105

5. TAX EXPENDITURES

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

special exclusions, exemptions, deductions, credits, deferrals, or tax rates. They are alternatives to other policy instruments, such as spending or regulatory programs, as means of achieving Federal policy goals. Tax

expenditures are created for a variety of reasons, including to encourage certain activities, to improve fairness, to ease compliance with and administration of

the tax system, and to reduce certain tax-induced distortions. The Congressional Budget Act of 1974 (Public

Law 93–344) requires that a list of tax expenditures

be included in the budget.

The largest tax expenditures tend to be associated

with the individual income tax. For example, tax preferences are provided for pension contributions and

earnings, employer contributions for medical insurance,

mortgage interest payments on owner-occupied homes,

capital gains, and payments of State and local individual income and property taxes. Tax expenditures under

the corporate income tax tend to be related to the rate

of cost recovery for various investments; as is discussed

below, the extent to which these provisions are classified as tax expenditures varies according to the conceptual baseline used. Charitable contributions and credits

for State taxes on bequests are the largest tax expenditures under the unified transfer (i.e., estate and gift)

tax.

Because of potential interactions among provisions,

this chapter does not present a grand total revenue

loss estimate for tax expenditures. Moreover, past tax

changes entailing broad elimination of tax expenditures

were generally accompanied by changes in tax rates

or other basic provisions, so that the net effects on

Federal revenues were considerably (if not totally) offset. Nevertheless, in aggregate, tax expenditures have

revenue impacts of hundreds of billions of dollars, and

are some of the most important ways in which the

Federal Government affects economic decisions and social welfare.

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

They are estimated for fiscal years 1998–2004 using

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

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

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

in a section at the end of the chapter.

The section in this chapter on Performance Measures

and the Economic Effects of Tax Expenditures presents

information related to assessment of the effect of tax

expenditures on the achievement of program performance goals. This section was prepared under the Government Performance and Results Act of 1993 and is

included by reference in the government-wide performance plan required by this Act (see also Sections III,

IV, and VI of the Budget volume). Tax expenditures

are also discussed in Section VI of the Budget, which

considers the Federal Government’s spending, regulatory, and tax policies across functional areas.

TAX EXPENDITURES IN THE INCOME TAX

Tax Expenditure Estimates

The Treasury Department prepared all tax expenditure estimates presented here based upon tax law enacted as of December 31, 1998. The analysis includes

new tax expenditures that were enacted in the Tax

and Trade Relief Extension Act of 1998. Expired or

repealed provisions are not listed if their revenue effects result only from taxpayer activity occurring before

fiscal year 1998. Due to the time required to estimate

the large number of tax expenditures, the estimates

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

provisions, which involve outlay components and hence

are updated to reflect the economic assumptions used

elsewhere in the budget.

The total revenue loss estimates for tax expenditures

for fiscal years 1998–2004 are displayed by the budget’s

functional categories in table 5–1. Descriptions of the

specific tax expenditure provisions follow the tables of

estimates and discussion of general features of the tax

expenditure concept.

As in prior years, two baseline concepts—the normal

tax baseline and the reference tax law baseline—are

used to identify tax expenditures. For the most part,

the two concepts coincide. However, items treated as

tax expenditures under the normal tax baseline, but

not the reference tax law baseline, are indicated by

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

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

discussed in detail following the estimates.

Table 5–2 reports the respective portions of the total

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

under the individual and corporate headings does not

imply that these categories of filers benefit from the

special tax provisions in proportion to the respective

tax expenditure amounts shown. Rather, these break-
106 ANALYTICAL PERSPECTIVES

downs show the specific tax accounts through which

the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures could be stockholders, employees, customers, or others, depending on

economic forces.

Table 5–3 ranks the major tax expenditures by fiscal

year 2000 revenue loss. This table merges several individual entries provided in table 5–1; for example, table

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

table 5–1.

Interpreting Tax Expenditure Estimates

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

change in the budget balance) that would result from

repealing the special provisions, for the following reasons:

• Eliminating a tax expenditure may have incentive

effects that alter economic behavior. These incentives can affect the resulting magnitudes of the

formerly subsidized activity or of other tax preferences or Government programs. For example,

if deductibility of mortgage interest were limited,

some taxpayers would hold smaller mortgages,

with a concomitantly smaller effect on the budget

than if no such limits were in force.

