehensive income tax is in the treatment of saving, or in the taxation of capital income. Consequently, many current 

tax expenditures related to preferential taxation of capital income would not be tax expenditures under a consumption tax. However, preferential treatment of items 

of income unrelated to fairly broad-based saving incentives would remain tax expenditures under a consumption baseline. 

Table 2 shows the thirty largest tax expenditures 

from the 2004 Budget classified according to whether 

they would be considered a tax expenditure under a 

consumption tax. Four of the thirty items clearly would 

be tax expenditures (those in panel A). 

The official tax expenditures for Social Security benefits reflects exceptions for low income taxpayers from 

the general rule that 85 percent of Social Security benefits are included in the recipient’s tax base. The 85 

percent inclusion is intended as a simplified mechanism 

for taxing Social Security benefits as if the Social Security program were a private pension with employee contributions made from after-tax income. Under these tax 

rules, income earned on contributions made by both 

employers and employees benefits from tax deferral, 

but employer contributions also benefit because the employee may exclude them from his taxable income, 

while the employee’s own contributions are included 

in his taxable income. These tax rules give the equivalent of consumption tax treatment, a zero effective tax 

rate on the return, to the extent that the original pension contributions are made by the employer, but give 

less generous treatment to the extent that the original 

contributions are made by the employee. Income earned 

on employee contributions is taxed at a low, but positive, effective tax rate. Based on historical calculations, 

the 85 percent inclusion reflects roughly the outcome 

of applying these tax rules to a lower-income earner 

when one-half of the contributions are from the employer and one-half from the employee. 

The current tax expenditure measures a tax benefit 

relative to a baseline that is somewhere between a comprehensive income tax and a consumption tax. The 

properly measured tax expenditure relative to a consumption tax baseline would include only those Social 

Security benefits that are accorded treatment more favorable than that implied by a consumption tax, which 
136 ANALYTICAL PERSPECTIVES 

would correspond to including 50 percent of Social Security benefits in the recipient’s tax base. 

Exclusion of workers’ compensation benefits allows 

an exclusion from income that is unrelated to investment, and so should be included in the base of a comprehensive consumption tax. 

The credit for increasing research activities gives a 

negative effective tax rate because the cost of investment in research can be deducted immediately. As discussed above, expensing reduces to zero the effective 

tax rate on the income from an investment. Giving 

a tax credit on top of expensing leads to a negative 

effective tax rate; it gives better than consumption tax 

treatment to the income earned by the qualifying investment. A tax subsidy for research might be justified 

to the extent that the full social return from an investment is not captured by the investor, because, e.g., 

others can freely learn from the results of the research. 

Nonetheless, such a subsidy is inconsistent with a 

broad-based consumption tax. 

An additional twelve items (panel B) probably would 

be tax expenditures under a consumption base. Each 

of these twelve, however, comes with some ambiguity. 

Several of these items relate to the costs of medical 

care or to charitable contributions. As discussed in the 

previous section of the appendix, there is disagreement 

within the tax policy community over the extent to 

which medical care and charitable giving represent consumption items. While widely held to be consumption, 

a competing view is that they represent reductions in 

net worth that should be excluded from the tax base 

because they do not yield direct satisfaction to taxpayer 

who makes the expenditure. 

There also is the issue of how to tax employer-provided medical insurance. Under current law, employees 

do not have to include insurance premiums paid for 

by employers in their income. The self-employed also 

may exclude (via a deduction) medical insurance premiums from their taxable income. Assume first that 

medical spending is consumption. From some perspectives, these premiums should be in the tax base because 

they appear to represent consumption. Yet an alternative perspective would support excluding the premium from tax as long as the consumption tax base 

included the value of any medical services paid for by 

the insurance policy, because the premium equals the 

expected value of insurance benefits received. But even 

from this alternative perspective, the official tax expenditure might continue to be a tax expenditure under 

a consumption tax baseline because current law excludes the value of medical services paid with insurance 

benefits from the employee’s taxable income. 

If medical spending is not consumption, one approach 

to measuring the consumption base would ignore insurance, but allow the consumer to deduct the value of 

all medical services obtained. An alternative approach 

would allow a deduction for the premium but include 

the value of any insurance benefits received, while continuing to allow a deduction for the value of all medical 

services obtained. In either case, the official tax expenditure for the exclusion of employer provided medical 

insurance and expenses would not be a tax expenditure 

relative to a consumption tax baseline. 

Ambiguity also surrounds the deductibility of home 

mortgage interest. A consumption tax seeks to tax the 

consumption value of housing services consumed no 

matter how the house is financed. From this perspective, home mortgage interest should not be deductible. 

