285 

19. 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 employer contributions for medical insurance, 

pension contributions and earnings, 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 

2005–2011 using two methods of accounting: revenue 

effects and present values. The present value approach 

provides estimates of the revenue effects for tax expenditures that generally involve deferrals of tax payments 

into the future. 

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 2004, 2005, and 2006 Budgets included a thorough review of important ambiguities in the tax expenditure concept. In particular, this review focused 

on defining tax expenditures relative to a comprehensive income tax baseline, defining tax expenditures relative to a broad-based consumption tax baseline, and 

defining negative tax expenditures, i.e., provisions of 

current law that over-tax certain items or activities. 

A similar review is presented in the Appendix again 

this year. 

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, 2005. Expired or repealed provisions are not listed 

if their revenue effects result only from taxpayer activity occurring before fiscal year 2005. 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 2005–2011 are displayed according to the 

Budget’s functional categories in Table 19–1. 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 income tax expenditures. These baseline concepts are thoroughly discussed in Special Analysis G of the 1985 Budget, where the former is referred 

to as the pre-1983 method and the latter the post1982 method. 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 

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

Table 19–2 reports the respective portions of the total 

revenue effects that arise under the individual and corporate income taxes separately. The location of the estimates under the individual and corporate headings does 

not imply that these categories of filers benefit from 
286 ANALYTICAL PERSPECTIVES 

1The Administration has dropped the estimates of the outlay equivalents because they 

were often the same as the normal tax expenditure estimates, and the criteria for applying 

the concepts as to when they should differ were often judgmental and hard to apply with 

consistency across time and across tax expenditure items. 

the special tax provisions in proportion to the respective 

tax expenditure amounts shown. Rather, these breakdowns show the specific tax accounts through which 

the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures could be shareholders, employees, customers, or other providers of 

capital, depending on economic forces. 

Table 19–3 ranks the major tax expenditures by the 

size of their 2007–2011 revenue effect. Outlay Equivalent Estimates of Income Tax Expenditures, which were 

included in prior volumes of Analytical Perspectives, 

are no longer included in this chapter.1

Interpreting Tax Expenditure Estimates 

The estimates shown for individual tax expenditures 

in Tables 19–1, 19–2, and 19–3 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: 

First, 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. 

Second, 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 19–1 are the totals 

of individual and corporate income tax revenue effects 

reported in Table 19–2 and do not reflect any possible 

interactions between individual and corporate income 

tax receipts. For this reason, the estimates in Table 

19–1 should be regarded as approximations. 
19. TAX EXPENDITURES 287 

Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 

(in millions of dollars) 

Total from corporations and individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ........................................................... 2,990 3,020 3,050 3,070 3,110 3,140 3,170 15,390 

International affairs: 

2 Exclusion of income earned abroad by U.S. citizens ............................................................................... 2,750 2,810 2,940 3,100 3,270 3,450 3,640 16,400 

3 Exclusion of certain allowances for Federal employees abroad .............................................................. 900 950 1,000 1,050 1,100 1,160 1,230 5,540 

4 Extraterritorial income exclusion ................................................................................................................ 5,220 4,370 1,720 110 50 50 40 1,970 

5 Inventory property sales source rules exception ....................................................................................... 1,560 1,680 1,840 2,040 2,230 2,380 2,540 11,030 

6 Deferral of income from controlled foreign corporations (normal tax method) ........................................ 10,500 11,160 11,940 12,770 13,650 14,600 15,620 68,580 

7 Deferred taxes for financial firms on certain income earned overseas ................................................... 2,190 2,260 960 .............. .............. .............. .............. 960 

General science, space, and technology: 

8 Expensing of research and experimentation expenditures (normal tax method) ..................................... 4,110 7,920 6,990 6,260 5,360 4,800 4,840 28,250 

9 Credit for increasing research activities ..................................................................................................... 5,160 2,160 920 390 180 50 .............. 1,540 

Energy: 

10 Expensing of exploration and development costs, fuels ........................................................................... 390 680 870 830 650 500 380 3,230 

11 Excess of percentage over cost depletion, fuels ...................................................................................... 590 670 690 660 640 620 620 3,230 

12 Alternative fuel production credit ................................................................................................................ 2,320 2,390 2,460 990 .............. .............. .............. 3,450 

13 Exception from passive loss limitation for working interests in oil and gas properties ........................... 40 40 40 40 40 40 40 200 

14 Capital gains treatment of royalties on coal .............................................................................................. 90 90 90 100 70 60 80 400 

15 Exclusion of interest on energy facility bonds ........................................................................................... 80 90 90 100 100 110 110 510 

16 Enhanced oil recovery credit ...................................................................................................................... 300 .............. .............. .............. .............. .............. 20 20 

17 New technology credit ................................................................................................................................ 240 510 690 800 850 860 860 4,060 

18 Alcohol fuel credits 1 ................................................................................................................................... 40 40 40 50 50 60 30 230 

19 Tax credit and deduction for clean-fuel burning vehicles ......................................................................... 70 90 200 140 140 –20 –40 420 

20 Exclusion of utility conservation subsidies ................................................................................................. 80 80 80 80 80 70 70 380 

21 Credit for holding clean renewable energy bonds .................................................................................... .............. .............. 10 30 40 50 50 180 

22 Deferral of gain from dispositions of transmission property to implement FERC restructuring policy ... 490 620 530 230 –100 –360 –510 –210 

23 Credit for production from advanced nuclear power facilities .................................................................. .............. .............. .............. .............. .............. .............. .............. ................

24 Credit for investment in clean coal facilities .............................................................................................. .............. 50 50 100 150 200 280 780 

25 Temporary 50% expensing for equipment used in the refining of liquid fuels ........................................ .............. 10 30 120 240 260 180 830 

26 Pass through low sulfur diesel expensing to cooperative owners ........................................................... 40 .............. –10 .............. –10 .............. –10 –30 

27 Natural gas distribution pipelines treated as 15–year property ................................................................ .............. 20 50 90 120 150 150 560 

28 Amortize all geological and geophysical expenditures over 2 years ....................................................... .............. 40 150 180 140 100 60 630 

29 Allowance of deduction for certain energy efficient commercial building property .................................. .............. 80 190 140 30 –10 –10 340 

30 Credit for construction of new energy efficient homes ............................................................................. .............. 10 20 10 10 .............. .............. 40 

31 Credit for energy efficiency improvements to existing homes .................................................................. .............. 220 380 150 .............. .............. .............. 530 

32 Credit for energy efficient appliances ........................................................................................................ .............. 120 80 .............. .............. .............. .............. 80 

33 30% credit for residential purchases/installations of solar and fuel cells ................................................ .............. 10 10 10 .............. .............. .............. 20 

34 Credit for business installation of qualified fuel cells and stationary microturbine power plants ............ .............. 80 130 50 –10 –10 –10 150 

35 Alternative Fuel and Fuel Mixture tax credit ............................................................................................. 150 170 .............. .............. .............. .............. .............. ................

Natural resources and environment: 

36 Expensing of exploration and development costs, nonfuel minerals ....................................................... .............. .............. .............. .............. .............. .............. .............. ................

37 Excess of percentage over cost depletion, nonfuel minerals ................................................................... 270 280 300 310 310 330 340 1,590 

38 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ................................ 450 480 500 550 580 600 620 2,850 

39 Capital gains treatment of certain timber income ..................................................................................... 90 90 90 100 70 60 80 400 

40 Expensing of multiperiod timber growing costs ......................................................................................... 350 370 380 400 410 430 430 2,050 

41 Tax incentives for preservation of historic structures ............................................................................... 350 370 380 400 420 440 470 2,110 

42 Expensing of capital costs with respect to complying with EPA sulfur regulations ................................ 10 10 10 30 50 30 .............. 120 

43 Exclusion of gain or loss on sale or exchange of certain brownfield sites ............................................. .............. .............. 10 30 40 70 60 210 

Agriculture: 

44 Expensing of certain capital outlays .......................................................................................................... 110 130 130 130 140 140 150 690 

45 Expensing of certain multiperiod production costs .................................................................................... 60 70 70 80 80 80 90 400 

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

47 Capital gains treatment of certain income ................................................................................................. 880 870 900 1,050 750 590 780 4,070 

48 Income averaging for farmers .................................................................................................................... 40 40 40 40 40 40 50 210 

49 Deferral of gain on sale of farm refiners ................................................................................................... 10 10 20 20 20 20 20 100 

50 Bio-Diesel and small agri-biodiesel producer tax credits .......................................................................... 30 90 100 90 40 20 20 270 

Commerce and housing: 

Financial institutions and insurance: 

51 Exemption of credit union income ......................................................................................................... 1,290 1,370 1,450 1,540 1,640 1,740 1,850 8,220 

52 Excess bad debt reserves of financial institutions ................................................................................ 10 10 10 .............. .............. .............. .............. 10 

53 Exclusion of interest on life insurance savings ..................................................................................... 19,200 19,970 20,770 22,600 26,100 28,990 31,350 129,810 

54 Special alternative tax on small property and casualty insurance companies .................................... 20 20 20 20 20 20 30 110 

55 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................ 210 220 230 240 250 260 270 1,250 

56 Small life insurance company deduction ............................................................................................... 60 60 60 60 60 60 50 290 

57 Exclusion of interest spread of financial institutions ............................................................................. 1,450 1,540 1,620 1,710 1,800 1,890 1,990 12,000 
288 ANALYTICAL PERSPECTIVES 

Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued 

(in millions of dollars) 

Total from corporations and individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 

Housing: 

58 Exclusion of interest on owner-occupied mortgage subsidy bonds ..................................................... 930 990 1,040 1,140 1,210 1,240 1,280 5,910 

59 Exclusion of interest on rental housing bonds ...................................................................................... 410 430 450 500 530 540 550 2,570 

60 Deductibility of mortgage interest on owner-occupied homes .............................................................. 62,160 72,060 79,860 87,820 94,490 100,980 108,280 471,430 

61 Deductibility of State and local property tax on owner-occupied homes ............................................ 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200 

62 Deferral of income from post 1987 installment sales ........................................................................... 1,120 1,130 1,160 1,180 1,200 1,310 1,430 6,280 

63 Capital gains exclusion on home sales ................................................................................................. 35,990 39,750 43,900 48,490 59,900 78,860 87,100 318,250 

64 Exclusion of net imputed rental income ................................................................................................ 28,600 29,720 33,210 36,860 40,630 44,785 49,364 204,849 

65 Exception from passive loss rules for $25,000 of rental loss .............................................................. 6,470 6,370 6,230 6,060 5,880 5,700 5,510 29,380 

66 Credit for low-income housing investments .......................................................................................... 3,880 4,060 4,250 4,460 4,710 4,950 5,220 23,590 

67 Accelerated depreciation on rental housing (normal tax method) ....................................................... 9,610 10,630 11,470 12,660 13,820 14,710 15,920 68,580 

Commerce: 

68 Cancellation of indebtedness ................................................................................................................. 30 160 110 40 40 40 40 270 

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

70 Capital gains (except agriculture, timber, iron ore, and coal) .............................................................. 26,170 25,990 26,760 31,280 22,340 17,580 23,410 121,370 

71 Capital gains exclusion of small corporation stock ............................................................................... 200 230 260 300 320 350 470 1,700 

72 Step-up basis of capital gains at death ................................................................................................ 26,820 29,510 32,460 35,700 36,480 34,560 38,010 177,210 

73 Carryover basis of capital gains on gifts .............................................................................................. 410 540 640 750 790 1,270 6,370 9,820 

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

75 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................... –910 –280 90 550 360 950 1,580 3,530 

76 Accelerated depreciation of machinery and equipment (normal tax method) ..................................... 20,220 40,520 52,230 61,940 73,480 81,090 88,460 353,600 

77 Expensing of certain small investments (normal tax method) ............................................................. 5,390 4,720 4,360 350 868 1,110 1,460 8,148 

78 Graduated corporation income tax rate (normal tax method) .............................................................. 3,160 3,450 3,590 3,940 4,180 4,300 4,390 20,400 

79 Exclusion of interest on small issue bonds .......................................................................................... 390 420 440 480 510 530 540 2,500 

80 Deduction for US production activities .................................................................................................. 6,220 5,150 10,670 12,190 13,110 20,320 22,270 78,560 

81 Special rules for certain film and TV production .................................................................................. 90 110 90 70 –40 –90 –60 –30 

Transportation: 

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

83 Exclusion of reimbursed employee parking expenses .............................................................................. 2,590 2,730 2,880 3,030 3,180 3,330 3,420 15,840 

84 Exclusion for employer-provided transit passes ........................................................................................ 480 550 630 710 790 880 960 3,970 

85 Tax credit for certain expenditures for maintaining railroad tracks .......................................................... 70 140 150 110 50 30 10 350 

86 Exclusion of interest on bonds for Financing of Highway Projects and rail-truck transfer facilities ....... .............. 25 50 75 95 95 100 415 

Community and regional development: 

87 Investment credit for rehabilitation of structures (other than historic) ...................................................... 40 40 40 40 40 40 40 200 

88 Exclusion of interest for airport, dock, and similar bonds ........................................................................ 800 860 910 990 1,060 1,080 1,120 5,160 

89 Exemption of certain mutuals’ and cooperatives’ income ......................................................................... 60 60 70 70 70 70 70 350 

90 Empowerment zones and renewal communities ....................................................................................... 1,120 1,210 1,340 1,480 1,740 1,130 420 6,110 

91 New markets tax credit .............................................................................................................................. 430 610 830 870 790 670 520 3,680 

92 Expensing of environmental remediation costs ......................................................................................... 70 60 40 .............. –20 –10 –10 ................

93 Credit to holders of Gulf Tax Credit Bonds .............................................................................................. .............. .............. 10 10 10 10 10 50 

Education, training, employment, and social services: 

Education: 

94 Exclusion of scholarship and fellowship income (normal tax method) ................................................ 1,380 1,450 1,510 1,580 1,640 1,720 1,790 8,240 

95 HOPE tax credit ..................................................................................................................................... 3,710 3,650 3,060 3,090 3,220 3,240 3,480 16,090 

96 Lifetime Learning tax credit ................................................................................................................... 2,330 2,340 2,020 2,030 2,060 2,090 2,220 10,420 

97 Education Individual Retirement Accounts ............................................................................................ 70 90 110 140 180 230 280 940 

98 Deductibility of student-loan interest ...................................................................................................... 780 800 810 820 830 840 780 4,080 

99 Deduction for higher education expenses ............................................................................................. 1,830 1,840 .............. .............. .............. .............. .............. ................

100 State prepaid tuition plans ..................................................................................................................... 430 540 620 710 810 930 1,090 4,160 

101 Exclusion of interest on student-loan bonds ......................................................................................... 280 300 320 350 370 380 390 1,810 

102 Exclusion of interest on bonds for private nonprofit educational facilities ........................................... 1,080 1,160 1,220 1,330 1,410 1,450 1,500 6,910 

103 Credit for holders of zone academy bonds .......................................................................................... 110 130 140 150 150 150 150 740 

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

105 Parental personal exemption for students age 19 or over ................................................................... 3,760 2,500 1,760 1,650 1,510 1,420 2,740 9,080 

106 Deductibility of charitable contributions (education) .............................................................................. 3,420 3,680 4,030 4,260 4,550 4,870 5,210 22,920 

107 Exclusion of employer-provided educational assistance ....................................................................... 560 590 620 660 690 730 40 2,740 

108 Special deduction for teacher expenses ............................................................................................... 160 150 .............. .............. .............. .............. .............. ................