• Tax expenditures are interdependent even without

incentive effects. Repeal of a tax expenditure provision can increase or decrease the revenue losses

associated with other provisions. For example,

even if behavior does not change, repeal of an

itemized deduction could increase the revenue

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

Alternatively, repeal of an itemized deduction

could lower the revenue loss from other deductions

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

in tax liability could be greater or less than the

sum of the two separate tax expenditures, since

each is estimated assuming that the other remains

in force. In addition, the estimates reported in

Table 5–1 are the totals of individual and corporate income tax revenue losses reported in Table

5–2 and do not reflect any possible interactions

between the individual and corporate income tax

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

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

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

• Revenues raised by changes to tax expenditures

are sensitive to timing effects and effective dates.

Changes in some provisions would yield their full

potential revenue gains relatively quickly, whereas

changes to other provisions would only gradually

yield their full revenue potential, as certain deductions or exemptions would likely be grandfathered.

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

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

difference between taxes deferred in the current

year and incoming revenues that are received due

to deferrals of taxes from prior years. While such

estimates are useful as a measure of cash flows

into the Government, they do not accurately reflect the true economic cost of these provisions.

For example, for a provision where activity levels

have changed, so that incoming tax receipts from

past deferrals are greater than deferred receipts

from new activity, the cash-basis tax expenditure

estimate can be negative, despite the fact that

in present-value terms current deferrals do have

a real cost to the Government. Alternatively, in

the case of a newly enacted deferral provision,

a cash-based estimate can overstate the real cost

to the Government because the newly deferred

taxes will ultimately be received. Present-value estimates, which are a useful supplement to the

cash-basis estimates for provisions involving deferrals, are discussed below.

• Repeal of some provisions could affect overall levels of income and rates of economic growth. In

principle, repeal of major tax provisions may have

some impact on the budget economic assumptions.

In general, however, most changes in particular

provisions are unlikely to have significant macroeconomic effects.

Present-Value Estimates

Discounted present-value estimates of revenue losses

are presented in Table 5–4 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

losses, net of future tax payments, that follow from

activities undertaken during calendar year 1999 which

cause the deferrals or other long-term revenue effects.

For instance, a pension contribution in 1999 would

cause a deferral of tax payments on wages in 1999

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

the 1999 pension contribution and accrued earnings will

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

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

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

direct loans and guarantees in a given year affect future cash flows.
5. TAX EXPENDITURES 107

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1998 1999 2000 2001 2002 2003 2004 2000–2004

National Defense:

1 Exclusion of benefits and allowances to armed forces personnel .......................................................... 2,095 2,120 2,140 2,160 2,180 2,200 2,220 10,900

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ............................................................................. 1,990 2,235 2,500 2,800 3,125 3,460 3,830 15,715

3 Exclusion of income of foreign sales corporations .................................................................................. 2,150 2,250 2,400 2,550 2,700 2,900 3,100 13,650

4 Inventory property sales source rules exception ..................................................................................... 1,000 1,050 1,100 1,150 1,250 1,350 1,450 6,300

5 Deferral of income from controlled foreign corporations (normal tax method) ....................................... 5,500 5,800 6,200 6,600 7,000 7,450 7,900 35,150

6 Deferred taxes for financial firms on certain income earned overseas .................................................. 400 1,075 65 0 0 0 0 65

General science, space, and technology:

7 Expensing of research and experimentation expenditures (normal tax method) ................................... 260 330 510 610 675 735 765 3,295

8 Credit for increasing research activities ................................................................................................... 2,125 1,655 980 425 180 60 0 1,645

Energy:

9 Expensing of exploration and development costs, fuels ......................................................................... –110 –70 –10 –15 0 30 40 45

10 Excess of percentage over cost depletion, fuels ..................................................................................... 250 260 265 270 275 280 290 1,380

11 Alternative fuel production credit .............................................................................................................. 860 810 760 720 675 435 125 2,715

12 Exception from passive loss limitation for working interests in oil and gas properties ......................... 30 35 35 35 40 40 40 190

13 Capital gains treatment of royalties on coal ............................................................................................ 60 65 65 70 70 75 80 360

14 Exclusion of interest on energy facility bonds ......................................................................................... 110 110 110 115 115 115 115 570

15 Enhanced oil recovery credit .................................................................................................................... 140 160 180 210 240 275 320 1,225