However, what governs the proper treatment of interest 

under a consumption tax is whether financial flows are 

in or out of the consumption tax base. A result equivalent to disallowing the interest deduction would require 

that the loan be taken into income and would permit 

the associated interest and principal payments to be 

deducted. If the loans are taken into income (as they 

would be under some types of consumption taxes), then 

the associated interest and principal payments should 

be deductible, otherwise not. Without specifying how 

financial flows are treated, it is unclear how to treat 

the home mortgage interest deduction. Nonetheless, 

given that loans are not taken into income under current law, and this treatment’s equivalency to disallowing the interest deduction, classifying the deduction of home mortgage interest as a tax expenditure 

might be reasonable. 

Ambiguities arise about the proper treatment of State 

and local taxes, as they do under an income tax. These 

taxes are not of themselves consumption items, but 

might serve as proxies for the value of government 

services consumed. 

The child credit and the earned income tax credit 

can be viewed as social welfare programs unrelated 

to measuring and taxing consumption. As such, they 

would be tax expenditures relative to a consumption 

baseline. Yet, from another perspective, these credits 

look similar to a personal or dependent deduction that 

many would see as appropriate under a broad-based 

consumption tax. 

The extraterritorial income exclusion replaces the 

previous Foreign Sales Corporation program. It provides an exclusion from income for certain exports. To 

the extent that the program is viewed as a component 

of a destination-based VAT it might not be a tax expenditure. In addition, to the extent that the exclusion 

is an investment subsidy, it might be consistent with 

consumption tax principles (i.e., a low tax rate on capital income). 

The remaining items in the table (panels C and D) 

are not likely to be tax expenditures under a consumption base. Exemption of workers’ compensation insurance premiums would not be a tax expenditure because 

it represents double counting, given that the exemption 

of benefits already is a tax expenditure, as discussed 

in the previous section of the appendix. 

Most of the other items that would not be tax expenditures relate to tax provisions that eliminate or reduce 

the tax on various types of capital income because a 

zero tax on capital income is consistent with consumption tax principles 
6. TAX EXPENDITURES 137

The graduated corporate income tax rates would not 

be a tax expenditure under a comprehensive consumption baseline. A consumption tax would have no tax 

on corporate income or profits, hence the issue of 

whether the rate structure on corporate income provides a special benefit to corporations with low income 

would not arise. 

The exception from the passive loss rules probably 

would not be a tax expenditure because proper measurement of income, and hence of consumption, requires 

full deduction of losses. 

Major Tax Expenditures under a Consumption 

Tax That Are Excluded from the Current 

Budget 

Several differences between current law and a consumption tax are left off the official tax expenditure 

list. Additional tax expenditures include the imputed 

consumption value from consumer durables and owneroccupied housing, private gifts and inheritances received, possibly benefits paid by insurance policies, inkind benefits from such government programs as foodstamps, Medicaid, and public housing, and benefits received from charities. Under some ideas of a comprehensive consumption tax, the value of leisure and 

of household production of goods and services would 

be included as a tax expenditure if they were not imputed to the tax base. 

A consumption tax implemented as a tax on cash 

flows would tax all proceeds from sales of capital assets 

when consumed, rather than just capital gains; because 

of expensing, taxpayers effectively would have a zero 

basis. The proceeds from borrowing would be in the 

base of a consumption tax that also allowed a deduction 

for repayment of principal and interest, but are excluded from the current tax base. The deduction of business interest expense might be a tax expenditure, since 

under some forms of consumption taxation interest is 

neither deducted from the borrower’s tax base nor included in the lender’s tax base. The personal exemption 

and standard deduction also might be considered tax 

expenditures, although they can be viewed differently, 

e.g., as elements of the basic tax rate schedule. 

The foreign tax credit also might be a tax expenditure 

relative to a consumption baseline, but the argument 

for this is not air-tight. From a formalistic perspective, 

the foreign tax credit would be a tax expenditure because it applies against income tax and there would 

be no income tax under a consumption baseline. In 

addition, it is sometimes argued that a deduction for 

foreign taxes, rather than a credit, is appropriate under 

a comprehensive consumption tax because the taxpayer’s increase in net worth properly is measured after 

payment of foreign taxes. Nonetheless, simply eliminating the credit for foreign taxes would subject the 

return earned by U.S. residents on overseas investment 

to double taxation, and would disfavor foreign investment relative to domestic investment. 