109 Discharge of student loan indebtedness ............................................................................................... 20 20 20 20 20 20 20 100 

Training, employment, and social services: 

110 Work opportunity tax credit .................................................................................................................... 160 210 190 130 110 70 30 530 

111 Welfare-to-work tax credit ...................................................................................................................... 70 80 70 40 10 .............. .............. 120 

112 Employer provided child care exclusion ................................................................................................ 610 810 920 960 1,010 1,060 1,070 5,020 

113 Employer-provided child care credit ...................................................................................................... 10 10 10 20 20 20 10 80 

114 Assistance for adopted foster children .................................................................................................. 310 320 350 370 400 430 470 2,020 

115 Adoption credit and exclusion ................................................................................................................ 360 540 560 570 580 600 540 2,850 

116 Exclusion of employee meals and lodging (other than military) .......................................................... 850 890 930 970 1,010 1,060 1,110 5,080 
19. TAX EXPENDITURES 289 

Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued 

(in millions of dollars) 

Total from corporations and individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 

117 Child credit 2 ........................................................................................................................................... 41,790 42,090 42,120 42,070 41,830 41,870 31,730 199,620 

118 Credit for child and dependent care expenses ..................................................................................... 3,060 2,740 1,820 1,750 1,660 1,590 1,540 8,360 

119 Credit for disabled access expenditures ............................................................................................... 30 30 30 40 40 40 40 190 

120 Deductibility of charitable contributions, other than education and health .......................................... 29,670 32,550 34,500 36,790 39,410 42,210 45,210 198,120 

121 Exclusion of certain foster care payments ............................................................................................ 440 440 450 450 450 460 470 2,280 

122 Exclusion of parsonage allowances ...................................................................................................... 460 480 510 540 580 610 640 2,880 

123 Employee retention credit for employers affected by Hurricane Katrina, Rita, and Wilma ................ .............. 140 20 20 .............. .............. .............. 40 

Health: 

124 Exclusion of employer contributions for medical insurance premiums and medical care ....................... 118,420 132,730 146,780 161,120 176,290 191,980 212,820 888,990 

125 Self-employed medical insurance premiums ............................................................................................. 3,790 4,240 4,630 5,080 5,570 6,050 6,730 28,060 

126 Medical Savings Accounts / Health Savings Accounts ............................................................................. 1,050 1,830 2,650 3,510 3,960 3,910 3,860 17,890 

127 Deductibility of medical expenses .............................................................................................................. 6,110 4,410 5,310 6,490 7,720 9,220 12,260 41,000 

128 Exclusion of interest on hospital construction bonds ................................................................................ 1,880 2,010 2,110 2,300 2,450 2,520 2,600 11,980 

129 Deductibility of charitable contributions (health) ........................................................................................ 3,350 3,670 3,890 4,150 4,450 4,770 5,110 22,370 

130 Tax credit for orphan drug research .......................................................................................................... 210 230 260 290 320 360 410 1,640 

131 Special Blue Cross/Blue Shield deduction ................................................................................................ 710 780 850 920 760 830 920 4,280 

132 Tax credit for health insurance purchased by certain displaced and retired individuals ........................ 20 20 30 30 30 30 30 150 

Income security: 

133 Exclusion of railroad retirement system benefits ....................................................................................... 390 390 380 360 370 370 350 1,830 

134 Exclusion of workers’ compensation benefits ............................................................................................ 5,770 6,000 6,180 6,390 6,630 6,860 7,090 33,150 

135 Exclusion of public assistance benefits (normal tax method) ................................................................... 430 450 470 490 510 530 550 2,550 

136 Exclusion of special benefits for disabled coal miners ............................................................................. 50 50 50 40 40 40 40 210 

137 Exclusion of military disability pensions ..................................................................................................... 100 110 110 120 120 130 130 610 

Net exclusion of pension contributions and earnings: 

138 Employer plans ....................................................................................................................................... 50,630 50,360 52,470 48,100 45,760 44,760 36,910 228,000 

139 401(k) plans ............................................................................................................................................ 37,440 37,330 39,800 43,100 48,810 53,870 47,290 232,870 

140 Individual Retirement Accounts ............................................................................................................. 3,100 4,230 5,970 7,180 8,300 8,840 8,060 38,350 

141 Low and moderate income savers credit .............................................................................................. 1,310 1,380 830 .............. .............. .............. .............. 830 

142 Keogh plans ............................................................................................................................................ 9,400 9,990 10,670 11,630 12,670 13,800 15,040 63,810 

Exclusion of other employee benefits: 

143 Premiums on group term life insurance ................................................................................................ 2,020 2,070 2,180 2,250 2,310 2,380 2,490 11,610 

144 Premiums on accident and disability insurance .................................................................................... 280 290 300 310 320 330 340 1,600 

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

146 Special ESOP rules ............................................................................................................................... 1,650 1,760 1,890 2,030 2,170 2,330 2,490 10,910 

147 Additional deduction for the blind .......................................................................................................... 40 30 30 40 40 40 50 200 

148 Additional deduction for the elderly ....................................................................................................... 1,850 1,740 1,740 1,880 1,930 1,980 2,940 10,470 

149 Tax credit for the elderly and disabled ................................................................................................. 20 20 20 10 10 10 10 60 

150 Deductibility of casualty losses .............................................................................................................. 250 980 640 300 320 330 360 1,950 

151 Earned income tax credit 3 ..................................................................................................................... 4,925 5,050 5,150 5,445 5,640 5,810 6,070 28,115 

152 Additional exemption for housing Hurricane Katrina displaced individuals .......................................... .............. 110 20 .............. .............. .............. .............. 20 

Social Security: 

Exclusion of social security benefits: 

153 Social Security benefits for retired workers .......................................................................................... 19,110 19,350 19,590 20,250 20,700 21,000 23,330 104,870 

154 Social Security benefits for disabled ..................................................................................................... 3,600 3,810 4,110 4,330 4,570 4,960 5,530 23,500 

155 Social Security benefits for dependents and survivors ........................................................................ 3,940 3,980 4,040 4,070 4,100 4,180 4,360 20,750 

Veterans benefits and services: 

156 Exclusion of veterans death benefits and disability compensation .......................................................... 3,320 3,600 3,770 3,900 4,050 4,140 4,350 20,210 

157 Exclusion of veterans pensions ................................................................................................................. 130 140 140 140 140 150 150 720 

158 Exclusion of GI bill benefits ....................................................................................................................... 150 170 210 240 280 330 400 1,460 

159 Exclusion of interest on veterans housing bonds ..................................................................................... 40 40 50 50 50 50 50 250 

General purpose fiscal assistance: 

160 Exclusion of interest on public purpose State and local bonds ............................................................... 26,360 28,180 29,640 32,330 34,410 35,440 36,510 168,330 

161 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ..................... 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710 

162 Tax credit for corporations receiving income from doing business in U.S. possessions ........................ 800 400 40 .............. .............. .............. .............. 40 

Interest: 

163 Deferral of interest on U.S. savings bonds ............................................................................................... 1,350 1,340 1,350 1,360 1,380 1,390 1,440 6,920 

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied homes ............................................................................................ 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200 

Nonbusiness State and local taxes other than on owner-occupied homes ........................................ 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710 

Exclusion of interest on State and local bonds for: 

Public purposes ...................................................................................................................................... 26,360 28,180 29,640 32,330 34,410 35,440 36,510 168,330 

Energy facilities ...................................................................................................................................... 80 90 90 100 100 110 110 510 

Water, sewage, and hazardous waste disposal facilities ..................................................................... 450 480 500 550 580 600 620 2,850 
290 ANALYTICAL PERSPECTIVES 

Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued 

(in millions of dollars) 

Total from corporations and individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 

Small-issues ............................................................................................................................................ 390 420 440 480 510 530 540 2,500 

Owner-occupied mortgage subsidies ..................................................................................................... 930 990 1,040 1,140 1,210 1,240 1,280 5,910 

Rental housing ........................................................................................................................................ 410 430 450 500 530 540 550 2,570 

Airports, docks, and similar facilities ..................................................................................................... 800 860 910 990 1,060 1,080 1,120 5,160 

Student loans .......................................................................................................................................... 280 300 320 350 370 380 390 1,810 

Private nonprofit educational facilities ................................................................................................... 1,080 1,160 1,220 1,330 1,410 1,450 1,500 6,910 

Hospital construction .............................................................................................................................. 1,880 2,010 2,110 2,300 2,450 2,520 2,600 11,980 

Veterans’ housing ................................................................................................................................... 40 40 50 50 50 50 50 250 

Credit for holders of zone academy bonds ................................................................................................... 110 130 140 150 150 150 150 740 

1 In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2005 $1,500; 2006 $2,110; 2007 $2,400; 2008 $2,740; 2009 $3,080; 2010 $3,410 and 

2011 $870. 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: 2005 $14,620; 2006 $14,110; 2007 $13,540; 2008 

$12,950; 2009 $12,760 and 2010 $12,330:2011 $12,110 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: 2005 $34,559;2006 $35,098; 2007 

$35,645; 2008 $36,955; 2009 $38,048; 2010 $38,823; and 2011 $40,278. 

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. 

Present-Value Estimates 

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

Table 19–4. 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 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. 

Discounted present-value estimates of revenue effects 

are presented in Table 19–4 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 2005 which 

cause the deferrals or other long-term revenue effects. 

For instance, a pension contribution in 2005 would 

cause a deferral of tax payments on wages in 2005 

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

the 2005 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. 
19. TAX EXPENDITURES 291 

Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES 

(in millions of dollars) 

Corporations Individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 2005 2006 2007 2008 2009 2010 2011 2007–11 

National Defense 

1 Exclusion of benefits and allowances to 

armed forces personnel ........................ ............ ............ ................ ................ ................ ................ ................ ................ 2,990 3,020 3,050 3,070 3,110 3,140 3,170 15,390 

International affairs: 

2 Exclusion of income earned abroad by 

U.S. citizens .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,750 2,810 2,940 3,100 3,270 3,450 3,640 16,400 

3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ................ ................ ................ ................ ................ ................ 900 950 1,000 1,050 1,100 1,160 1,230 5,540 

4 Extraterritorial income exclusion ............... 5,220 4,370 1,720 110 50 50 40 1,970 ................ ................ ................ ................ ................ ................ ................ ................

5 Inventory property sales source rules exception ................................................... 1,560 1,680 1,840 2,040 2,230 2,380 2,540 11,030 ................ ................ ................ ................ ................ ................ ................ ................

6 Deferral of income from controlled foreign 

corporations (normal tax method) ........ 10,500 11,160 11,940 12,770 13,650 14,600 15,620 68,580 ................ ................ ................ ................ ................ ................ ................ ................

7 Deferred taxes for financial firms on certain income earned overseas ............... 2,190 2,260 960 ................ ................ ................ ................ 960 ................ ................ ................ ................ ................ ................ ................ ................

General science, space, and technology: 

8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... 4,010 7,770 6,850 6,140 5,250 4,700 4,740 27,680 100 150 140 120 110 100 100 570 

9 Credit for increasing research activities ... 5,110 2,120 920 390 180 50 ................ 1,540 50 40 ................ ................ ................ ................ ................ ................

Energy: 

10 Expensing of exploration and development costs, fuels ................................... 340 590 760 720 560 430 330 2,800 50 90 110 110 90 70 50 430 

11 Excess of percentage over cost depletion, 

fuels ....................................................... 530 600 620 600 580 560 560 2,920 60 70 70 60 60 60 60 310 

12 Alternative fuel production credit .............. 2,220 2,290 2,360 950 ................ ................ ................ 3,310 100 100 100 40 ................ ................ ................ 140 

13 Exception from passive loss limitation for 

working interests in oil and gas properties ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 40 40 40 200 

14 Capital gains treatment of royalties on 

coal ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 90 90 90 100 70 60 80 400 

15 Exclusion of interest on energy facility 

bonds ..................................................... 20 20 20 20 20 20 20 100 60 70 70 80 80 90 90 410 

16 Enhanced oil recovery credit .................... 270 ............ ................ ................ ................ ................ 20 20 30 ................ ................ ................ ................ ................ ................ ................

17 New technology credit ............................... 220 470 640 750 800 810 810 3,810 20 40 50 50 50 50 50 250 

18 Alcohol fuel credits 1 .................................. 30 30 30 40 40 50 20 180 10 10 10 10 10 10 10 50 

19 Tax credit and deduction for clean-fuel 

burning vehicles .................................... 50 30 –10 –10 –20 –30 –30 –100 20 60 210 150 160 10 –10 520 

20 Exclusion of utility conservation subsidies ............ ............ ................ ................ ................ ................ ................ ................ 80 80 80 80 80 70 70 380 

21 Credit for holding clean renewable energy 

bonds ..................................................... ............ ............ 10 30 40 50 50 180 ................ ................ ................ ................ ................ ................ ................ ................

22 Deferral of gain from dispositions of 

transmission property to implement 

FERC restructuring policy ..................... 490 620 530 230 –100 –360 –510 –210 ................ ................ ................ ................ ................ ................ ................ ................

23 Credit for production from advanced nuclear power facilities ............................. ............ ............ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................

24 Credit for investment in clean coal facilities ......................................................... ............ 50 50 100 150 200 280 780 ................ ................ ................ ................ ................ ................ ................ ................

25 Temporary 50% expensing for equipment 

used in the refining of liquid fuels ........ ............ 10 30 120 240 260 180 830 ................ ................ ................ ................ ................ ................ ................ ................

26 Pass through low sulfur diesel expensing 

to cooperative owners ........................... ............ ............ ................ ................ ................ ................ ................ ................ 40 ................ –10 ................ –10 ................ –10 –30 

27 Natural gas distribution pipelines treated 

as 15–year property .............................. ............ 20 50 90 120 150 150 560 ................ ................ ................ ................ ................ ................ ................ ................

28 Amortize all geological and geophysical 

expenditures over 2 years .................... ............ 30 120 140 110 80 50 500 ................ 10 30 40 30 20 10 130 

29 Allowance of deduction for certain energy 

efficient commercial building property .. ............ 60 150 110 20 –10 –10 260 ................ 20 40 30 10 ................ ................ 80 

30 Credit for construction of new energy efficient homes ........................................... ............ 10 20 10 10 ................ ................ 40 ................ ................ ................ ................ ................ ................ ................ ................

31 Credit for energy efficiency improvements 

to existing homes .................................. ............ ............ ................ ................ ................ ................ ................ ................ ................ 220 380 150 ................ ................ ................ 530 

32 Credit for energy efficient appliances ....... ............ 120 80 ................ ................ ................ ................ 80 ................ ................ ................ ................ ................ ................ ................ ................

33 30% credit for residential purchases/installations of solar and fuel cells .......... ............ ............ ................ ................ ................ ................ ................ ................ ................ 10 10 10 ................ ................ ................ 20 

34 Credit for business installation of qualified 

fuel cells and stationary microturbine 

power plants .......................................... ............ 60 100 40 –10 –10 –10 110 ................ 20 30 10 ................ ................ ................ 40 

35 Alternative Fuel and Fuel Mixture tax 

credit ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 150 170 ................ ................ ................ ................ ................ ................

Natural resources and environment: 

36 Expensing of exploration and development costs, nonfuel minerals ................ ............ ............ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................ ................

37 Excess of percentage over cost depletion, 

nonfuel minerals .................................... 250 260 280 290 290 310 320 1,490 20 20 20 20 20 20 20 100 

38 Exclusion of interest on bonds for water, 

sewage, and hazardous waste facilities 100 100 100 110 110 110 120 550 350 380 400 440 470 490 500 2,300 

39 Capital gains treatment of certain timber 

income ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 90 90 90 100 70 60 80 400 

40 Expensing of multiperiod timber growing 

costs ...................................................... 240 250 260 280 290 300 300 1,430 110 120 120 120 120 130 130 620 

41 Tax incentives for preservation of historic 

structures ............................................... 270 280 290 310 320 340 360 1,620 80 90 90 90 100 100 110 490 

42 Expensing of capital costs with respect to 

complying with EPA sulfur regulations 10 10 10 30 50 30 ................ 120 ................ ................ ................ ................ ................ ................ ................ ................
292 ANALYTICAL PERSPECTIVES 

Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued 

(in millions of dollars) 

Corporations Individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 2005 2006 2007 2008 2009 2010 2011 2007–11 

43 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....... ............ ............ 10 20 30 50 40 150 ................ ................ ................ 10 10 20 20 60 

Agriculture: 

44 Expensing of certain capital outlays ......... 20 20 20 20 20 20 30 110 90 110 110 110 120 120 120 580 

45 Expensing of certain multiperiod production costs ............................................... 10 10 10 10 10 10 20 60 50 60 60 70 70 70 70 340 

46 Treatment of loans forgiven for solvent 

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

47 Capital gains treatment of certain income ............ ............ ................ ................ ................ ................ ................ ................ 880 870 900 1,050 750 590 780 4,070 

48 Income averaging for farmers ................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 40 40 50 210 

49 Deferral of gain on sale of farm refiners 10 10 20 20 20 20 20 100 ................ ................ ................ ................ ................ ................ ................ ................

50 Bio-Diesel and small agri-biodiesel producer tax credits ................................... ............ ............ ................ ................ ................ ................ ................ ................ 30 90 100 90 40 20 20 270 

Commerce and housing: 

Financial institutions and insurance: 

51 Exemption of credit union income ........ 1290 1370 1450 1540 1640 1,740 1,850 8,220 ................ ................ ................ ................ ................ ................ ................ ................

52 Excess bad debt reserves of financial 

institutions ......................................... 10 10 10 ................ ................ ................ ................ 10 ................ ................ ................ ................ ................ ................ ................ ................

53 Exclusion of interest on life insurance 

savings .............................................. 1,760 1,830 1,910 2,120 2,400 2,620 2,810 11,860 17,440 18,140 18,860 20,480 23,700 26,370 28,540 117,950 

54 Special alternative tax on small property and casualty insurance companies .................................................... 20 20 20 20 20 20 30 110 ................ ................ ................ ................ ................ ................ ................ ................

55 Tax exemption of certain insurance 

companies owned by tax-exempt organizations ........................................ 210 220 230 240 250 260 270 1,250 ................ ................ ................ ................ ................ ................ ................ ................

56 Small life insurance company deduction ..................................................... 60 60 60 60 60 60 50 290 ................ ................ ................ ................ ................ ................ ................ ................