16 New technology credit ............................................................................................................................... 25 30 35 40 40 35 35 185

17 Alcohol fuel credits 1 ................................................................................................................................. 15 15 15 15 15 15 15 75

18 Tax credit and deduction for clean-fuel burning vehicles ....................................................................... 75 80 90 95 90 75 60 410

19 Exclusion from income of conservation subsidies provided by public utilities ....................................... 80 80 80 75 75 75 80 385

Natural resources and environment:

20 Expensing of exploration and development costs, nonfuel minerals ...................................................... 25 25 25 25 25 30 30 135

21 Excess of percentage over cost depletion, nonfuel minerals ................................................................. 225 240 245 255 270 280 295 1,345

22 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .............................. 440 440 445 455 455 460 465 2,280

23 Capital gains treatment of certain timber income .................................................................................... 60 65 65 70 70 75 80 360

24 Expensing of multiperiod timber growing costs ....................................................................................... 485 500 510 530 550 570 590 2,750

25 Investment credit and seven-year amortization for reforestation expenditures ...................................... 10 10 10 10 15 15 15 65

26 Tax incentives for preservation of historic structures .............................................................................. 215 235 255 275 285 305 315 1,435

Agriculture:

27 Expensing of certain capital outlays ......................................................................................................... 65 70 70 75 75 80 85 385

28 Expensing of certain multiperiod production costs .................................................................................. 80 85 85 90 95 100 105 475

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

30 Capital gains treatment of certain income ............................................................................................... 605 630 655 685 715 750 785 3,590

31 Income averaging for farmers ................................................................................................................... 10 75 75 80 80 80 85 400

32 Deferral of gain on sale of farm refiners ................................................................................................. 10 10 10 10 10 15 15 60

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ....................................................................................................... 785 840 905 970 1,040 1,120 1,200 5,235

34 Excess bad debt reserves of financial institutions .............................................................................. 70 30 10 5 5 5 0 25

35 Exclusion of interest on life insurance savings ................................................................................... 13,465 14,200 14,990 15,810 16,680 17,595 18,840 83,915

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations ...................... 210 225 240 260 275 310 325 1,410

38 Small life insurance company deduction ............................................................................................. 100 100 100 105 105 110 100 520

Housing:

39 Exclusion of interest on owner-occupied mortgage subsidy bonds .................................................... 860 875 880 885 900 905 915 4,485

40 Exclusion of interest on rental housing bonds .................................................................................... 150 150 150 150 155 155 155 765

41 Deductibility of mortgage interest on owner-occupied homes ............................................................ 51,700 52,990 55,100 57,590 60,415 63,425 66,615 303,145

42 Deductibility of State and local property tax on owner-occupied homes ........................................... 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

43 Deferral of income from post-1987 installment sales .......................................................................... 975 995 1,015 1,035 1,055 1,075 1,095 5,275

44 Capital gains exclusion on home sales ............................................................................................... 17,475 18,000 18,540 19,095 19,670 20,260 20,870 98,435

45 Exception from passive loss rules for $25,000 of rental loss ............................................................ 4,735 4,455 4,215 4,000 3,785 3,575 3,375 18,950

46 Credit for low-income housing investments ......................................................................................... 3,120 3,225 3,335 3,485 3,540 3,620 3,615 17,595

47 Accelerated depreciation on rental housing (normal tax method) ...................................................... 2,405 2,740 3,095 4,170 4,590 4,495 4,570 20,920

Commerce:

48 Cancellation of indebtedness ............................................................................................................... 50 30 20 15 20 20 25 100

49 Exceptions from imputed interest rules ............................................................................................... 155 160 160 160 165 165 165 815

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................... 38,275 39,415 40,585 41,795 43,035 44,310 45,625 215,350

51 Capital gains exclusion of small corporation stock ............................................................................. 0 5 5 5 5 5 5 25

52 Step-up basis of capital gains at death ............................................................................................... 24,570 25,800 27,090 28,240 29,370 30,545 31,765 147,010

53 Carryover basis of capital gains on gifts ............................................................................................. 170 175 185 195 205 210 220 1,015

54 Ordinary income treatment of loss from small business corporation stock sale ............................... 35 35 35 40 40 40 40 195

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ..................... 6,270 4,895 3,430 2,385 2,365 1,875 585 10,640
108 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1998 1999 2000 2001 2002 2003 2004 2000–2004