Negative Tax Expenditures 

Importantly, current law also deviates from a consumption tax norm in ways that increase, rather than 

decrease, tax liability. These could be called negative 

tax expenditures. The official budget excludes negative 

tax expenditures on the theory that tax expenditures 

are intended to substitute for government spending programs. Yet excluding negative tax expenditures would 

give a very one-sided look at the differences between 

the existing tax system and a consumption tax. 

A large item on this list would be the inclusion of 

capital income in the current individual income tax 

base. The revenue from the corporation income tax also 

would be a negative tax expenditure. Depreciation allowances, even if accelerated, would be a negative tax 

expenditure since consumption tax treatment generally 

would require expensing. Depending on the treatment 

of loans, the borrower’s inability to deduct payments 

of principal and the lender’s inability to deduct loans 

might be a negative tax expenditure. The passive loss 

rules, restrictions on the deductibility of capital losses, 

and NOL carryforward provisions also would generate 

negative tax expenditures, because the change in net 

worth requires a deduction for losses. If human capital 

were considered an asset, then its cost (e.g., certain 

education and training expenses, including perhaps 

costs of college and professional school) should be expensed, but it is not under current law. Certain restrictions under the individual AMT as well as the phaseout of personal exemptions and of itemized deductions 

also might be considered negative tax expenditures. 

Tax Expenditures and the Tax Rate Structure 

Under some views, the graduated personal income 

tax rate structure might result in a tax expenditure 

or in a negative tax expenditure when compared with 

a consumption tax base. To the extent that one views 

a single tax rate as most compatible with a consumption tax base, tax rates above the appropriate single 

rate would yield a negative tax expenditure. To the 

extent that one views a graduated tax rate structure 

as most desirable, then differences between the appropriate graduated tax rate structure and the actual tax 

rate structure would lead to tax expenditures or negative tax expenditures. 

REVISED ESTIMATES OF SELECTED TAX EXPENDITURES 

Accelerated Depreciation 

Under the reference tax law baseline no tax expenditures arise from accelerated depreciation. In the past, 

official tax expenditure estimates of accelerated depreciation under the normal tax law baseline compared 

tax allowances based on the historic cost of an asset 

with allowances calculated using the straight-line method over relatively long recovery periods. Normal law 
138 ANALYTICAL PERSPECTIVES 

29See Barbara Fraumeni, ‘‘The Measurement of Depreciation in the U.S. National Income 

and Product Accounts,’’ in Survey of Current Business 77 No. 7 (Washington, D.C.: Department of Commerce, Bureau of Economic Analysis, July, 1997), pp. 7–42, and the National 

Income and Product Accounts of the United States, Table 7.6, ‘‘Chain-type Quantity and 

Price Indexes for Private Fixed Investment by Type,’’ U.S. Department of Commerce, Bureau 

of Economic Analysis. 30The temporary provision allows 30 percent of the cost of a qualifying investment to 

be deducted immediately rather than capitalized and depreciated over time. It is generally 

effective for qualifying investments made after September 10, 2001 and before September 

11, 2004. Qualifying investments generally are limited to tangible property with depreciation 

recovery periods of 20 years or less, certain software, and leasehold improvements, but 

this set of assets corresponds closely to machinery and equipment. 31 Estimates under the old methodology are no longer shown in the tables. 32 U.S. Department of the Treasury, Report to the Congress on Depreciation Recovery 

Periods and Methods (Washington, D.C.: U.S. Government Printing Office, July, 2000), 

p. 32. 33 National Income and Production Accounts, Table 2.4. 

allowances also were determined by the historical cost 

of the asset and so did not adjust for inflation, although 

such an adjustment is required when measuring economic depreciation, the age related fall in the real value 

of the asset. 

In this year’s budget, the tax expenditures for accelerated depreciation under the normal law concept have 

been recalculated using as a baseline depreciation rates 

and replacement cost indexes from the National Income 

and Product Accounts. 29 The revised estimates are intended to approximate the degree of acceleration provided by current law over a baseline determined by 

real, inflation adjusted, economic depreciation. Current 

law depreciation allowances for machinery and equipment include the benefits of the temporary 30 percent 

expensing provision. 30 The estimates are shown in tables in the body of the main text, e.g., Table 6–1. 