57 Exclusion of interest spread of financial 

institutions ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,450 1,540 1,620 1,710 1,800 1,890 1,990 12,000 

Housing: 

58 Exclusion of interest on owner-occupied 

mortgage subsidy bonds ....................... 200 210 210 220 230 230 240 1,130 730 780 830 920 980 1,010 1,040 4,780 

59 Exclusion of interest on rental housing 

bonds ..................................................... 90 90 90 100 100 100 100 490 320 340 360 400 430 440 450 2,080 

60 Deductibility of mortgage interest on 

owner-occupied homes ......................... ............ ............ ................ ................ ................ ................ ................ ................ 62,160 72,060 79,860 87,820 94,490 100,980 108,280 471,430 

61 Deductibility of State and local property 

tax on owner-occupied homes ............. ............ ............ ................ ................ ................ ................ ................ ................ 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200 

62 Deferral of income from post 1987 installment sales ............................................. 290 290 300 300 310 310 310 1,530 830 840 860 880 890 1,000 1,120 4,750 

63 Capital gains exclusion on home sales .... ............ ............ ................ ................ ................ ................ ................ ................ 35,990 39,750 43,900 48,490 59,900 78,860 87,100 318,250 

64 Exclusion of net imputed rental income ... ............ ............ ................ ................ ................ ................ ................ ................ 28,600 29,720 33,210 36,860 40,630 44,785 49,364 204,849 

65 Exception from passive loss rules for 

$25,000 of rental loss ........................... ............ ............ ................ ................ ................ ................ ................ ................ 6470 6370 6230 6060 5880 5700 5510 29,380 

66 Credit for low-income housing investments ..................................................... 3,300 3,450 3,610 3,790 4,000 4,210 4,440 20,050 580 610 640 670 710 740 780 3,540 

67 Accelerated depreciation on rental housing (normal tax method) ....................... 650 710 760 840 910 960 1,030 4,500 8,960 9,920 10,710 11,820 12,910 13,750 14,890 64,080 

Commerce: 

68 Cancellation of indebtedness .................... ............ ............ ................ ................ ................ ................ ................ ................ 30 160 110 40 40 40 40 270 

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

70 Capital gains (except agriculture, timber, 

iron ore, and coal) ................................ ............ ............ ................ ................ ................ ................ ................ ................ 26,170 25,990 26,760 31,280 22,340 17,580 23,410 121,370 

71 Capital gains exclusion of small corporation stock ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 200 230 260 300 320 350 470 1,700 

72 Step-up basis of capital gains at death ... ............ ............ ................ ................ ................ ................ ................ ................ 26,820 29,510 32,460 35,700 36,480 34,560 38,010 177,210 

73 Carryover basis of capital gains on gifts .. ............ ............ ................ ................ ................ ................ ................ ................ 410 540 640 750 790 1,270 6,370 9,820 

74 Ordinary income treatment of loss from 

small business corporation stock sale ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 50 50 50 250 

75 Accelerated depreciation of buildings 

other than rental housing (normal tax 

method) .................................................. 220 400 530 720 730 970 1,230 4,180 –1,130 –680 –440 –170 –370 –20 350 –650 

76 Accelerated depreciation of machinery 

and equipment (normal tax method) .... 15,850 30,250 39,870 47,870 57,290 63,410 69,170 277,610 4,370 10,270 12,360 14,070 16,190 17,680 19,290 75,990 

77 Expensing of certain small investments 

(normal tax method) .............................. 1,710 1,440 1,240 –280 –2 160 310 1,428 3,680 3,280 3,120 630 870 950 1,150 6,720 

78 Graduated corporation income tax rate 

(normal tax method) .............................. 3,160 3,450 3,590 3,940 4,180 4,300 4,390 20,400 ................ ................ ................ ................ ................ ................ ................ ................

79 Exclusion of interest on small issue 

bonds ..................................................... 80 90 90 90 100 100 100 480 310 330 350 390 410 430 440 2,020 

80 Deduction for US production activities ..... 4,870 3,980 8,320 9,770 10,630 16,550 16,880 62,150 1,350 1,170 2,350 2,420 2,480 3,770 5,390 16,410 

81 Special rules for certain film and TV production ................................................... 70 90 70 60 –30 –70 –50 –20 20 20 20 10 –10 –20 –10 –10 

Transportation: 

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

83 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,590 2,730 2,880 3,030 3,180 3,330 3,420 15,840 

84 Exclusion for employer-provided transit 

passes ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 480 550 630 710 790 880 960 3,970 

85 Tax credit for certain expenditures for 

maintaining railroad tracks .................... 70 140 150 110 50 30 10 350 ................ ................ ................ ................ ................ ................ ................ ................

86 Exclusion of interest on bonds for Financing of Highway Projects and rail-truck 

transfer facilities .................................... ............ 10 15 20 25 25 25 110 ................ 15 35 55 70 70 75 305 
19. TAX EXPENDITURES 293 

Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued 

(in millions of dollars) 

Corporations Individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 2005 2006 2007 2008 2009 2010 2011 2007–11 

Community and regional development: 

87 Investment credit for rehabilitation of 

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

88 Exclusion of interest for airport, dock, and 

similar bonds ......................................... 170 180 190 190 200 200 210 990 630 680 720 800 860 880 910 4,170 

89 Exemption of certain mutuals’ and cooperatives’ income ................................ 60 60 70 70 70 70 70 350 ................ ................ ................ ................ ................ ................ ................ ................

90 Empowerment zones and renewal communities ................................................. 290 310 340 370 420 190 60 1,380 830 900 1,000 1,110 1,320 940 360 4,730 

91 New markets tax credit ............................. 110 150 210 220 200 170 130 930 320 460 620 650 590 500 390 2,750 

92 Expensing of environmental remediation 

costs ...................................................... 60 50 30 ................ –20 –10 –10 –10 10 10 10 ................ ................ ................ ................ 10 

93 Credit to holders of Gulf Tax Credit 

Bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ ................ ................ 10 10 10 10 10 50 

Education, training, employment, and social services: 

Education: 

94 Exclusion of scholarship and fellowship 

income (normal tax method) ............ ............ ............ ................ ................ ................ ................ ................ ................ 1,380 1,450 1,510 1,580 1,640 1,720 1,790 8,240 

95 HOPE tax credit .................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,710 3,650 3,060 3,090 3,220 3,240 3,480 16,090 

96 Lifetime Learning tax credit .................. ............ ............ ................ ................ ................ ................ ................ ................ 2,330 2,340 2,020 2,030 2,060 2,090 2,220 10,420 

97 Education Individual Retirement Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 70 90 110 140 180 230 280 940 

98 Deductibility of student-loan interest .... ............ ............ ................ ................ ................ ................ ................ ................ 780 800 810 820 830 840 780 4,080 

99 Deduction for higher education expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,830 1,840 ................ ................ ................ ................ ................ ................

100 State prepaid tuition plans .................... ............ ............ ................ ................ ................ ................ ................ ................ 430 540 620 710 810 930 1,090 4,160 

101 Exclusion of interest on student-loan 

bonds ................................................. 60 60 70 70 70 70 70 350 220 240 250 280 300 310 320 1,460 

102 Exclusion of interest on bonds for private nonprofit educational facilities .. 230 240 250 260 260 270 280 1,320 850 920 970 1070 1150 1180 1220 5,590 

103 Credit for holders of zone academy 

bonds ................................................. 110 130 140 150 150 150 150 740 ................ ................ ................ ................ ................ ................ ................ ................

104 Exclusion of interest on savings bonds 

redeemed to finance educational expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 10 20 20 20 20 20 20 100 

105 Parental personal exemption for students age 19 or over ....................... ............ ............ ................ ................ ................ ................ ................ ................ 3,760 2,500 1,760 1,650 1,510 1,420 2,740 9,080 

106 Deductibility of charitable contributions 

(education) ........................................ 540 560 590 620 660 700 740 3,310 2,880 3,120 3,440 3,640 3,890 4,170 4,470 19,610 

107 Exclusion of employer-provided educational assistance ........................... ............ ............ ................ ................ ................ ................ ................ ................ 560 590 620 660 690 730 40 2,740 

108 Special deduction for teacher expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 160 150 ................ ................ ................ ................ ................ ................

109 Discharge of student loan indebtedness ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 

Training, employment, and social services: 

110 Work opportunity tax credit ................... 130 180 150 100 80 50 20 400 30 30 40 30 30 20 10 130 

111 Welfare-to-work tax credit ..................... 60 70 60 30 10 ................ ................ 100 10 10 10 10 ................ ................ ................ 20 

112 Employer provided child care exclusion ............ ............ ................ ................ ................ ................ ................ ................ 610 810 920 960 1010 1060 1070 5,020 

113 Employer-provided child care credit ..... ............ ............ ................ ................ ................ ................ ................ ................ 10 10 10 20 20 20 10 80 

114 Assistance for adopted foster children ............ ............ ................ ................ ................ ................ ................ ................ 310 320 350 370 400 430 470 2,020 

115 Adoption credit and exclusion .............. ............ ............ ................ ................ ................ ................ ................ ................ 360 540 560 570 580 600 540 2,850 

116 Exclusion of employee meals and 

lodging (other than military) ............. ............ ............ ................ ................ ................ ................ ................ ................ 850 890 930 970 1,010 1,060 1,110 5,080 

117 Child credit 2 .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 41,790 42,090 42,120 42,070 41,830 41,870 31,730 199,620 

118 Credit for child and dependent care 

expenses ........................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,060 2,740 1,820 1,750 1,660 1,590 1,540 8,360 

119 Credit for disabled access expenditures .................................................. 10 10 10 10 10 10 10 50 20 20 20 30 30 30 30 140 

120 Deductibility of charitable contributions, 

other than education and health ...... 1,230 1,290 1,360 1,430 1,500 1,570 1640 7,500 28,440 31,260 33,140 35,360 37,910 40,640 43,570 190,620 

121 Exclusion of certain foster care payments ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 440 440 450 450 450 460 470 2,280 

122 Exclusion of parsonage allowances ..... ............ ............ ................ ................ ................ ................ ................ ................ 460 480 510 540 580 610 640 2,880 

123 Employee retention credit for employers affected by Hurricane Katrina, 

Rita, and Wilma ................................ ............ 40 ................ ................ ................ ................ ................ ................ ................ 100 20 20 ................ ................ ................ 40 

Health: 

124 Exclusion of employer contributions for 

medical insurance premiums and medical care ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 118,420 132,730 146,780 161,120 176,290 191,980 212,820 888,990 

125 Self-employed medical insurance premiums .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,790 4,240 4,630 5,080 5,570 6,050 6,730 28,060 

126 Medical Savings Accounts / Health Savings Accounts ........................................ ............ ............ ................ ................ ................ ................ ................ ................ 1,050 1,830 2,650 3,510 3,960 3,910 3,860 17,890 

127 Deductibility of medical expenses ............. ............ ............ ................ ................ ................ ................ ................ ................ 6,110 4,410 5,310 6,490 7,720 9,220 12,260 41,000 

128 Exclusion of interest on hospital construction bonds .............................................. 410 420 430 440 460 470 490 2,290 1,470 1,590 1,680 1,860 1,990 2,050 2,110 9,690 

129 Deductibility of charitable contributions 

(health) ................................................... 160 160 170 180 190 200 210 950 3,190 3,510 3,720 3,970 4,260 4,570 4,900 21,420 

130 Tax credit for orphan drug research ........ 210 230 260 290 320 360 410 1,640 ................ ................ ................ ................ ................ ................ ................ ................

131 Special Blue Cross/Blue Shield deduction 710 780 850 920 760 830 920 4,280 ................ ................ ................ ................ ................ ................ ................ ................
294 ANALYTICAL PERSPECTIVES 

Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued 

(in millions of dollars) 

Corporations Individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 2005 2006 2007 2008 2009 2010 2011 2007–11 

132 Tax credit for health insurance purchased 

by certain displaced and retired individuals ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 20 20 30 30 30 30 30 150 

Income security: 

133 Exclusion of railroad retirement system 

benefits .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 390 390 380 360 370 370 350 1,830 

134 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 5,770 6,000 6,180 6,390 6,630 6,860 7,090 33,150 

135 Exclusion of public assistance benefits 

(normal tax method) .............................. ............ ............ ................ ................ ................ ................ ................ ................ 430 450 470 490 510 530 550 2,550 

136 Exclusion of special benefits for disabled 

coal miners ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 40 40 40 40 210 

137 Exclusion of military disability pensions ... ............ ............ ................ ................ ................ ................ ................ ................ 100 110 110 120 120 130 130 610 

Net exclusion of pension contributions 

and earnings: 

138 Employer plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 50,630 50,360 52,470 48,100 45,760 44,760 36,910 228,000 

139 401(k) plans ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 37,440 37,330 39,800 43,100 48,810 53,870 47,290 232,870 

140 Individual Retirement Accounts ................. ............ ............ ................ ................ ................ ................ ................ ................ 3,100 4,230 5,970 7,180 8,300 8,840 8,060 38,350 

141 Low and moderate income savers credit ............ ............ ................ ................ ................ ................ ................ ................ 1,310 1,380 830 ................ ................ ................ ................ 830 

142 Keogh plans ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 9,400 9,990 10,670 11,630 12,670 13,800 15,040 63,810 

Exclusion of other employee benefits: 

143 Premiums on group term life insurance ............ ............ ................ ................ ................ ................ ................ ................ 2,020 2,070 2,180 2,250 2,310 2,380 2,490 11,610 

144 Premiums on accident and disability insurance .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 280 290 300 310 320 330 340 1,600 

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

146 Special ESOP rules .............................. 1310 1410 1520 1640 1780 1940 2100 8,980 340 350 370 390 390 390 390 1,930 

147 Additional deduction for the blind ......... ............ ............ ................ ................ ................ ................ ................ ................ 40 30 30 40 40 40 50 200 

148 Additional deduction for the elderly ...... ............ ............ ................ ................ ................ ................ ................ ................ 1,850 1,740 1,740 1,880 1,930 1,980 2,940 10,470 

149 Tax credit for the elderly and disabled ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 10 10 10 10 60 

150 Deductibility of casualty losses ............. ............ ............ ................ ................ ................ ................ ................ ................ 250 980 640 300 320 330 360 1,950 

151 Earned income tax credit 3 ................... ............ ............ ................ ................ ................ ................ ................ ................ 4,925 5,050 5,150 5,445 5,640 5,810 6,070 28,115 

152 Additional exemption for housing Hurricane Katrina displaced individuals ... ............ ............ ................ ................ ................ ................ ................ ................ ................ 110 20 ................ ................ ................ ................ 20 

Social Security: 

Exclusion of social security benefits: 

153 Social Security benefits for retired 

workers .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 19,110 19,350 19,590 20,250 20,700 21,000 23,330 104,870 

154 Social Security benefits for disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 3,600 3,810 4,110 4,330 4,570 4,960 5,530 23,500 

155 Social Security benefits for dependents 

and survivors .................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,940 3,980 4,040 4,070 4,100 4,180 4,360 20,750 

Veterans benefits and services: 

156 Exclusion of veterans death benefits and 

disability compensation ......................... ............ ............ ................ ................ ................ ................ ................ ................ 3,320 3,600 3,770 3,900 4,050 4,140 4,350 20,210 

157 Exclusion of veterans pensions ................ ............ ............ ................ ................ ................ ................ ................ ................ 130 140 140 140 140 150 150 720 

158 Exclusion of GI bill benefits ...................... ............ ............ ................ ................ ................ ................ ................ ................ 150 170 210 240 280 330 400 1,460 

159 Exclusion of interest on veterans housing 

bonds ..................................................... 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200 

General purpose fiscal assistance: 

160 Exclusion of interest on public purpose 

State and local bonds ........................... 5,710 5,880 6,060 6,240 6,430 6,620 6,820 32,170 20,650 22,300 23,580 26,090 27,980 28,820 29,690 136,160 

161 Deductibility of nonbusiness state and 

local taxes other than on owner-occupied homes ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710 

162 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 800 400 40 ................ ................ ................ ................ 40 ................ ................ ................ ................ ................ ................ ................ ................

Interest: 

163 Deferral of interest on U.S. savings 

bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,350 1,340 1,350 1,360 1,380 1,390 1,440 6,920 

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200 

Nonbusiness State and local taxes 

other than on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710 

Exclusion of interest on State and local 

bonds for: 

Public purposes ..................................... 5,710 5,880 6,060 6,240 6,430 6,620 6,820 32,170 20,650 22,300 23,580 26,090 27,980 28,820 29,690 136,160 

Energy facilities ..................................... 20 20 20 20 20 20 20 100 60 70 70 80 80 90 90 410 

Water, sewage, and hazardous waste 

disposal facilities ............................... 100 100 100 110 110 110 120 550 350 380 400 440 470 490 500 2,300 

Small-issues .......................................... 80 90 90 90 100 100 100 480 310 330 350 390 410 430 440 2,020 

Owner-occupied mortgage subsidies ... 200 210 210 220 230 230 240 1,130 730 780 830 920 980 1,010 1,040 4,780 

Rental housing ...................................... 90 90 90 100 100 100 100 490 320 340 360 400 430 440 450 2,080 

Airports, docks, and similar facilities .... 170 180 190 190 200 200 210 990 630 680 720 800 860 880 910 4,170 

Student loans ........................................ 60 60 70 70 70 70 70 350 220 240 250 280 300 310 320 1,460 

Private nonprofit educational facilities .. 230 240 250 260 260 270 280 1,320 850 920 970 1,070 1,150 1,180 1,220 5,590 

Hospital construction ............................. 410 420 430 440 460 470 490 2,290 1,470 1,590 1,680 1,860 1,990 2,050 2,110 9,690 

Veterans’ housing ................................. 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200 
19. TAX EXPENDITURES 295 

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

such as Social Security benefits. 

Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued 

(in millions of dollars) 

Corporations Individuals 

2005 2006 2007 2008 2009 2010 2011 2007–11 2005 2006 2007 2008 2009 2010 2011 2007–11 

Credit for holders of zone academy bonds .. 110 130 140 150 150 150 150 740 ................ ................ ................ ................ ................ ................ ................ ................

1 In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2005 $1,500; 2006 $2,110; 2007 $2,400; 2008 $2,740; 2009 $3,080; 2010 

$3,410 and 2011 $870. 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: 2005 $14,620; 2006 $14,110; 2007 $13,540; 

2008 $12,950; 2009 $12,760 and 2010 $12,330:2011 $12,110. 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: 2005 $34,559;2006 $35,098; 2007 

$35,645; 2008 $36,955; 2009 $38,048; 2010 $38,823; and 2011 $40,278. 

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 that usually results in a 

reduction in the amount of tax owed. 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, most of this year’s tax expenditure 

estimates are presented using two baselines: the normal 

tax baseline and the reference tax law baseline. An 

exception is provided for the lower tax rate on dividends 

and capital gains on corporate shares as discussed 

below. 

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 deduction of 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. 

In the case of income taxes, 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 generally tax expenditures under the normal tax baseline, but the reverse is not always true. 

Both the normal and reference tax baselines allow 

several major departures from a pure comprehensive 

income tax. For example, under the normal and reference tax baselines: 

• Income is taxable only when it is realized in exchange. Thus, either the deferral of tax on unrealized capital gains nor the tax exclusion of imputed 

income (such as the rental value of owner-occupied 

housing or farmers’ consumption of their own 

produce) is regarded as a tax expenditure. Both 

accrued and imputed income would be taxed under 

a comprehensive income tax. 

• A comprehensive income tax would generally not 

exclude from the tax base amounts for personal 

exemptions or a standard deduction, except perhaps to ease tax administration. 

• There generally is a separate corporate income 

tax. 

• Tax rates vary by level of income. 

• Tax rates are allowed to vary with marital status. 

• 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). 

Although the reference law and normal tax baselines 

are generally similar, areas of difference include: 

Tax rates. The separate schedules applying to the 

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

below the maximum statutory rate do not give 

rise to a tax expenditure. The normal tax baseline 

is similar, except that, by convention, 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. Again, by convention, the alternative minimum tax is treated 

as part of the baseline rate structure under both 

the reference and normal tax methods. 

Income subject to the tax. Income subject to tax 

is defined as gross income less the costs of earning 

that income. The Federal income tax defines gross 

income to include: (1) consideration received in 

the exchange of goods and services, including labor 

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

of gross or net income earned and/or reported by 

another entity (such as a partnership). Under the 

reference tax rules, therefore, gross income does 

not include gifts defined as receipts of money or 

property that are not consideration in an exchange 

or most transfer payments, which can be thought 

of as gifts from the Government.2 The normal tax 

baseline also excludes gifts between individuals 

from gross income. Under the normal tax baseline, 

however, all cash transfer payments from the Gov-
296 ANALYTICAL PERSPECTIVES 

3 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. 

ernment to private individuals are counted in 

gross income, and exemptions of such transfers 

from tax are identified as tax expenditures. The 

costs of earning income are generally deductible 

in determining taxable income under both the reference and normal tax baselines. 3

Capital recovery. Under the reference tax law 

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

the depreciation allowance for property is computed using estimates of economic depreciation. 

The latter represents a change in the calculation 

of the tax expenditure under normal law first 

made in the 2004 Budget. The Appendix provides 

further details on the new methodology and how 

it differs from the prior methodology. 

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. 

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2007–2011 PROJECTED REVENUE EFFECT 

(in millions of dollars) 

Provision 2007 2007–11 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 146,780 888,990 

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 79,860 471,430 

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 52,230 357,200 

Capital gains exclusion on home sales ............................................................................................................................... 43,900 318,250 

401(k) plans .......................................................................................................................................................................... 39,800 232,870 

Employer plans ..................................................................................................................................................................... 52,470 228,000 

Exclusion of net imputed rental income .............................................................................................................................. 33,210 204,849 

Child credit ............................................................................................................................................................................ 42,120 199,620 

Deductibility of charitable contributions, other than education and health ......................................................................... 34,430 198,120 

Step-up basis of capital gains at death .............................................................................................................................. 32,460 177,210 

Exclusion of interest on public purpose State and local bonds ......................................................................................... 29,640 168,330 

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 27,210 161,710 

Exclusion of interest on life insurance savings ................................................................................................................... 20,770 129,810 

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 26,760 121,370 

Social Security benefits for retired workers ......................................................................................................................... 19,590 104,870 

Deduction for US production activities ................................................................................................................................ 10,670 78,560 

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 12,810 74,200 

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 11,940 68,580 

Keogh plans .......................................................................................................................................................................... 10,670 63,810 

Deductibility of medical expenses ........................................................................................................................................ 5,310 41,000 

Individual Retirement Accounts ............................................................................................................................................ 5,970 38,350 

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,180 33,150 

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 6,230 29,380 

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 6,990 28,250 

Earned income tax credit ..................................................................................................................................................... 5,147 28,104 

Self-employed medical insurance premiums ....................................................................................................................... 4,630 28,060 

Credit for low-income housing investments ......................................................................................................................... 4,250 23,590 

Social Security benefits for disabled ................................................................................................................................... 4,110 23,500 

Deductibility of charitable contributions (education) ............................................................................................................ 4,030 22,920 

Deductibility of charitable contributions (health) .................................................................................................................. 3,890 22,370 

Social Security benefits for dependents and survivors ....................................................................................................... 4,040 20,750 

Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,590 20,400 

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,770 20,210 

Medical Savings Accounts/Health Savings Accounts ......................................................................................................... 2,650 17,890 

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,940 16,400 

HOPE tax credit ................................................................................................................................................................... 3,060 16,090 

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,880 15,840 
19. TAX EXPENDITURES 297 

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2007–2011 PROJECTED REVENUE EFFECT— 

Continued 

(in millions of dollars) 

Provision 2007 2007–11 

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 3,050 15,390 

Exclusion of interest spread of financial institutions ........................................................................................................... 1,620 12,000 

Exclusion of interest on hospital construction bonds .......................................................................................................... 2,110 11,980 

Premiums on group term life insurance .............................................................................................................................. 2,180 11,610 

Inventory property sales source rules exception ................................................................................................................. 1,840 11,030 

Special ESOP rules .............................................................................................................................................................. 1,890 10,910 

Additional deduction for the elderly ..................................................................................................................................... 1,740 10,470 

Lifetime Learning tax credit .................................................................................................................................................. 2,020 10,420 

Carryover basis of capital gains on gifts ............................................................................................................................. 640 9,820 

Parental personal exemption for students age 19 or over ................................................................................................. 1,760 9,080 

Credit for child and dependent care expenses ................................................................................................................... 1,820 8,360 

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,510 8,240 

Exemption of credit union income ....................................................................................................................................... 1,450 8,220 

Expensing of certain small investments (normal tax method) ............................................................................................ 4,360 8,148 

Deferral of interest on U.S. savings bonds ......................................................................................................................... 1,350 6,920 

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 1,220 6,910 

Deferral of income from post 1987 installment sales ......................................................................................................... 1,160 6,280 

Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,340 6,110 

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 1,040 5,910 

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 1,000 5,540 

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 910 5,160 

Exclusion of employee meals and lodging (other than military) ........................................................................................ 930 5,080 

Employer provided child care exclusion .............................................................................................................................. 920 5,020 

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 850 4,280 

State prepaid tuition plans ................................................................................................................................................... 620 4,160 

Deductibility of student-loan interest .................................................................................................................................... 810 4,080 

Capital gains treatment of certain income ........................................................................................................................... 900 4,070 

New technology credit .......................................................................................................................................................... 690 4,060 

Exclusion for employer-provided transit passes .................................................................................................................. 630 3,970 

New markets tax credit ........................................................................................................................................................ 830 3,680 

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... 90 3,530 

Alternative fuel production credit ......................................................................................................................................... 2,460 3,450 

Excess of percentage over cost depletion, fuels ................................................................................................................ 690 3,230 

Expensing of exploration and development costs, fuels .................................................................................................... 870 3,230 

Exclusion of parsonage allowances ..................................................................................................................................... 510 2,880 

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 500 2,850 

Adoption credit and exclusion .............................................................................................................................................. 560 2,850 

Exclusion of employer-provided educational assistance ..................................................................................................... 620 2,740 

Exclusion of interest on rental housing bonds .................................................................................................................... 450 2,570 

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 470 2,550 

Exclusion of interest on small issue bonds ......................................................................................................................... 440 2,500 

Extraterritorial income exclusion .......................................................................................................................................... 1,960 2,350 

Exclusion of certain foster care payments .......................................................................................................................... 450 2,280 

Tax incentives for preservation of historic structures ......................................................................................................... 380 2,110 

Expensing of multiperiod timber growing costs ................................................................................................................... 380 2,050 

Assistance for adopted foster children ................................................................................................................................ 350 2,020 

Deductibility of casualty losses ............................................................................................................................................ 640 1,950 

Exclusion of railroad retirement system benefits ................................................................................................................ 380 1,830 

Exclusion of interest on student-loan bonds ....................................................................................................................... 320 1,810 

Capital gains exclusion of small corporation stock ............................................................................................................. 260 1,700 

Tax credit for orphan drug research .................................................................................................................................... 260 1,640 

Premiums on accident and disability insurance .................................................................................................................. 300 1,600 

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. 300 1,590 

Credit for increasing research activities .............................................................................................................................. 920 1,540 

Exclusion of GI bill benefits ................................................................................................................................................. 210 1,460 

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 230 1,250 

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 960 960 

Education Individual Retirement Accounts .......................................................................................................................... 110 940 

Low and moderate income savers credit ............................................................................................................................ 830 830 

Temporary 50% expensing for equipment used in the refining of liquid fuels .................................................................. 30 830 

Credit for investment in clean coal facilities ....................................................................................................................... 50 780 

Credit for holders of zone academy bonds ......................................................................................................................... 140 740 

Exclusion of veterans pensions ........................................................................................................................................... 140 720 

Expensing of certain capital outlays .................................................................................................................................... 130 690 

Amortize all geological and geophysical expenditures over 2 years ................................................................................. 150 630 

Exclusion of military disability pensions .............................................................................................................................. 110 610 

Natural gas distribution pipelines treated as 15–year property .......................................................................................... 50 560 
298 ANALYTICAL PERSPECTIVES 

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2007–2011 PROJECTED REVENUE EFFECT— 

Continued 

(in millions of dollars) 

Provision 2007 2007–11 

Work opportunity tax credit .................................................................................................................................................. 190 530 

Credit for energy efficiency improvements to existing homes ............................................................................................ 380 530 

Exclusion of interest on energy facility bonds .................................................................................................................... 90 510 

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 200 420 

Exclusion of interest on bonds for Financing of Highway Projects and rail-truck transfer facilities ................................. 50 415 

Capital gains treatment of royalties on coal ....................................................................................................................... 90 400 

Capital gains treatment of certain timber income ............................................................................................................... 90 400 

Expensing of certain multiperiod production costs .............................................................................................................. 70 400 

Exclusion of utility conservation subsidies .......................................................................................................................... 80 380 

Tax credit for certain expenditures for maintaining railroad tracks .................................................................................... 150 350 

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 70 350 

Allowance of deduction for certain energy efficient commercial building property ............................................................ 190 340 

Small life insurance company deduction ............................................................................................................................. 60 290 

Cancellation of indebtedness ............................................................................................................................................... 110 270 

Bio-Diesel tax credit ............................................................................................................................................................. 100 270 

Exclusion of interest on veterans housing bonds ............................................................................................................... 50 250 

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

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

Alcohol fuel credits ............................................................................................................................................................... 40 230 

Exclusion of special benefits for disabled coal miners ....................................................................................................... 50 210 

Income averaging for farmers .............................................................................................................................................. 40 210 

Exclusion of gain or loss on sale or exchange of certain brownfield sites ....................................................................... 10 210 

Investment credit for rehabilitation of structures (other than historic) ................................................................................ 40 200 

Additional deduction for the blind ........................................................................................................................................ 30 200 

Exception from passive loss limitation for working interests in oil and gas properties ..................................................... 40 200 

Credit for disabled access expenditures ............................................................................................................................. 30 190 

Credit for holding clean renewable energy bonds .............................................................................................................. 10 180 

Tax credit for health insurance purchased by certain displaced and retired individuals .................................................. 30 150 

Credit for business installation of qualified fuel cells and stationary microturbine power plants ...................................... 130 150 

Welfare-to-work tax credit .................................................................................................................................................... 70 120 

Expensing of capital costs with respect to complying with EPA sulfur regulations .......................................................... 11 113 

Special alternative tax on small property and casualty insurance companies .................................................................. 20 110 

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

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

Discharge of student loan indebtedness ............................................................................................................................. 20 100 

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

Deferral of gain on sale of farm refiners ............................................................................................................................. 20 100 

Employer-provided child care credit .................................................................................................................................... 10 80 

Credit for energy efficient appliances .................................................................................................................................. 80 80 

Tax credit for the elderly and disabled ............................................................................................................................... 20 60 

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

Credit to holders of Gulf Tax Credit Bonds ........................................................................................................................ 10 50 

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 40 40 

Credit for construction of new energy efficient homes ....................................................................................................... 20 40 

Employee retention credit for employers affected by Hurricane Katrina, Rita, and Wilma ............................................... 20 40 

Enhanced oil recovery credit ............................................................................................................................................... ............................ 20 

30% credit for residential purchases/installations of solar and fuel cells .......................................................................... 10 20 

Additional exemption for housing Hurricane Katrina displaced individuals ........................................................................ 20 20 

Excess bad debt reserves of financial institutions .............................................................................................................. 10 10 

Deduction for higher education expenses ........................................................................................................................... ............................ ............................

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

Special deduction for teacher expenses ............................................................................................................................. ............................ ............................

Expensing of environmental remediation costs ................................................................................................................... 40 ............................

Alternative Fuel and Fuel Mixture tax credit ....................................................................................................................... ............................ ............................

Credit for production from advanced nuclear power facilities ............................................................................................ ............................ ............................

Special rules for certain film and TV production ................................................................................................................ 90 –30 

Pass through low sulfur diesel expensing to cooperative owners ..................................................................................... –10 –30 

Deferral of gain from dispositions of transmission property to implement FERC restructuring policy ............................. 530 –210 
19. TAX EXPENDITURES 299 

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

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

Table 19–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN 

CALENDAR YEAR 2005 

(in millions of dollars) 

Provision

2005 

Present Value 

of Revenue 

Loss 

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 10,020 

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 2,270 

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 2,390 

4 Expensing of exploration and development costs—fuels .................................................................................... 180 

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

6 Expensing of multiperiod timber growing costs ................................................................................................... 200 

7 Expensing of certain multiperiod production costs—agriculture .......................................................................... 140 

8 Expensing of certain capital outlays—agriculture ................................................................................................ 180 

9 Deferral of income on life insurance and annuity contracts ................................................................................ 19,640 

10 Accelerated depreciation on rental housing ......................................................................................................... 16,088 

11 Accelerated depreciation of buildings other than rental ...................................................................................... 15,980 

12 Accelerated depreciation of machinery and equipment ....................................................................................... 64,330 

13 Expensing of certain small investments (normal tax method) ............................................................................ 1,100 

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

15 Credit for holders of zone academy bonds ......................................................................................................... 210 

16 Credit for low-income housing investments ......................................................................................................... 3,970 

17 Deferral for state prepaid tuition plans ................................................................................................................. 1,190 

18 Exclusion of pension contributions—employer plans ........................................................................................... 81,160 

19 Exclusion of 401(k) contributions .......................................................................................................................... 102,640 

20 Exclusion of IRA contributions and earnings ....................................................................................................... 4,460 

21 Exclusion of contributions and earnings for Keogh plans ................................................................................... 3,190 

22 Exclusion of interest on public-purpose bonds .................................................................................................... 19,830 

23 Exclusion of interest on non-public purpose bonds ............................................................................................. 6,700 

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

25 Exclusion of Roth earnings and distributions ....................................................................................................... 8,170 

26 Exclusion of non-deductible IRA earnings ........................................................................................................... 370 

Double Taxation of Corporate Profits 

In a gradual transition to a more economically neutral tax system where corporate income is subject to 

a single layer of tax, the lower tax rates on dividends 

and capital gains on corporate equity have not been 

considered tax preferences since the 2005 Budget. Thus, 

the difference between ordinary tax rates and the lower 

tax rates on dividends, introduced by the Jobs and 

Growth Tax Relief Reconciliation Act of 2003 

(JGTRRA), does not give rise to a tax expenditure. 

Similarly, the lower capital gains tax rates applied to 

gains realized from the disposition of corporate equity 

do not give rise to a tax expenditure. As a consequence, 

tax expenditure estimates for the lower tax rates on 

capital, step-up in basis, and the inside build-up on 

pension assets, 401k plans, IRAs, among others, are 

limited to capital gains from sources other than corporate equity. The Appendix provides a greater discussion of alternative baselines. 

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 4 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 savings 

tax expenditures will continue over the next several 

years. 
300 ANALYTICAL PERSPECTIVES 

5 Although this chapter 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. 

Comparison of tax expenditure, spending, and regulatory policies. Tax expenditures by definition work 

through the tax system and, particularly, the income 

tax. Thus, they may be relatively advantageous policy 

approaches when the benefit or incentive is related to 

income and is intended to be widely available.5 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 operation 

of the tax system, (for example, the exclusion for up 

to $500,000 of capital gains on home sales). Tax expenditures also implicitly subsidize certain activities. Spending, regulatory or tax-disincentive policies can also modify behavior, but may have different economic effects. 

Finally, a variety of tax expenditure tools can be used 

e.g., deductions, credits, exemptions, deferrals, floors, 

ceilings; phase-ins; phase-outs; dependent on income, 

expenses, or demographic characteristics (age, number 

of family members, etc.). This wide range of policy instruments means that tax expenditures can be flexible 

and can have very different economic effects. 

Tax expenditures also have limitations. In many 

cases they add to the complexity of the tax system, 

which raises both administrative and compliance costs. 

For example, personal exemptions, deductions, credits 

and phase-outs can complicate filing and decision-making. The income tax system may have little or no contact with persons who have no or very low incomes, 

and does not require information on certain characteristics of individuals used in some spending programs, 

such as wealth. These features may reduce the effectiveness of tax expenditures for addressing certain income-transfer objectives. Tax expenditures also generally do not enable the same degree of agency discretion as an outlay program. For example, grant or direct 

Federal service delivery programs can prioritize activities to be addressed with specific resources in a way 

that is difficult to emulate with tax expenditures. 

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 also 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. 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 often 

be changed as needed by the Executive Branch without 

legislation. Like tax expenditures, regulations often rely 

largely on 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 degree of 

scrutiny that outlay programs receive. However, major 

regulations are subjected to a formal regulatory 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. When 

measured against a comprehensive income tax, for example, 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 in-
19. TAX EXPENDITURES 301 

tended 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 

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 benefiting existing output) and their cost-effectiveness relative to other policies. Analysis could also consider objectives that are 

more difficult to measure but still are ultimate goals, 

such as promoting the Nation’s technological base, energy security, environmental quality, or economic 

growth. Such an assessment is likely to involve tax 

analysis as well as consideration of non-tax matters 

such as market structure, scientific, and other information (such as the effects of increased domestic fuel production on imports from various regions, or the effects 

of various energy sources on the environment). 