The revised tax expenditure estimates differ substantially from estimates calculated under the old methodology. In general, the new tax expenditure estimates 

are smaller than the old estimates. 31 In part this is 

because the new baseline uses depreciation allowances 

that are faster than those in the old baseline. In addition, the new baseline calculates depreciation on a replacement cost basis rather on the historic cost basis 

previously used; this translates into larger depreciation 

allowances to the extent that asset prices rise over 

time. In many years the new tax expenditures are negative, indicating that current law’s tax depreciation allowances are smaller than those implied by economic 

depreciation. Because these estimates are on a cash 

flow, rather than a present value, basis, the negative 

value does not necessarily indicate that tax depreciation 

is decelerated relative to economic depreciation over the 

life of an investment. Even when tax depreciation is 

accelerated over the life of an investment, negative annual cash flow estimates could obtain in the later years 

of an investment’s economic life. This type of vintage 

effect contributes importantly to the negative tax expenditures calculated for equipment in 2005–2008 because the temporary expensing provision expires in 

2004. Calculations that compare the present value of 

tax depreciation (without 30 percent expensing) with 

the present value of inflation indexed economic depreciation over each investment’s economic life show that 

for many types of assets tax depreciation is accelerated, 

but only slightly, assuming a moderate rate of inflation. 32

Owner-Occupied Housing 

A homeowner receives a flow of housing services 

equal in gross value to the rent that could have been 

earned had the owner chosen to rent the house to others. Comprehensive income would include in its base 

the implicit net rental income earned on investment 

in owner-occupied housing. Current law, however, excludes from its tax base such net rental income. This 

exclusion is a tax expenditure relative to a comprehensive income base. 

In contrast to a comprehensive income baseline, the 

official list of tax expenditures does not include the 

exclusion of implicit rental income on owner-occupied 

housing. Instead, it includes as tax expenditures deductions for home mortgage interest and for property taxes. 

These are poor proxies for the exclusion of implicit net 

rental income. To the extent that a homeowner owns 

his house outright, unencumbered by a mortgage, he 

would have no home mortgage interest deduction, yet 

he still would enjoy the benefits of receiving tax free 

the implicit rental income earned on his house. When 

measuring the net income from an investment in 

owner-occupied housing, mortgage interest and property 

taxes generally would be deductible. The official tax 

expenditures do not allow for depreciation and other 

costs incurred by the homeowner that must be deducted 

in determining his net rental income. 

Table 3 shows an estimate of the tax expenditure 

caused by the exclusion of implicit net rental income 

from investment in owner-occupied housing. This estimate starts with the NIPA calculated value of gross 

rent on owner-occupied housing, and subtracts interest, 

taxes, economic depreciation, and other costs in arriving 

at an estimate of net-rental income from owner-occupied housing. 33

The tax expenditure estimate is substantial, growing 

from $20 billion in 1994 to $31 billion in 2008. Nonetheless, it is only about one-third as large as the official 

tax expenditure for the deduction of home mortgage 

interest. In part this discrepancy reflects depreciation 

and other expenses that must be subtracted from gross 

rents in arriving at net rental income. In part, it also 

might reflect homeowners’ ability to borrow against 

their homes to fund other spending, leading to a relatively high debt/equity ratio for housing. 

Double Tax on Corporate Profits 

A comprehensive income tax would tax all sources 

of income once at a tax rate appropriate for the particular taxpayer. Taxes would not vary by type or 

source of income. 

In contrast to this benchmark, current law may tax 

income that shareholders earn on investment in corporate stocks at least twice, and at combined rates that 

generally are higher than those imposed on other 

sources of income. Corporate profits are taxed once at 

the company level under the corporation income tax. 

They are taxed again at the shareholder level when 
6. TAX EXPENDITURES 139

received as a dividend or recognized as a capital gain. 

Corporate profits can be taxed more then twice when 

they pass through multiple corporations before beings 

distributed to noncorporate shareholders. Corporate 

level taxes cascade because corporations and are taxed 

on capital gains they realize on the sale of stock shares 

and on some dividend income received. Compared to 

a comprehensive income tax current law’s double (or 

more) tax on corporate profits is an example of a negative tax expenditure because it subjects income to a 

larger tax burden than implied by a comprehensive income baseline. The President has proposed in this 

Budget to remove the double taxation of corporate profits. 

Table 3 provides an estimate of the negative tax expenditure caused by the multiple levels of tax on corporate profits. This negative tax expenditure includes 

the shareholder level tax on dividends paid and capital 

gains realized out of earnings that have been taxed 

at the corporate level. It also includes the corporate 

tax paid on inter-corporate dividends and on corporate 

capital gains attributable to the sale of stock shares. 

The negative tax expenditure is large in magnitude; 

it grows from $25 billion in 2004 to $33 billion in 2008. 

It is comparable in size (but opposite in sign) to all 

but the largest official tax expenditures. 

Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE INCOME TAX 1

Description Revenue Effect 

(2004) 

A. Tax Expenditure Under a Comprehensive Income Tax 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 67,870

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 55,290

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 53,930

Exclusion of interest on public purpose State and local bonds ......................................................................................... 27,310

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 23,130

Capital gains exclusion on home sales ............................................................................................................................... 20,860

Exclusion of interest on life insurance savings ................................................................................................................... 20,740

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 16,670

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,900

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 7,616

Extraterritorial income exclusion .......................................................................................................................................... 5,510

Credit for increasing research activities .............................................................................................................................. 4,990

Exclusion of Social security benefits of dependents and survivors ................................................................................... 4,140

B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications 

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ............................................ 50,910 

Step-up basis of capital gains at death ............................................................................................................................. 28,500 

Child credit .......................................................................................................................................................................... 21,310

Exclusion of Social Security benefits for retired workers .................................................................................................. 18,930

Exclusion of workers’ compensation benefits .................................................................................................................... 6,460

Workers’ compensation insurance premiums .................................................................................................................... 6,190

Earned income tax credit .................................................................................................................................................... 5,090

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 120,160

Deductibility of charitable contributions, other than education and health ......................................................................... 33,990

Deductibility of medical expenses ........................................................................................................................................ 6,340

Deductibility of charitable contributions (health) .................................................................................................................. 4,580

Deductibility of charitable contributions (education) ............................................................................................................ 4,350

Deductibility of self-employed medical insurance premiums .............................................................................................. 3,690

D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax 

Deductibility of mortgage interest on owner-occupied homes .......................................................................................... 68,440

Deductibility of State and local property tax on owner-occupied homes ......................................................................... 22,160

Graduated corporation income tax rate (normal tax method) ........................................................................................... 5,700

Exception from passive loss rules for $25,000 of rental loss ........................................................................................... 4,920

1 The measurement of certain tax expenditures under a comprehensive income tax baseline may differ from the official budget estimate even when the provision would be a tax expenditure under both baselines.

Source: Table 6–2, Tax Expenditure Budget. 
140 ANALYTICAL PERSPECTIVES 

Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE CONSUMPTION TAX 1

Description Revenue Effect 

(2004) 

A. Tax Expenditure Under a Consumption Base 

Exclusion of Social Security benefits for retired workers ................................................................................................... 18,930

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,460

Credit for increasing research activities .............................................................................................................................. 4,990

Exclusion of Social Security benefits of dependents and survivors ................................................................................... 4,140

B. Probably a Tax Expenditure Under a Consumption Base 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 120,160

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 68,440

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 50,910

Deductibility of charitable contributions, other than education and health ......................................................................... 33,990

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 22,160

Child credit ............................................................................................................................................................................ 21,310 

Deductibility of medical expenses ........................................................................................................................................ 6,340

Extraterritorial income exclusion .......................................................................................................................................... 5,510

Earned income tax credit ..................................................................................................................................................... 5,090 

Deductibility of charitable contributions (health) .................................................................................................................. 4,580

Deductibility of charitable contributions (education) ............................................................................................................ 4,350 

Deductibility of self-employed medical insurance premiums .............................................................................................. 3,690

C. Probably Not a Tax Expenditure Under a Consumption Base 

Workers’ compensation insurance premiums ...................................................................................................................... 6,190

D. Not a Tax Expenditure Under a Consumption Base 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 67,870 

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 55,290

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 53,930

Step-up basis of capital gains at death .............................................................................................................................. 28,500

Exclusion of interest on public purpose State and local bonds ......................................................................................... 27,310 

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 23,130

Capital gains exclusion on home sales ............................................................................................................................... 20,860 

Exclusion of interest on life insurance savings ................................................................................................................... 20,740 

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 16,663

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,900 

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 7,616

Graduated corporation income tax rate (normal tax method) ............................................................................................ 5,700

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,920

1 The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even 

when the provision would be a tax expenditure under both baselines.

Source: Table 6-2, Tax Expenditure Budget. 

Appendix Table 3. POSSIBLE FUTURE ADDITIONS TO TAX EXPENDITURE ESTIMATES 1

2004 2005 2006 2007 2008

Imputed Rent On Owner-Occupied Housing ..................................... 20,517 24,064 25,092 28,052 31,002 

Double Tax on Corporate Profits 2 .................................................... –25,373 –32,723 –31,590 –32,022 –33,096

1 Calculations described in the appendix text.

2 This is a negative tax expenditure, a tax provision that overtaxes income relative to the treatment specified by the 

baseline tax system.