Housing investment also benefits from tax expenditures. The imputed net rental income from owner-occupied housing is excluded from the tax base. The mortgage interest deduction and property tax deduction on 

personal residences also are reported as tax expenditures 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 com-
302 ANALYTICAL PERSPECTIVES 

pared with alternative programs that address housing 

supply and demand. 

Transportation. Employer-provided parking is a 

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

taxation. The tax expenditure estimates reflect the cost 

of parking that is leased by employers for employees; 

an estimate is not currently available for the value 

of parking owned by employers and provided to their 

employees. The exclusion for employer-provided transit 

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

could be compared with alternative transportation policies. 

Community and regional development. A series of tax 

expenditures is intended to promote community and 

regional development by reducing the costs of financing 

specialized infrastructure, such as airports, docks, and 

stadiums. Empowerment zone and enterprise community provisions are designed to promote activity in disadvantaged areas. These provisions can be compared 

with grants and other policies designed to spur economic development. 

Education, training, employment, and social services. 

Major provisions in this function are intended to promote post-secondary education, to offset costs of raising 

children, and to promote a variety of charitable activities. The education incentives can be compared with 

loans, grants, and other programs designed to promote 

higher education and training. The child credits are 

intended to adjust the tax system for the costs of raising children; as such, they could be compared to other 

Federal tax and spending policies, including related features of the tax system, such as personal exemptions 

(which are not defined as a tax expenditure). Evaluation of charitable activities requires consideration of 

the beneficiaries of these activities, who are generally 

not the parties receiving the tax reduction. 

Health. Individuals also benefit from favorable treatment of employer-provided health insurance. Measures 

of these benefits could include increased coverage and 

pooling of risks. The effects of insurance coverage on 

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

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

health care or health care costs) could also be investigated. 

Income security, Social Security, and veterans benefits 

and services. Major tax expenditures in the income security function benefit retirement savings, through employer-provided pensions, individual retirement accounts, and Keogh plans. These provisions might be 

evaluated in terms of their effects on boosting retirement incomes, private savings, and national savings 

(which would include the effect on private savings as 

well as public savings or deficits). Interactions with 

other programs, including Social Security, also may 

merit analysis. As in the case of employer-provided 

health insurance, analysis of employer-provided pension 

programs requires imputing the 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 benefiting 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 on in this chapter follow. 

These descriptions relate to current law as of December 

31, 2005, and do not reflect proposals made elsewhere 

in the Budget. Legislation enacted in 2005, such as 

the Safe, Accountable, Flexible, Efficient Transportation 

Equity Act: A Legacy For Users, The Energy Tax Incentives Act of 2005, The Katrina Emergency Tax Relief 

Act of 2005, and the Gulf Opportunity Zone Act of 

2005, expanded the scope of existing tax expenditures 

and introduced several new provisions. These include: 

(1) Exclusion of interest on clean renewable energy 

bonds; (2) Deferral of gain from dispositions of transmission property to implement FERC restructuring policy; (3) Credit for production from advanced nuclear 

power facilities; (4) Credit for investment in clean coal 

facilities; (5) Temporary 50 percent expensing for equip-
19. TAX EXPENDITURES 303 

6The 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. 

ment used in the refining of liquid fuels; (6) Passthrough low-sulfur diesel expensing to cooperative owners; (7) Natural gas distribution pipelines treated as 

15-year property; (8) Amortize all geological and geophysical expenditures over 2 years; (9) Allowance of 

deduction for certain energy efficient commercial building property; (10) Credit for construction of new energy 

efficient homes; (11) Credit for energy efficiency improvements to existing homes; (12) Credit for energy 

efficient appliances; (13) 30 percent credit for residential purchases/installations of solar and fuel cells; (14) 

Credit for business installation of qualified fuel cells 

and stationary microturbine power plants; (15) Business solar investment tax credit; (16) Alternative motor 

vehicle credit; (17) Credit for installation of alternative 

fueling stations; (18) Small agri-biodiesel producer credit; (19) Alternative fuel and fuel mixture tax credit; 

(20) Exclusion of interest spread of financial institutions; (21) Exclusion of interest on bonds for financing 

of highway projects and rail-truck transfer facilities; 

and (22) expanded and extended scope of a number 

of existing benefits to taxpayers in areas affected by 

hurricanes Katrina, Rita, and Wilma. 

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 may exclude up to 

$80,000 in foreign earned income from U.S. taxes. 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 ($76,193 in 2005). 

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 exclusion.6—The exclusion for extraterritorial income was repealed by the 

American Jobs Creation Act of 2004. Under the transition rules, taxpayers retain 80% of ETI benefits for 

2005, 60% of ETI benefits for 2006, and no ETI benefits 

thereafter. The exclusion for extraterritorial income remains in effect for certain transactions which occur pursuant to a binding contract entered into on or before 

September 17, 2003. 

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 yet 

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 
304 ANALYTICAL PERSPECTIVES 

for a taxpayer’s payments to universities for basic research. A 20-percent ‘‘flat’’ credit with no threshold base 

amount is available for energy research expenditures 

paid to certain research consortia. The credit applies 

to research conducted before January 1, 2006 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 

producers. Unlike depreciation or cost depletion, percentage depletion deductions can exceed the cost of the 

investment. 

12. Alternative fuel production credit.—A credit 

of $3 per oil-equivalent barrel of production (in 1979 

dollars) is provided for gas produced from biomass and 

liquid, gaseous, or solid synthetic fuels produced from 

coal. The credit is generally available if the price of 

oil stays below $29.50 (in 1979 dollars). The credit applies only to fuel (1) produced at a facility placed in 

service before July 1, 1998, and (2) sold before January 

1, 2008. 

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. Eligible costs include the cost of constructing a gas treatment plant 

to prepare Alaska natural gas for pipeline transportation and any of the following costs with respect to 

a qualified EOR project: (1) the cost of depreciable or 

amortizable tangible property that is an integral part 

of the project; (2) intangible drilling costs (IDCs) that 

the taxpayer can elect to deduct; and (3) deductible 

tertiary injectant costs. The credit rate is reduced in 

taxable years following calendar years during which 

the annual average unregulated wellhead price per barrel of domestic crude oil exceeds an inflation adjusted 

threshold of $28 (adjusted for inflation). 

17. New technology, refined coal, Indian coal 

and coke and coke gas credits.—A credit is provided 

equal to 10 percent of the basis of solar property (30 

percent for purchases beginning in 2006 through 2007) 

and 10 percent of the basis of geothermal property 

placed in service during the taxable year. Equipment 

that uses fiber-optic distributed sunlight to illuminate 

the inside of a structure is solar energy property eligible for a 30 percent credit in 2006 and 2007. A credit 

is also available for certain electricity produced from 

wind energy, biomass, poultry waste, geothermal energy, solar energy, small irrigation power, municipal 

solid waste, or qualified hydropower and sold to an 

unrelated party. The credit rate in 2005 is 1.9 cents 

per kilowatt hour (0.9 cents per kilowatt hour for openloop biomass, small irrigation power, municipal solid 

waste and qualified hydropower) and the rate is indexed in subsequent years. To qualify for the credit 

the electricity must be produced at a facility placed 

in service after a specified date (December 31, 1992, 

in the case of a closed-loop biomass facility, December 

31, 1993, in the case of a wind energy facility, December 31, 1999, in the case of a poultry waste facility, 

August 8, 2005 in the case of qualified hydropower 

and October 22, 2004, in all other cases) and before 

January 1, 2006 for solar facilities and January 1, 2008 

for all other qualifying facilities with the exception of 

hydropower facilities. To qualify for the credit, qualifying hydropower facilities must be placed in service 

before January 1, 2009. In addition, the electricity must 

be produced during the 10-year period after the facility 

is originally placed in service. A credit is available for 

refined coal produced at facilities placed in service during the period from October 22, 2004, through December 31, 2008, and sold during the 10-year period beginning on the date the facility was placed in service. 

The credit rate in 2005 is $5.481 per ton and the rate 

is indexed in subsequent years. A credit is available 

for Indian coal. The taxpayer may claim a credit for 

sales of coal to an unrelated third party from a quali-
19. TAX EXPENDITURES 305 

fied facility for the seven-year period beginning on January 1, 2006, and ending after December 31, 2012. The 

value of the credit is $1.50 per ton for the first four 

years of the seven-year production period and $2.00 

per ton for the last three years of the seven-year period. 

The credit amounts are indexed for inflation. A credit 

is available for the production of coke or coke gas from 

a qualified facility. Qualified facilities must have been 

placed in service before January 1, 1993, or after June 

30, 1998, and before January 1, 2010. 

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 51 cents 

per gallon through 2010. In lieu of the alcohol mixture 

credit, the taxpayer may claim a refundable excise 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 and alternative motor vehicle credits.—A tax credit of 10 percent (not to exceed $4,000) 

is provided for purchasers of electric vehicles. The credit is reduced by 75 percent for vehicles placed in service 

in 2006 and is not available for vehicles placed in service after December 31, 2006. Purchasers of other cleanfuel burning vehicles and owners of clean-fuel refueling 

property may deduct part of their expenditures. No deduction is available to taxpayers for vehicles placed 

in service after December 31, 2005. The deduction for 

clean-fuel property is available for costs incurred before 

January 1, 2007. A taxpayer may claim a 30 percent 

credit for the cost of installing clean-fuel vehicle refueling property for property placed in service after December 31, 2005 and before January 1, 2008. The taxpayer 

may not claim deductions with respect to property for 

which the credit is claimed. A tax credit is also available for the purchase of hybrid vehicles, fuel cell vehicles, alternative fuel vehicles and advanced lean burn 

vehicles. The provision applies to vehicles placed in 

service after December 31, 2005, in the case of qualified 

fuel cell motor vehicles, before January 1, 2015; in the 

case of qualified hybrid motor vehicles that are automobiles and light trucks and in the case of advanced 

lean-burn technology vehicles, before January 1, 2011; 

in the case of qualified hybrid motor vehicles that are 

medium and heavy trucks, before January 1, 2010; and 

in the case of qualified alternative fuel motor vehicles, 

before January 1, 2011. A tax credit is available for 

the purchase of hybrid vehicles, fuel cell vehicles, alternative fuel vehicles and advanced lean burn vehicles. 

The provision applies to vehicles placed in service after 

December 31, 2005, in the case of qualified fuel cell 

motor vehicles, before January 1, 2015; in the case of 

qualified hybrid motor vehicles that are automobiles 

and light trucks and in the case of advanced leanburn technology vehicles, before January 1, 2011; in 

the case of qualified hybrid motor vehicles that are 

medium and heavy trucks, before January 1, 2010; and 

in the case of qualified alternative fuel motor vehicles, 

before January 1, 2011. 

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. 

21. Credit to holders of clean renewable energy 

bonds.—The Energy Tax Incentives Act of 2005 introduced this provision which provides for up to $800 million in aggregate issuance of Clean Renewable Energy 

Bonds (CREBs) through December 31, 2007. Taxpayers 

holding CREBs on a credit allowance date are entitled 

to a tax credit. 

22. Deferral of gain from dispositions of transmission property to implement FERC restructuring 

policy.—Utilities that sell their transmission assets to 

a FERC-approved independent transmission company 

are allowed a longer recognition period for their gains 

from sale. Rather than paying tax on any gain from 

the sale in the year that the sale is completed, utilities 

will have 8 years to pay the tax on any gain from 

the sale. The rule expires at the end of 2007. 

23. Credit for production from advanced nuclear 

power facilities.—This provision was introduced by 

the Energy Tax Incentives Act of 2005. A taxpayer producing electricity at a qualifying advanced nuclear 

power facility may claim a credit equal to 1.8 cents 

per kilowatt-hour of electricity produced for the eightyear period starting when the facility is placed in service, limited no more than $125 million in tax credits 

per 1,000 megawatts of allocated capacity in any one 

year. 

24. Credit for investment in clean coal facilities.—This provision was introduced by the Energy Tax 

Incentives Act of 2005. Three investment tax credits 

for clean coal facilities are available: a 15 percent and 

20 percent investment tax credit for clean coal facilities 

producing electricity; and a 20 percent credit for industrial gasification projects. Integrated gasification combined cycle (IGCC) projects get a 20 percent investment 

tax credit and other advanced coal-based projects that 

produce electricity get a 15 percent credit. The Secretary of the Treasury may allocate up to $800 million 

for IGCC projects and up to $500 million for other 

advanced coal-based technologies and up to $350 million for industrial gasification. 

25. Temporary 50 percent expensing for equipment used in the refining of liquid fuels.—This provision was introduced by the Energy Tax Incentives 

Act of 2005. Taxpayers may expense 50 percent of the 

cost of refinery investments which increase the capacity 

of an existing refinery by at least 5 percent or increase 

the throughput of qualified fuels by at least 25 percent. 

Qualified fuels include oil from shale and tar sands. 

Investments must be placed in service before January 

1, 2012. 

26. Pass through low sulfur diesel expensing to 

cooperative owners.—This provision was introduced 

by the Energy Tax Incentives Act of 2005. Taxpayers 

may expense certain costs for investments to comply 

with EPA low sulfur diesel regulations. The deduction 
306 ANALYTICAL PERSPECTIVES 

may be passed-through to members of a cooperative 

if the cooperative makes an election on their tax return. 

27. Natural gas distribution pipelines treated as 

15-year property.—This provision was introduced by 

the Energy Tax Incentives Act of 2005. The depreciation period is shortened to 15 years for any gas distribution lines the original use of which occurred after 

April 11, 2004 and before January 1, 2011. The provision does not apply to any property which the taxpayer 

or a related party had entered into a binding contract 

for the construction thereof or self-constructed on or 

before April 11, 2005. 

28. Amortize all geological and geophysical expenditures over 2 years.—This provision was introduced by the Energy Tax Incentives Act of 2005. Geological and geophysical amounts incurred in connection 

with oil and gas exploration in the United States may 

be amortized over two years. In the case of abandoned 

property, any remaining basis may no longer be recovered in the year of abandonment of a property as all 

basis is recovered over the two-year amortization period. 

29. Allowance of deduction for certain energy efficient commercial building property.—This provision was introduced by the Energy Tax Incentives Act 

of 2005. A deduction for energy efficient commercial 

buildings that reduce annual energy and power consumption by 50 percent compared to the American Society of Heating, Refrigerating, and Air Conditioning Engineers (ASHRAE) standard is allowed. The provision 

is effective for property placed in service after December 31, 2005 and prior to January 1, 2008. 

30. Credit for construction of new energy efficient homes.—This provision was introduced by the 

Energy Tax Incentives Act of 2005. A credit is available 

to eligible contractors for construction of a qualified 

new energy-efficient home. The credit applies to homes 

whose construction is substantially completed after December 31, 2005 and which are purchased after December 31, 2005 and prior to January 1, 2008. 

31. Credit for energy efficiency improvements to 

existing homes.—This provision was introduced by the 

Energy Tax Incentives Act of 2005. A 10 percent investment tax credit for expenditures with respect to improvements to building envelope is available. Credits 

for purchases of advanced main air circulating fans, 

natural gas, propane, or oil furnaces or hot water boilers, and other qualified energy efficient property are 

also available. Credit applies to property placed in service after December 31, 2005 and prior to January 1, 

2008. 

32. Credit for energy efficient appliances.—This 

provision was introduced by the Energy Tax Incentives 

Act of 2005. Tax credits for the manufacture of efficient 

dishwashers, clothes washers, and refrigerators are 

available. Credits vary depending on the efficiency of 

the unit. The provision is effective for appliances manufactured in 2006 and 2007. 

33. Credit for residential purchases/installations 

of solar and fuel cells.—This provision was introduced by the Energy Tax Incentives Act of 2005. A 

credit, equal to 30 percent of qualifying expenditures, 

for purchase for qualified photovoltaic property and 

solar water heating property is available. A 30 percent 

credit for the purchase of qualified fuel cell power 

plants is also allowed and applies to property placed 

in service after December 31, 2005 and prior to January 

1, 2008. 

34. Credit for business installation of qualified 

fuel cells and stationary microturbine power 

plants.—This provision was introduced by the Energy 

Tax Incentives Act of 2005. A 30 percent business energy credit for purchase of qualified fuel cell power 

plants for businesses and a 10 percent credit for purchase of qualifying stationary microturbine power 

plants are allowed. 

35. Alternative fuel and fuel mixture tax credit.—This provision was introduced in the Safe, Accountable, Flexible, Efficient Transportation Equity Act of 

2005. A tax credit is available against the excise tax 

imposed on the retail sale or use of alternative fuels 

or mixture of alternative fuel and other taxable fuel. 

The credit is 50 cents per gallon of alternative fuel. 

Natural Resources and Environment 

36. 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. 

37. 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. 

38. 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. 

39. Capital gains treatment of certain timber.— 

Certain timber sales can be treated as a capital gain 

rather than ordinary income. 

40. 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. 

41. 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. 

42. Expensing of capital costs with respect to 

complying with EPA sulfur regulations.—Small refiners are allowed to deduct 75 percent of qualified 

capital costs incurred by the taxpayer during the taxable year. This provision was introduced by the American Jobs Creation Act (AJCA) enacted in 2004. 
19. TAX EXPENDITURES 307 

43. Exclusion of gain or loss on sale or exchange 

of certain brownfield sites.—In general, an organization that is otherwise exempt from federal income tax 

is taxed on income from any trade or business regularly 

carried on by the organization that is not substantially 

related to the organization’s exempt purpose. The AJCA 

of 2004 created a special exclusion from unrelated business taxable income of the gain or loss from the sale 

or exchange of certain qualifying brownfield properties. 

The exclusion applies regardless of whether the property is debt-financed. In order to qualify, a minimum 

amount of remediation expenditures must be incurred 

by the organization. 

Agriculture 

44. 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. 

45. 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. 

46. Loans forgiven solvent farmers.—Farmers are 

forgiven the tax liability on certain forgiven debt. Normally, debtors must include the amount of loan forgiveness as income or reduce their recoverable basis in 

the property to which the loan relates. If the debtor 

elects to reduce basis and the amount of forgiveness 

exceeds the basis in the property, the excess forgiveness 

is taxable. For insolvent (bankrupt) debtors, however, 

the amount of loan forgiveness reduces carryover losses, 

then unused credits, and then basis; any remainder 

of the forgiven debt is excluded from tax. Farmers with 

forgiven debt are considered insolvent for tax purposes, 

and thus qualify for income tax forgiveness. 

47. Capital gains treatment of certain income.— 

Certain agricultural income, such as unharvested crops, 

can be treated as capital gains rather than ordinary 

income. 

48. Income averaging for farmers.—Taxpayers can 

lower their tax liability by averaging, over the prior 

three-year period, their taxable income from farming 

and fishing. 

49. 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. 

50. Bio-Diesel tax credit.—An income tax credit of 

$0.50, similar to Ethanol benefits, is available for each 

gallon of biodiesel used or sold. Biodiesel derived from 

virgin sources (agri-biodiesel) receives an increased 

credit of $1.00 per gallon. The provision was introduced 

by the AJCA in 2004. The Energy Tax Incentives Act 

of 2005 extends the income tax credit, excise tax credit, 

and payment provisions through December 31, 2008 

and adds a credit for small agri-biodiesel producers. 

The conference agreement also creates a similar income 

tax credit, excise tax credit and payment system for 

renewable diesel, however there is no credit for small 

producers of renewable diesel. Renewable diesel means 

diesel fuel derived form biomass using thermal 

depolymerization process. 

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. 

51. Credit union income.—The earnings of credit 

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

52. 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. 

53. 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. 

54. Small property and casualty insurance companies.—For taxable years beginning before January 

1, 2004, insurance companies that were not life insurance companies and which had annual net premiums 

of less than $350,000 were exempt from tax; those with 

$350,000 to $1.2 million of annual net premiums could 

elect to pay tax only on the income earned by their 

taxable investment portfolio. For taxable years beginning after December 31, 2003, stock non-life insurance 

companies are generally exempt from tax if their gross 

receipts for the taxable year do not exceed $600,00 and 

more than 50 percent of such gross receipts consists 

of premiums. Mutual non-life insurance companies are 

generally tax-exempt if their annual gross receipts do 

not exceed $150,000 and more than 35 percent of gross 

receipts consist of premiums. Also, for taxable years 
308 ANALYTICAL PERSPECTIVES 

beginning after December 31, 2003, non-life insurance 

companies with no more than $1.2 million of annual 

net premiums may elect to pay tax only on their taxable 

investment income. 

55. 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. 

56. 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. 

57. Exclusion of interest spread of financial institutions.—Consumers and non-profit organizations 

pay for some deposit-linked services, such as check 

cashing, by accepting a below-market interest rate on 

their demand deposits. If they received a market rate 

of interest on those deposits and paid explicit fees for 

the associated services, they would pay taxes on the 

full market rate and (unlike businesses) could not deduct the fees. The government thus foregoes tax on 

the difference between the risk-free market interest 

rate and below-market interest rates on demand deposits, which under competitive conditions should equal 

the value added of deposit services. 

58. 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 was $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. 

59. 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. 

60. 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. 

61. 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. 

62. 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. 

63. 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. 

64. Imputed net rental income on owner occupied housing.—The implicit rental value of home ownership, net of expenses such as mortgage interest and 

depreciation, is excluded from income. The appendix 

provides a greater explanation of this new addition to 

the tax expenditure budget. 

65. 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. 

66. 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 
19. TAX EXPENDITURES 309 

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. 

67. 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. 

68. 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. 

69. 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. 

70. 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. Under the revised reference law baseline used for the 2005 Budget, the lower rate on capital 

gains is considered a tax expenditure under the reference law method, but only for capital gains that have 

not been previously taxed under the corporate income 

tax. As discussed above, this treatment partially adjusts 

for the double tax on corporate income and is more 

consistent with a comprehensive income tax base. 

Prior to passage of the Jobs Growth Tax Relief Reconciliation Act (JGTRRA), the top capital gains tax rate 

for most assets held for more than 1 year was 20 percent. For assets acquired after December 31, 2000, the 

top capital gains tax rate for assets held for more than 

5 years was 18 percent. Since January 1, 2001, taxpayers may mark-to-market existing assets to start the 

5-year holding period. Losses from the mark-to-market 

are not recognized. 

For assets held for more than 1 year by taxpayers 

in the 15-percent ordinary tax bracket, the top capital 

gains tax rate was 10 percent. After December 31, 2000, 

the top capital gains tax rate for assets held by these 

taxpayers for more than 5 years was 8 percent. 

JGTRRA reduced the previous 20 percent and 18 percent rates on net capital gains to 15 percent and the 

previous 10 percent and 8 percent rates to 5 percent 

(0 percent, in 2008). The lower rates apply to assets 

held for more than one year. The lower rates apply 

to assets sold after May 6, 2003 through 2008. 

71. 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. 

72. 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 for 2010 under the Economic Growth 

and Tax Relief Reconciliation Act (EGTRRA) of 2001, 

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. 

73. 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. 

74. 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. 

75. 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. 

76. 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. 
310 ANALYTICAL PERSPECTIVES 

77. Expensing of certain small investments.—As 

of 2003, under prior law, qualifying investments in tangible property up to $25,000 could have been expensed 

rather than depreciated over time. The amount eligible 

for expensing was decreased to the extend the taxpayer’s qualifying investment during the year exceeded 

$200,000. For 2003, however, the expensing limit was 

temporarily increased to $100,000, the phase-out limit 

was temporarily increased to $400,000, and computer 

software became temporarily eligible for expensing 

treatment. For 2004, through 2007, these higher limits 

are indexed for inflation, and computer software continues to be an eligible investment. In all years, the 

amount expensed cannot exceed the taxpayer’s taxable 

income for the year. The prior rules will apply for taxable years beginning after 2007. 

78. 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. 

79. 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. 

80. Deduction for U.S. production activities.— 

This provision was introduced by the AJCA in 2004 

and allows for a deduction equal to a portion of taxable 

income attributable to domestic production. For taxable 

years beginning in 2004, 2005, 2006, 2007, and 2008, 

the amount of the deduction is 5, 5, 5, 6, and 7 percent, 

respectively. For taxable years beginning after 2008, 

the amount of the deduction is 9 percent. 

81. Special rules for certain film and TV production.—Taxpayers may deduct up to $15 million ($15 

million in certain distressed areas) per production expenditures in the year incurred. Excess expenditures 

may be deducted over three years using the straight 

line method. This provision was introduced by the 

AJCA enacted in 2004. Under prior law, production 

expenses were depreciated. 

Transportation 

82. 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. 

83. 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 2005, 

the maximum amount of the parking exclusion is $200 

(indexed) per month. The tax expenditure estimate does 

not include parking at facilities owned by the employer. 

84. 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 2005, 

the maximum amount of the exclusion is $105 (indexed) 

per month. 

85. Tax credit for certain expenditures for maintaining railroad tracks.—Eligible taxpayers may 

claim a credit equal to the lesser of 50 percent of maintenance expenditures and the product of $3,500 and 

the number of miles of track owned or leased. This 

provision was introduced by the AJCA in 2004. 

86. Exclusion of interest on bonds for Financing 

of Highway Projects and Rail-Truck Transfer Facilities.—This provision provides for $15 billion of taxexempt bond authority to finance qualified highway or 

surface freight transfer facilities. It was introduced by 

the Safe, Accountable, Flexible, Efficient Transportation 

Equity Act: A Legacy For Users enacted in 2005. The 

authority to issue these bonds expires on December 

31, 2015. 

Community and Regional Development 

87. 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. 

88. 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. 
19. TAX EXPENDITURES 311 

89. 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. 

90. Empowerment zones and renewal communities.—Qualifying businesses in designated economically depressed areas can receive tax benefits such as 

an employer wage credit, increased expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain capital gains incentives. Empowerment zone and renewal community designations expire at the end of 2009. The Job Creation 

and Worker Assistance Act of 2002 expanded the existing provisions by adding the ‘‘New York City Liberty 

Zone.’’ In addition, the Working Families Tax Relief 

Act of 2004 extended the District of Columbia Enterprise Zone and the District of Columbia first time 

homebuyer credit by two years through 2005. 

The Gulf Opportunity Zone Act of 2005 added several 

provisions targeted to encourage the redevelopment of 

areas affected by hurricanes Katrina, Rita and Wilma, 

including some provisions that have already been listed 

elsewhere in this table. Gulf Opportunity Zone Act provisions not listed elsewhere include additional tax-exempt bond financing authority, accelerated depreciation 

of investment in both structures and equipment, partial 

expensing for certain demolition and clean-up costs, increased carryback of certain net operating losses, increased authority to allocate low-income housing tax 

credits and new markets tax credits within the affected 

areas and other provisions. 

91. New markets tax credit.—Taxpayers who make 

qualified equity investments in a community development entity (CDE), which then makes qualified investments in low-income communities, are eligible for a 

tax credit received over 7 years. 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 

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. Credit authority is allocated 

to CDEs through a competitive application process. 

92. Expensing of environmental remediation 

costs.—Taxpayers who clean up certain hazardous substances at a qualified site may expense the clean-up 

costs, even though the expenses will generally increase 

the value of the property significantly or appreciably 

prolong the life of the property. The Working Families 

Tax Relief Act of 2004 extended this provision for two 

years, allowing remediation expenditures incurred before December 31, 2005 to be eligible for expensing. 

The Gulf Opportunity Zone Act of 2005 extends this 

provision through December 31, 2007 for sites located 

in the Gulf Opportunity Zone and expands the allowable costs to include petroleum product remediation. 

93. Credit to holders of Gulf Tax Credit Bonds.— 

Taxpayers that own Gulf Tax Credit 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. The maximum amount that 

can be issued is $200 million in the case of Louisiana, 

$100 million in the case of Mississippi, and $50 million 

in the case of Alabama. 

Education, Training, Employment, and Social 

Services 

94. 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). 

95. 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 2005, the 

credit is phased out ratably for taxpayers with modified 

AGI between $87,000 and $107,000 ($43,000 and 

$53,000 for singles), indexed. 

96. 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, up 

to a maximum credit per return is $2,000. The credit 

is phased out ratably for taxpayers with modified AGI 

between $87,000 and $107,000 ($43,000 and $53,000 

for singles) (indexed beginning in 2002). The credit applies to both undergraduate and graduate students. 

97. Deduction for Higher Education Expenses.— 

The maximum annual deduction for qualified higher 

education expenses is $4,000 in 2005 for taxpayers with 

adjusted gross income up to $130,000 on a joint return 

($65,000 for singles). 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. 

98. 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 
312 ANALYTICAL PERSPECTIVES 

an education IRA is tax-exempt when withdrawn to 

pay for a student’s tuition and fees. The maximum contribution to an education IRA in 2005 is $2000 per 

beneficiary. The maximum contribution is phased down 

ratably for taxpayers with modified AGI between 

$190,000 and $220,000 ($95,000 and $110,000 for singles). 

99. 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. In 2005, the maximum deduction 

is phased down ratably for taxpayers with modified 

AGI between $105,000 and $135,000 ($50,000 and 

$65,000 for singles), indexed. 

100. 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. In 

2001 taxes on the earnings from these plans are paid 

by the beneficiaries and are deferred until tuition is 

actually paid. Beginning in 2002, investment income 

is not taxed when earned, and is tax-exempt when 

withdrawn to pay for qualified expenses. 

101. 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. 

102. 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. 

103. 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 2005. 

104. 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 $91,850 and $121.850 ($61,200 and 

$76,200 for singles) in 2005. 

105. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent 

children who are over the age of 18 or under the age 

of 24 and who (1) reside with the taxpayer for over 

half the year (with exceptions for temporary absences 

from home, such as for school attendance), (2) are fulltime students, and (3) do not claim a personal exemption on their own tax returns. 

106. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to 

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the asset’s 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. 

107. 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. EGTRRA permanently extended this 

exclusion and extended the exclusion to also include 

graduate education (beginning in 2002). 

108. Special deduction for teacher expenses.— 

Educators in both public and private elementary and 

secondary schools, who work at least 900 hours during 

a school year as a teacher, instructor, counselor, principal or aide, may subtract up to $250 of qualified expenses when figuring their adjusted gross income (AGI). 

109. Discharge of student loan indebtedness.— 

Certain professionals who perform in underserved 

areas, and as a consequence get their student loans 

discharged, may not recognize such discharge as income. This provision was expanded by the AJCA to 

include health professionals. 

110. Work opportunity tax credit.—Employers can 

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2005 

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. The Katrina Emergency Tax Relief Act of 2005 

expanded WOTC eligibility to Hurricane Katrina Employees, defined as persons whose principal places of 

abode on August 28, 2005 were in the core disaster 

area and who beginning on such date and through August 28, 2007, are hired for a position principally located in the core disaster area; and beginning on such 

date and through December 31, 2005, are hired for 

a position regardless of its location. The usual certification process rules are waived for Hurricane Katrina 

employees. 

111. 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, 2005. 
19. TAX EXPENDITURES 313 

112. Employer-provided child care exclusion.—Up 

to $5,000 of 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. 

113. Employer-provided child care credit.—Employers can deduct expenses for supporting child care 

or child care resource and referral services. EGTRRA 

provides a tax credit to employers for qualified expenses 

beginning 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. 

114. 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. 

115. Adoption credit and exclusion.—Taxpayers 

can receive a nonrefundable tax credit for qualified 

adoption expenses. The maximum credit is $10,630 per 

child for 2005, and is phased-out ratably for taxpayers 

with modified AGI between $159,450 and $199,450. 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. 

116. 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. 

117. Child credit.—Taxpayers with children under 

age 17 can qualify for a $1,000 partially refundable 

per child credit. The maximum credit declines to $500 

in 2011 and later years. 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). 

118. 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 

$3,000 for one dependent and $6,000 for two or more 

dependents are eligible for the credit. The credit is 

equal to 35 percent of qualified expenditures for taxpayers with incomes of $15,000. The credit is reduced 

to a minimum of 20 percent by one percentage point 

for each $2,000 of income in excess of $15,000. 

119. 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. 

120. 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. 

121. 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. 

122. 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. 

123. Provide an employee retention credit to employers affected by hurricane Katrina, Rita, and 

Wilma.—Businesses located within the Gulf Opportunity (GO) Zone on August 28, 2005 are eligible for 

a 40 percent tax credit on the first $6,000 in qualified 

wages paid to qualified employees employed within the 

GO Zone. Qualified wages are those paid by an eligible 

employer to an eligible employee on any day after August 28, 2005 and before January 1, 2006 during the 

period beginning on the date on which the trade or 

business first became inoperable at the principal place 

of employment of the employee by reason of hurricane 

Katrina and ending on the date on which such trade 

or business resumed significant operations at such principal place of employment. Similar rules apply to the 

Rita GO Zone and the Wilma GO Zone with initial 

effective dates of September 23, 2005, and October 23, 

2005, respectively. 

Health 

124. 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. 

125. 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 deduct-
314 ANALYTICAL PERSPECTIVES 

ible percentage is 60 percent in 2001, 70 percent in 

2002, and 100 percent in 2003 and thereafter. 

126. Medical and health 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 employersponsored 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. The Medicare Prescription Drug, Improvement, 

and Modernization Act of 2003 introduced health savings accounts (HSA) which provides a tax-favored savings for health care expenses. The definition of a highdeductible health plan is less restrictive for HSAs than 

for MSAs. 

127. 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. 

128. Hospital construction bonds.—Interest earned 

on State and local government debt issued to finance 

hospital construction is excluded from income subject 

to tax. 

129. 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. 

130. 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. 

131. 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. 

132. Tax credit for health insurance purchased 

by certain displaced and retired individuals.—The 

Trade Act of 2002 provided a refundable tax credit of 

65 percent for the purchase of health insurance coverage by individuals eligible for Trade Adjustment Assistance and certain PBGC pension recipients. 

Income Security 

133. 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. 

134. Workers’ compensation benefits.—Workers 

compensation provides payments to disabled workers. 

These benefits, although income to the recipients, are 

not subject to the income tax. 

135. 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. 

136. 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. 

137. Military disability pensions.—Most of the 

military pension income received by current disabled 

retired veterans is excluded from their income subject 

to tax. 

138. 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. 

139. 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 2004, an employee could exclude up to $14,000 

of wages from AGI under a qualified arrangement with 

an employer’s 401(k) plan. This increases to $15,000 

in 2006 (indexed thereafter). The tax on the investment 

income earned by 401(k)-type plans is deferred until 

withdrawn. 

Employees are allowed to make after-tax contributions to 401(k) and 401(k)-type plans. These contributions are not excluded from AGI, but the investment 

income of such after-tax contributions is not taxed when 

earned or withdrawn. 

140. Individual Retirement Accounts.—Individual 

taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs, 

non-deductible IRAs, and Roth IRAs. The annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. 

The IRA contribution limit is $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 $80,000 ($60,000 for 

non-joint filers) in 2005 can claim a deduction for IRA 

contributions. The IRA deduction is phased out for taxpayers with AGI between $70,000 and $80,000 ($50,000 

and $60,000 for non-joint). The phase-out range in-
19. TAX EXPENDITURES 315 

creases annually until it reaches $80,000 to $100,000 

in 2007. 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 $160,000 ($110,000 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 591/2, (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. 

141. Low and moderate income savers’ credit.— 

The Tax Code provides an additional incentive for 

lower-income taxpayers to save through a nonrefundable credit of up to 50 percent on IRA and other retirement contributions of up to $2,000. 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. 

142. 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 $42,000 in 2005. Total plan contributions are limited to 25 percent of a firm’s total wages. 

The tax on the investment income earned by Keogh 

plans is deferred until withdrawn. 

143. 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, but only to the extent that the employer’s 

share of the total costs does not exceed the cost of 

$50,000 of such insurance. 

144. 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. 

145. 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. 

146. 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. 

147. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,200 

standard deduction if single, or $1,000 if married in 

2005. 

148. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,200 standard deduction if single, or $1,000 

if married in 2005. 

149. 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. 

150. 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. 

151. 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 $7,830 of earned income in 2005. The credit 

is 40 percent of the first $11,000 of income for a family 

with two or more qualifying children. The credit is 

phased out beginning when the taxpayer’s income exceeds $14,370 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 $31,030 ($35,263 if 

two or more qualifying children are present), $33,030 

(or $37,263) for those married. 

The credit may also be claimed by workers who do 

not have children living with them. Qualifying workers 
316 ANALYTICAL PERSPECTIVES 

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 2005, 

the credit is 7.65 percent of the first $5,220 of earned 

income. When the taxpayer’s income exceeds $6,530 

(8,530 if married), the credit is phased out at the rate 

of 7.65 percent. It is completely phased out at $11,750 

($13,750 for married) 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, the base amount for the 

phase-out increases by $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. 

152. Additional exemption for housing Hurricane Katrina displaced individuals.—This provision, introduced by the Katrina Emergency Tax Relief 

Act of 2005, provides an additional exemption of $500 

for each Hurricane Katrina displaced individual for 

whom the taxpayer is providing shelter in his or her 

home, for a maximum additional exemption amount is 

$2,000. 

Social Security 

153. Social Security benefits for retired workers.—The non-taxation of Social Security benefits that 

exceed the beneficiary’s contributions out of taxed income 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. 

154. Social Security benefits for the disabled.— 

Benefit payments from the Social Security Trust Fund 

for disability are partially excluded from a beneficiary’s 

gross incomes. 

155. Social Security benefits for dependents and 

survivors.—Benefit payments from the Social Security 

Trust Fund for dependents and survivors are partially 

excluded from a beneficiary’s gross income. 

Veterans Benefits and Services 

156. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded 

from taxable income. 

157. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income. 

158. G.I. Bill benefits.—G.I. Bill benefits paid by 

the Veterans Administration are excluded from gross 

income. 

159. 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 

160. 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. 

161. 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. 

162. 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 

163. 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 a presentation of the Treasury Department’s continuing review of the tax expenditure budget. The review focuses 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). 
19. TAX EXPENDITURES 317 

7See, 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.. 

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 new estimates of the tax 

expenditure caused by accelerated depreciation and by 

the tax exemption of the return earned on owner-occupied housing, and an alternative estimate of the tax 

expenditure for the preferential treatment of capital 

gains. 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 the tax expenditure 

chapter, official tax expenditures are measured relative 

to normal law or reference law baselines that deviate 

from a uniform tax on a comprehensive concept of income. Consequently, tax expenditures identified in the 

Budget can differ from those that would be identified 

if a comprehensive income tax 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. Many large tax expenditures would continue to be tax expenditures were the 

baseline taken to be comprehensive income, although 

some would be smaller. 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, this treatment gives a one-sided picture of how current law deviates from the baseline tax system. Relative to comprehensive income, a number of current tax provisions 

would be negative tax expenditures. Some of these also 

might be negative tax expenditures under the reference 

law or normal law baselines, expanded to admit negative tax expenditures. 

Treatment of Major Tax Expenditures from the Current 

Budget under a Comprehensive Income Tax 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 (and losses) 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. A comprehensive income tax baseline would tax all sources of income once. Thus, it 

would not include a separate tax on corporate income 

that leads to the double taxation of corporate profits. 

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.7 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 consumer durable goods, including housing, automobiles, and major appliances. 

Furthermore, comprehensive income does not necessarily represent an ideal tax base; efficiency or equity 

would be improved by deviating from comprehensive 

income as a tax base, e.g., by reducing the tax on capital income in order to spur economic growth further 

or by subsidizing certain types of activities 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. 

Classifying individual tax provisions relative to a 

comprehensive income baseline is difficult, in part because of the ambiguity of the baseline. It also is difficult 

because of interactions between tax provisions (or their 

absence). These interactions mean that it may not always be appropriate to consider each provision in isolation. Nonetheless, Appendix Table 1 attempts such a 

classification for each of the thirty largest tax expenditures from the Budget. 

We classify fourteen of the thirty items as tax expenditures under a comprehensive tax base (those in 

panel A). 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 
318 ANALYTICAL PERSPECTIVES 

8 Expensing means immediate deduction. Proper income tax treatment requires capitalization followed by annual depreciation allowances reflecting the decay in value of the associated R&E spending. 9Suppose a taxpayer buys a one year term unemployment insurance policy at the beginning of the year. At that time he exchanges one asset, cash, for another, the insurance 

policy, so there is no change in net worth. But, at the end of the year, the policy expires 

and so is worthless, hence the taxpayer has a reduction in net worth equal to the premium. 

If the policy pays off during the year (i.e., the taxpayer has a work related injury), then 

the taxpayer would include the proceeds in income because they represent an increase 

in his net worth. 10 If there were no deduction for interest and property taxes, the tax expenditure base 

(i.e., the proper tax base minus the actual tax base) for owner-occupied housing would 

equal the homeowner’s net rental income: gross rents minus(depreciation+interest+property 

taxes+other expenses). With the deduction for interest and property taxes, the tax expenditure base rises to gross rents minus (depreciation+other expenses). 

11Fiscal Year 2003 Budget of the United States Government, Analytical Perspectives 

(Washington, D.C.: U.S. Government Printing Office, 2002) p. 127. 12 Property taxes on owner-occupied housing also might serve as a proxy for the value 

of untaxed local services provided to homeowners. As such, they would be listed in the 

tax expenditure budget (as configured, i.e., building on the estimate for the failure to 

tax net rents) twice, once because current law does not tax rental income and again as 

a proxy for government services received. Property taxes on other consumer durables such 

as automobiles also might be included twice, owing to current law’s exclusion from income 

of the associated service flow. 13 U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: U.S. Government 

Printing Office, 1977) p. 92. 14 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. 

structure of the income tax. Even these relatively clearcut items, however, can raise ambiguities particularly 

in light of the absence of integration of the corporate 

and individual tax systems. Given current law’s corporate income tax, the reduction or elimination of individual level tax on income from investment in corporate 

equities might not be a tax expenditure relative to a 

comprehensive income baseline. Rather, an individual 

income tax preference might undo the corporate tax 

penalty (i.e., the double tax). A similar line of reasoning 

could be used to argue that in the case of corporations, 

expensing 8 of R&E or accelerated depreciation are not 

a tax expenditures because they serve to offset the corporate tax penalty. 

Because net rental income (gross rents minus depreciation, interest, taxes, and other expenses) would be 

in the homeowner’s tax base under a comprehensive 

income tax baseline, this item would be a tax expenditure relative to a comprehensive income baseline. 

The exclusion of worker’s compensation benefits also 

would be a tax expenditure under comprehensive income principles. Under comprehensive income tax principles, if the worker 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 

in income the benefit when paid (since it represents 

an increase in net worth).9 If the employer pays 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. Current law allows the employer to deduct 

the premium and excludes both the premium and the 

benefits from the employee’s tax base. 

Panel B deals with items that probably are tax expenditures, but that raise issues. Current law allows 

deductions for home mortgage interest and for property 

taxes on owner-occupied housing. The tax expenditure 

budget includes both of these deductions. From one perspective, these two deductions would not be considered 

tax expenditures relative to a comprehensive tax base; 

a comprehensive base would allow both deductions. 

However, this perspective ignores current law’s failure 

to impute gross rental income. Conditional on this failure, the deductions for interest and property taxes 

might be viewed as inappropriate, because they move 

the tax system away from rather than towards a comprehensive income tax base.10 Indeed, the sum of the 

tax expenditure for these two deductions, plus the tax 

expenditure for the failure to include net rental income, 

sums to the tax expenditure for owner-occupied housing 

relative to a comprehensive income tax base. Consequently, there is a strong argument for classifying 

them as tax expenditures relative to a comprehensive 

income baseline. 

The deduction of nonbusiness State and local taxes 

other than on owner-occupied homes also is included 

in this section. These taxes include income, sales, 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.11 The 

idea is that these taxes represent (or serve as proxies 

for) consumption expenditures for which current law 

makes no imputations to income.12 The difficulty is that 

this presumes that one’s consumption of State and local 

services relates directly to the amount of State and 

local taxes paid. Such a presumption is difficult to sustain when taxes are levied inconsistently across taxpayers. 

In contrast to the view in the official Budget, however, 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 value of State and local government 

benefits received, but would allow a deduction for State 

and local taxes paid.13 Thus, in this sense the deductibility of State and local taxes is consistent with comprehensive income tax principles; it should not be a 

tax expenditure. Nonetheless, imputing the value of 

State and local services is difficult and is not done 

under current law. Consequently, a deduction for taxes 

might sensibly be viewed as a (roughly measured) tax 

expenditure relative to a comprehensive income baseline.14

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 suitably discretionary consumption value, or otherwise appropriately adjust for differing taxpaying capacity, 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. Even accepting this competing perspective, 

however, one might question why these programs come 

in the form of credits rather than deductions. 

The 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 
19. TAX EXPENDITURES 319 

15 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. 16This includes the tax expenditure for benefits paid to workers, that for benefits paid 

to survivors and dependents, and that for benefits paid to dependents. 

17The 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. 18Private 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. 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. 

baseline. Nonetheless, there are ambiguities. Under a 

comprehensive income baseline, all real inflation adjusted 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 benefits 

also is listed in panel B. Consider first Social Security 

retirement benefits. 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).15 Benefits 

paid out of prior contributions and the inside buildup, 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. 

A similar analysis applies to Social Security benefits 

paid to dependents and survivors. If these benefits represent transfers from the Government, then they should 

be included in the tax base. If the taxpaying unit consists of the worker plus dependents and survivors, then 

to the extent that Social Security benefits represent 

payments from a pension, the annual pension earnings 

should be taxed. However, benefits paid to dependents 

and survivors might be viewed as a gift or transfer 

from the decedent, in which case the dependents and 

survivors should pay tax on the full amount of the 

benefit received. (In this case the decedent or his estate 

should pay tax on the pension income as well, to the 

extent that the gift represents consumption rather than 

a reduction in net worth). 

In addition, dependent and survivors’ benefits might 

be viewed in part as providing life insurance. In that 

case, the annual premiums paid each year, or the portion of Social Security taxes attributable to the premiums, should be deducted from income, since they 

represent a decline in net worth, while benefits should 

be included in income. Alternatively, taxing premiums 

and excluding benefits also would represent appropriate 

income tax policy. 

In contrast to any of these treatments, current law 

excludes one-half of Social Security 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 current law’s treatment of Social Security 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 official Budget. 

The tax expenditures in the official Budget 16 reflect 

exemptions for lower-income beneficiaries from the tax 

on 85 percent of Social Security benefits.17 Historically, 

payroll taxes paid by the employee represented no more 

than 15 percent of the expected value of the retirement 

benefits received by a lower-earning Social Security 

beneficiary. The 85 percent inclusion rate is intended 

to tax upon distribution the remaining amount of the 

retirement benefit payment—the portion 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 the employer’s contributions and on the rate 

of return (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,18 on the assumption that Social Security is 

comparable to such pensions. Hence, the official tax 

expenditure understates the tax advantage accorded Social Security retirement benefits relative to a comprehensive income baseline. 

To the extent that the benefits paid to dependents 

and survivors should be taxed as private pensions, the 

same conclusion applies: the official tax expenditure 

understates the tax advantage. 

The deduction for U.S. production activities also 

raises some problems. To the extent it is viewed as 

a tax break for certain qualifying businesses (‘‘manufacturers’’), it would be a tax expenditure. In contrast, 

the deduction may prove to be so broad that it is available to most U.S. businesses, in which case it might 

not be seen as a tax expenditure. Rather, it would 

represent a feature of the baseline tax rate system, 

because the deduction is equivalent to a lower tax rate. 

In addition, to the extent that it is viewed as providing 

relief from the double tax on corporate profits, it might 

not be a tax expenditure. 

The next category (panel C) includes items whose 

treatment is less certain. The proper treatment of some 

of these items under a comprehensive income tax is 

ambiguous, while others perhaps serve as proxies for 

what would be a tax expenditure under a comprehensive income base.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 chari-
320 ANALYTICAL PERSPECTIVES 

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.. 

22 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. 23To the extent that premiums are deductible. 

table 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, however, 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 to the extent the recipient 

has net taxable income.21

Medical expenditures may or may not be an element 

of income (or consumption). Some argue that medical 

expenditures do not represent discretionary spending, 

and so are not really consumption. Instead, these expenditures are a reduction of net worth and should 

be excluded from the tax base. In contrast, others argue 

that there is no way to distinguish logically medical 

care from other consumption items. Those who view 

medical spending as consumption point out that there 

is choice in many 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. This element of 

choice makes it more difficult to argue, at least in many 

cases, that medical spending is more ‘‘necessary’’ than, 

or otherwise different from, other consumption spending. 

The exemption of full taxation of Social Security benefits paid to the disabled also raises some issues. Social 

Security benefits for the disabled most closely resemble 

either Government transfers or insurance. From either 

perspective, a comprehensive income tax would require 

the worker to include the benefit fully in his income 

and would allow him to deduct associated Social Security taxes. If viewed as insurance, an equivalent treatment would allow the taxpayer to include the premium 

(i.e., tax) and exclude the benefit. The deviation between either of these treatments and current law’s 

treatment (described above) would be a tax expenditure 

under a comprehensive income baseline. 

In contrast, as described above, the official tax expenditure measures the benefit of exemption for lowincome beneficiaries from the tax on 85 percent of Social Security benefits. This measurement does not correspond closely to that required under a comprehensive 

income base. If the payment of the benefit is viewed 

as a transfer and divorced from the treatment of Social 

Security taxes, then the current tax expenditure understates the tax expenditure measured relative to a comprehensive income baseline. If the payment of the benefit is viewed as a transfer but the inability to deduct 

the employee’s share of the Social Security tax is simultaneously considered, then it is less likely that the current tax expenditure overstates the tax expenditure relative to a comprehensive income baseline, and in some 

cases it may generate a negative tax expenditure. If 

the benefit is viewed as insurance and the tax as a 

premium, then the current tax expenditure overstates 

the tax expenditure relative to a comprehensive income 

baseline. Indeed, in the insurance model, the ability 

to exclude from tax only one-half of the premium might 

suggest that one-half of the payout should be taxed, 

so that the current tax rules impose a greater tax burden than that implied by a comprehensive income tax, 

i.e., a negative tax expenditure. 

The final category (panel D) includes items that 

would not be tax expenditures under a comprehensive 

income tax base. 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.22

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 certain consumer durables (e.g., automobiles), the 

difference between capital gains (and losses) 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,23 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. The foreign tax credit also might 

be a tax expenditure, since 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 intended to be similar to Government 

spending programs. 

If attention is expanded from a focus on spendinglike programs 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 ex-
19. TAX EXPENDITURES 321 

24 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. 

25See Bradford, Untangling the Income Tax, p. 41. 26 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. 

penditures, 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, or more generally the double 

tax on corporate profits, which would be eliminated 

under a comprehensive income tax. The Jobs and 

Growth Tax Relief and Reconciliation Act of 2003 

(JGTRRA) reduced the tax rate on dividends and capital gains to 15 percent, thus reducing the double tax 

compared to prior law. Nonetheless, as discussed later 

in the Appendix, current law still imposes a substantial 

double tax on corporate profits. The passive loss rules, 

restrictions on the deductibility of capital losses, and 

net operating loss (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.24 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 measure income properly, as seen by the equivalence between borrowing and reduced lending.25 As discussed above, the 

current treatment of Social Security payments to the 

disabled also might represent a negative tax expenditure, if viewed as payments on an insurance policy. 

Current tax law also fails to index for inflation interest receipts, capital gains, depreciation, and inventories. 

This failure leads to negative tax expenditures because 

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 also 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.26

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 tax 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 tax baseline, concluding that about onehalf of the top thirty official tax expenditures would 

remain tax expenditures under a consumption tax 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 

tax 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 tax 

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 only 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. The classification below suggests that medical spending and charitable contributions might be included in the definition of consumption, but also considers an alternative view. 

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 in-
322 ANALYTICAL PERSPECTIVES 

clude 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 could well be a tax expenditure, 

but takes note of alternative views. 

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 normal 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 takes a fairly broad view of 

this equivalence and considers many tax provisions that 

reduce or eliminate the tax on capital income to be 

roughly 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. The inability to save on a similar tax-favored 

basis irrespective of the ultimate purpose to which the 

saving is applied potentially distorts economic choices 

in ways that would not occur under a broad-based consumption tax. 

In addition, provisions can interact even once an appropriate treatment is determined. For example, suppose that it is determined that financial flows should 

be excluded from the tax base. Then the deduction for 

home mortgage interest would seem to be a tax expenditure. However, this conclusion is cast into doubt because current law generally taxes interest income. 

When combined with the mortgage interest deduction, 

this results in a zero tax rate on the interest flow, 

consistent with consumption tax treatment. 

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. 

Such considerations suggest that, as with an income 

tax, trying to compute the current tax’s deviations from 

‘‘the’’ base of a consumption tax is very difficult because 

deviations cannot be uniquely determined, making it 

problematic to do a consistent consistent accounting of 

the differences between the current tax base and a 

consumption tax base. Nonetheless, Appendix Table 2 

attempts a classification based on the judgments 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 that is unrelated to saving or investment 

incentives would remain tax expenditures under a consumption baseline. In addition, several official tax expenditures relating to items of income and expense are 

difficult to classify properly, while others may serve 

as proxies for properly measured tax expenditures. 

Appendix Table 2 shows thirty large official tax expenditures from the Budget classified according to 

whether they would be considered a tax expenditure 

under a consumption tax. One of the thirty items clearly would be a tax expenditure (shown in panel A) under 

a consumption tax, while an additional seven (those 

in panel B) probably would be tax expenditures. 

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 deductibility of home mortgage interest is a 

strong candidate for inclusion as a tax expenditure. 

A consumption tax would seek to tax the entire value 

of the flow of services from housing, and so would not 

allow a deduction for home mortgage interest. This 

would be the case regardless of whether the tax base 

included the annual flow of housing services, or instead 
19. TAX EXPENDITURES 323 

27One must guard against double counting here, however, to the extent that current 

law’s general taxation of capital income is calculated elsewhere in the tax expenditure 

budget as a negative tax expenditure.. 

28The failure to impute the value of government provided services casts doubt on the 

appropriateness of deducting property taxes on owner-occupied housing even under a consumption tax that allowed the homeowner to deduct the cost of the house from his taxable 

consumption and imputed to his tax base the house’s annual consumption flow. . 

used a tax-prepayment or yield exemption approach 

(discussed more completely below) to taxing housing 

services. A deduction for interest would be allowed 

under a consumption tax applied to both real and financial cash flows, but current law does not require the 

homeowner to take into income the proceeds of a home 

loan, nor does it allow him a deduction for principle 

repayments. 

Nonetheless, an ambiguity about the treatment if 

home mortgage interest arises as a result of current 

law’s taxation of interest income. Under a consumption 

tax, interest income generally would not be taxed (at 

least in present value terms). In a sense, the homeowner’s mortgage interest deduction could be viewed 

as counterbalancing the lender’s inclusion, eliminating 

interest flows from the tax base, as would be appropriate under many types of consumption taxes.27

The deductibility of property taxes on owner-occupied 

housing also is a strong candidate for inclusion as a 

tax expenditure under a consumption tax baseline, although there is a bit of ambiguity. Property taxes would 

be deducted under a consumption tax under which the 

base allowed expensing of the cost of the house and 

included the rental value of the house in the annual 

tax base. But, as discussed above in the income tax 

section, this deduction nonetheless is a strong candidate 

for inclusion as a tax expenditure because the current 

tax system does not impute the consumption value of 

housing services to the homeowner’s tax base. 

Under a consumption tax that applied the yield exemption or tax prepayment approach to housing, property taxes would not be deducted by the homeowner 

because the cash flows (positive and negative) related 

to the investment are simply ignored for tax purposes— 

they are outside the tax base. Their deduction under 

current law would represent a clear case of a tax expenditure. As discussed below, current law’s taxation 

of housing approximates a yield exemption approach; 

no deduction of the purchase price of the house, no 

tax on the house’s service flow. Consequently, the deduction for property taxes probably should be a tax 

expenditure relative to a consumption base—there is 

not even the slightest ambiguity here. 

With respect to the household sector’s deduction of 

state and local income taxes, some ambiguity arises 

because these taxes, when considered separately from 

the value of any consumption type government services 

they might fund, should be excluded from the base of 

a consumption tax because they represent a reduction 

in net worth. Under a consumed income tax collected 

from the household, they would need to be deducted 

to properly measure consumption. 

But state and local income taxes are used to fund 

government services, many of which would be included 

in the base of a consumption tax if paid for privately. 

The value of these services probably should be included 

in the base of a broad consumption tax. The value 

of such services is generally not imputed to the household under current tax law. One rough proxy for their 

value is the tax payments made to support them.28

Stated another way, the payment of state and local 

income taxes might not represent a reduction in net 

worth (or a real net cost to the household) to the extent 

that the payment is accompanied by the provision of 

services of equal value. 

The analysis of state and local sales taxes on consumption items would seem to parallel that of income 

taxes. When these taxes are considered in isolation 

from government services they might fund, they should 

be excluded from the base of a federal consumption 

tax. But to the extent sales taxes represent a user 

charges for government provided consumption goods, 

their deduction might be inappropriate because current 

federal tax law fails to impute to income the value 

of the state and local services funded by sales tax payments. 

Property taxes on assets other than housing would 

seem to be best thought of using the model discussed 

above for housing. These taxes typically are paid on 

assets, such as automobiles and boats, that yield a 

stream of services that current federal tax law fails 

to impute to income. 

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 
324 ANALYTICAL PERSPECTIVES 

would correspond to including 50 percent of Social Security benefits in the recipient’s tax base. Thus, the existing tax expenditure is correct conceptually, but is not 

measured properly relative to a comprehensive income 

tax. A similar analysis would apply to exclusion of Social Security benefits of dependents and retirees. 

There is a strong case for viewing the child credit 

and the earned income tax credit as social welfare programs (transfers). As such, they would be tax expenditures relative to a consumption baseline. Nonetheless, 

these credits could alternatively be viewed as relieving 

tax on ‘‘nondiscretionary’’ consumption, and so not properly considered a tax expenditure. 

The treatment of the items in panel C is less uncertain. 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. Medical care is widely held 

to be consumption, except perhaps the medical care 

that actually raises, rather than simply sustains the 

individual’s ability to work. Charitable giving, on the 

other hand, may be considered to be a reduction in 

net worth that should be excluded from the tax base 

because it does not yield direct satisfaction to taxpayer 

who makes the expenditure. In this case, the tax expenditure lies not with the individual making the charitable deduction, but with the exclusion from taxation 

of the amounts received by the recipient. 

There also is the issue of how to tax medical insurance premiums. 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. 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 a 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. 

Current law does not tax the annual rental value 

of owner-occupied housing. In contrast, the annual rental value of the housing would be taxed under a consumption tax. Hence, from one perspective, the exclusion of the net annual rental value of owner-occupied 

housing would be a tax expenditure relative to a consumption tax baseline. 

However, a consumption tax that included in its base 

the annual rental value of housing also would allow 

the homeowner a deduction for the price of the house 

in the year it was purchased; the investment in housing 

would be expensed. Current law fails to allow such 

a deduction, raising doubt about classifying as a tax 

expenditure the exclusion of net rental income from 

owner-occupied housing. Indeed, it is possible to interpret current law as applying the tax pre-payment or 

yield exemption method to housing, in which the purchase price of an investment, rather than the annual 

cash flow generated by the investment, is taxed. In 

the textbook case, the tax pre-payment approach is 

equivalent in expected present value terms to taxing 

directly the annual consumption value of the house. 

So it is not clear whether the failure to tax the rental 

income from housing represents a tax expenditure. 

The taxation of Social Security benefits for the disabled also is difficult to classify. As discussed in this 

appendix above, these benefits generally ought to be 

taxed because they represent purchasing power. However, the associated Social Security taxes ought to be 

fully deductible, but they are not. Hence the proper 

treatment is unclear. Moreover, if the insurance model 

is applied, the taxation of Social Security benefits might 

be a negative tax expenditure. 

The credit for low-income housing acts to lower the 

tax burden on qualified investment, and so from one 

perspective would not be a tax expenditure under a 

consumption tax baseline. However, in some cases the 

credit is too generous; it can give a negative tax on 

income from qualified investment rather than the zero 

tax called for under consumption tax principles. In addition, the credit is very narrowly targeted. Consequently, it could be considered a tax expenditure relative to a consumption tax baseline. 

The final panel (D) shows items that are not likely 

to be tax expenditures under a consumption base. Most 

of these 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. 

The deduction for U.S. production activities is not 

classified as a tax expenditure. This reflects the view 

that it represents a widespread reduction in taxes on 

capital income or an offset to the corporate income tax. 

In contrast to this classification, however, it would be 

a tax expenditure to the extent that it is viewed as 

a targeted tax incentive. 

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. 
19. TAX EXPENDITURES 325 

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. The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the deduction 

to 50 percent depreciation (up from 30 percent) of the cost new equipment purchased 

after May 5, 2003 and placed into service before January 1, 2005. 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. 

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 possibly include benefits paid by insurance policies, in-kind benefits from 

such Government programs as food-stamps, 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. 

A consumption tax implemented as a tax on gross 

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. 

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 

gives 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, including the income earned on inside-build up 

in Social Security accounts. The revenue from the corporate income tax, or more generally a measure of the 

double tax on corporate profits, 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 and NOL 

carry-forward provisions also might generate negative 

tax expenditures, because the change in net worth requires a deduction for losses (consumption = income— 

the change in net worth). 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 phase-out of personal 

exemptions and of itemized deductions also might be 

considered negative tax expenditures. Under some 

views, the current tax treatment of Social Security benefits paid to the disabled would be a negative tax expenditure. 

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 

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. 

Beginning with the 2004 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, and economic 

depreciation. Current law depreciation allowances for 

machinery and equipment include the benefits of a temporary expensing provision.30 The estimates are shown 

in tables in the body of the main text, e.g., Table 19–1. 

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 the homeowner’s tax base this gross rental flow, and would allow 

the homeowner a deduction for expenses such as interest, depreciation, property taxes, and other costs associated with earning the rental income. Thus, a com-
326 ANALYTICAL PERSPECTIVES 

31The homeowner’s tax base under a comprehensive income tax is net rents. Under 

current law, the homeowner’s tax base is -(interest + property taxes). The tax expenditure 

base is the difference between the comprehensive income base and current law’s tax base, 

which for homeowners is the sum of net rents plus interest plus property taxes. 32This estimate combines the positive tax expenditure for the failure to impute rental 

income with the negative tax expenditure for the failure to allow a deduction for depreciation 

and other costs. 33 National Income and Production Accounts, Table 2.4. 

prehensive tax base would include in its base the homeowner’s implicit net rental income (gross income minus 

deductions) earned on investment in owner-occupied 

housing. 

In contrast to a comprehensive income tax, current 

law makes no imputation for gross rental income and 

allows no deduction for depreciation or for other expenses, such as utilities and maintenance. Current law 

does, however, allow a deduction for home mortgage 

interest and for property taxes. Consequently, relative 

to a comprehensive income baseline, the total tax expenditure for owner-occupied housing is the sum of tax 

on net rental income plus the tax saving from the deduction for property taxes and for home mortgage interest.31

Prior to 2006, the official list of tax expenditures 

did not include the exclusion of net implicit rental income on owner-occupied housing. Instead, it included 

as tax expenditures deductions for home mortgage interest and for property taxes. While these deductions 

are legitimately considered tax expenditures, given current law’s failure to impute rental income, they are 

highly flawed as estimates of the total tax advantage 

to housing; they overlook the additional 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. The treatment of owner-occupied housing has 

been revised beginning in the 2006 budget, which now 

includes an item for the exclusion of net rental income 

of homeowners.32

Appendix Table 3, as well as the tables in the body 

of the main text, e.g., Tables 19–1 and 19–2, show 

estimates 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

Accrued Capital Gains 

Under a comprehensive income baseline, all real 

gains would be taxed as accrued. These gains would 

be taxed as ordinary income rather than at preferential 

rates. There would be no deferred unrealized gains on 

assets held at death, nor gains carried over on gifts, 

or other preferential treatments. Indeed, all of the provisions related to capitals gains listed in the tax expenditure budget would be dropped. Instead, in their 

place the difference between the ordinary tax on real 

gains accrued and the actual tax paid would be calculated. For 1999, for instance, the tax on real accrued 

gains on corporate equity is estimated at $594 billion. 

This compares to an estimated tax on realized gains 

of $62 billion, for forgone revenues of $562 billion. However, this forgone revenue may easily turn into a revenue gain given the limits on capital losses. For 2000, 

for instance, real accrued losses in corporate equity 

amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion in capital gains taxes. This roughly 

translates into an overpayment of taxes to the tune 

of $464 billion. 

Double Tax on Corporate Profits 

A comprehensive income tax would tax all sources 

of income once. Taxes would not vary by type or source 

of income. 

In contrast to this benchmark, current law taxes 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 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 being distributed 

to noncorporate shareholders. Corporate level taxes cascade because corporations 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. 

Appendix Table 3 provides an estimate of the negative tax expenditure caused by the multiple levels of 

tax on corporate profits. This negative tax expenditure 

is measured as the shareholder level tax on dividends 

paid and capital gains realized out of earnings that 

have been fully 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 estimate includes the reduction in the dividends and capital gains tax rates 

enacted in JGTRRA. 

The negative tax expenditure is large in magnitude; 

it exceeds $34 billion in the years 2007 through in 

2011. It is comparable in size (but opposite in sign) 

to all but the largest official tax expenditures. JGTRRA 

reduced but did not eliminate the double tax on corporate profits. 
19. TAX EXPENDITURES 327 

Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE INCOME TAX 1

Description Revenue Effect 

2007 

A. Tax Expenditure Under a Comprehensive Income Tax 

Net exclusion of pension contributions and earnings: Employer plans ......................................................................... 52,470 

Accelerated depreciation of machinery and equipment (normal tax method) ............................................................... 52,230 

Net exclusion of pension contributions and earnings: 401(k) plans .............................................................................. 39,800 

Capital gains exclusion on home sales .......................................................................................................................... 43,900 

Exclusion of net imputed rental income on owner-occupied housing ........................................................................... 33,210 

Capital gains (except agriculture, timber, iron ore, and coal) ........................................................................................ 26,760 

Exclusion of interest on public purpose State and local bonds .................................................................................... 29,640 

Exclusion of interest on life insurance savings .............................................................................................................. 20,770 

Net exclusion of pension contributions and earnings: Keogh plans .............................................................................. 10,670 

Expensing of research and experimentation expenditures (normal tax method) .......................................................... 6,990 

Deferral of income from controlled foreign corporations (normal tax method) .............................................................. 11,940 

Net exclusion of pension contributions and earnings: Individual Retirement Accounts ................................................ 5,970 

Exclusion of workers’ compensation benefits ................................................................................................................. 6,180 

Credit for low-income housing investments .................................................................................................................... 4,250 

B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications 

Deductibility of mortgage interest on owner-occupied homes ....................................................................................... 79,860 

Child credit ....................................................................................................................................................................... 42,120 

Step-up basis of capital gains at death .......................................................................................................................... 32,460 

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .......................................... 27,210 

Exclusion of Social Security benefits for retired workers ............................................................................................... 19,590 

Deductibility of State and local property tax on owner-occupied homes ...................................................................... 12,810 

Deduction for U.S. production activities .......................................................................................................................... 10,670 

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

Exclusion of Social security benefits of dependents and survivors ............................................................................... 4,040 

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ............................................ 146,780 

Deductibility of charitable contributions, other than education and health .................................................................... 34,500 

Deductibility of medical expenses ................................................................................................................................... 5,310 

Deductibility of self-employed medical insurance premiums .......................................................................................... 4,630 

Social security benefits for the disabled ......................................................................................................................... 4,110 

Deductibility of charitable contributions, education ......................................................................................................... 4,030 

D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax 

Exception from passive loss rules for $25,000 of rental loss ........................................................................................ 6,230 

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 19–2, Tax Expenditure Budget. 
328 ANALYTICAL PERSPECTIVES 

Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE CONSUMPTION TAX 1

Description Revenue Effect 

2007 

A. Tax Expenditure Under a Consumption Base 

Exclusion of workers’ compensation benefits ................................................................................................................. 6,180 

B. Probably a Tax Expenditure Under a Consumption Base 

Deductibility of mortgage interest on owner-occupied homes ....................................................................................... 79,860 

Child credit ....................................................................................................................................................................... 42,120 

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .......................................... 27,210 

Exclusion of Social Security benefits for retired workers ............................................................................................... 19,590 

Deductibility of State and local property tax on owner-occupied homes ...................................................................... 12,810 

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

Exclusion of Social Security benefits of dependents and survivors .............................................................................. 4,040 

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ............................................ 146,780 

Deductibility of charitable contributions, other than education and health .................................................................... 34,500 

Exclusion of net imputed rental income on owner-occupied housing ........................................................................... 33,210 

Deductibility of medical expenses ................................................................................................................................... 5,310 

Deductibility of self-employed medical insurance premiums .......................................................................................... 4,630 

Credit for low-income housing investments .................................................................................................................... 4,250 

Social Security benefits for disabled ............................................................................................................................... 4,110 

Deductibility of charitable contributions, education ......................................................................................................... 3,440 

D. Not a Tax Expenditure Under a Consumption Base 

Net exclusion of pension contributions and earnings: Employer plans ......................................................................... 52,470 

Accelerated depreciation of machinery and equipment (normal tax method) ............................................................... 52,230 

Capital gains exclusion on home sales .......................................................................................................................... 43,900 

Net exclusion of pension contributions and earnings: 401(k) plans .............................................................................. 39,800 

Step-up basis of capital gains at death .......................................................................................................................... 32,460 

Exclusion of interest on public purpose State and local bonds .................................................................................... 29,640 

Capital gains (except agriculture, timber, iron ore, and coal) ........................................................................................ 26,760 

Exclusion of interest on life insurance savings .............................................................................................................. 20,770 

Deferral of income from controlled foreign corporations (normal tax method) .............................................................. 11,940 

Net exclusion of pension contributions and earnings: Keogh plans .............................................................................. 10,670 

Deduction for U.S. production activities .......................................................................................................................... 10,670 

Expensing of research and experimentation expenditures (normal tax method) .......................................................... 6,990 

Exception from passive loss rules for $25,000 of rental loss ........................................................................................ 6,230 

Net exclusion of pension contributions and earnings: Individual Retirement Accounts ................................................ 5,970 

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 19–2, Tax Expenditure Budget. 

Appendix Table 3. REVISED TAX EXPENDITURE ESTIMATES 1

Provision

Revenue Loss 

2005 2006 2007 2008 2009 2010 2011 

Imputed Rent On Owner-Occupied Housing ..................................... 28,600 29,720 33,210 36,860 40,630 44,785 49,364 

Double Tax on corporate profit 2 ....................................................... –33,940 –33,320 –34,660 –35,900 –37,040 –38,216 –39,430 

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.