56 Accelerated depreciation of machinery and equipment (normal tax method) .................................... 28,885 32,505 35,465 36,830 36,985 36,510 35,855 181,645

57 Expensing of certain small investments (normal tax method) ............................................................ 1,185 1,235 1,275 1,175 1,730 1,605 995 6,780

58 Amortization of start-up costs (normal tax method) ............................................................................ 205 215 220 225 225 230 240 1,140

59 Graduated corporation income tax rate (normal tax method) ............................................................. 5,400 5,360 5,360 5,620 6,120 6,680 7,120 30,900

60 Exclusion of interest on small issue bonds ......................................................................................... 295 300 305 305 305 310 310 1,535

Transportation:

61 Deferral of tax on shipping companies .................................................................................................... 15 15 15 15 15 15 15 75

62 Exclusion of reimbursed employee parking expenses ............................................................................ 1,560 1,595 1,630 1,690 1,750 1,815 1,885 8,770

63 Exclusion for employer-provided transit passes ...................................................................................... 70 80 95 105 130 155 170 655

Community and regional development:

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

65 Exclusion of interest for airport, dock, and similar bonds ....................................................................... 695 705 710 715 725 730 740 3,620

66 Exemption of certain mutuals’ and cooperatives’ income ....................................................................... 45 50 50 50 50 50 55 255

67 Empowerment zones and enterprise communities .................................................................................. 290 380 430 435 415 305 290 1,875

68 Expensing of environmental remediation costs ....................................................................................... 90 110 145 60 –10 –25 –35 135

Education, training, employment, and social services:

Education:

69 Exclusion of scholarship and fellowship income (normal tax method) ............................................... 910 955 995 1,040 1,085 1,135 1,185 5,440

70 HOPE tax credit .................................................................................................................................... 200 4,015 4,855 5,325 5,730 5,765 5,950 27,625

71 Lifetime Learning tax credit .................................................................................................................. 110 2,510 2,655 2,970 3,015 3,355 4,565 16,560

72 Education Individual Retirement Accounts ........................................................................................... 20 100 230 380 540 710 885 2,745

73 Deductibility of student-loan interest .................................................................................................... 70 245 265 315 360 385 425 1,750

74 Deferral for State prepaid tuition plans ................................................................................................ 85 125 180 235 285 330 365 1,395

75 Exclusion of interest on student-loan bonds ....................................................................................... 235 235 240 245 245 250 250 1,230

76 Exclusion of interest on bonds for private nonprofit educational facilities ......................................... 560 570 570 575 580 590 595 2,910

77 Credit for holders of zone academy bonds ......................................................................................... 0 10 20 30 35 35 35 155

78 Exclusion of interest on savings bonds redeemed to finance educational expenses ....................... 10 10 15 15 15 15 20 80

79 Parental personal exemption for students age 19 or over ................................................................. 875 915 965 1,015 1,055 1,105 1,155 5,295

80 Child credit 2 .......................................................................................................................................... 3,525 18,740 18,725 18,430 18,160 17,745 17,155 90,215

81 Deductibility of charitable contributions (education) ............................................................................ 2,880 2,940 3,065 3,195 3,350 3,505 3,680 16,795

82 Exclusion of employer-provided educational assistance ..................................................................... 215 215 210 15 0 0 0 225

Training, employment, and social services:

83 Work opportunity tax credit .................................................................................................................. 170 335 330 160 40 5 0 535

84 Welfare-to-work tax credit ..................................................................................................................... 15 35 35 20 10 5 0 70

85 Exclusion of employer-provided child care .......................................................................................... 1,325 1,385 1,445 1,510 1,575 1,645 1,715 7,890

86 Adoption assistance .............................................................................................................................. 125 295 345 390 385 235 170 1,525

87 Exclusion of employee meals and lodging (other than military) ......................................................... 620 650 680 710 740 775 810 3,715

88 Credit for child and dependent care expenses ................................................................................... 2,485 2,455 2,425 2,395 2,365 2,340 2,310 11,835

89 Credit for disabled access expenditures .............................................................................................. 45 50 50 50 55 60 60 275

90 Expensing of costs of removing certain architectural barriers to the handicapped ........................... 0 5 5 5 5 5 5 25

91 Deductibility of charitable contributions, other than education and health ......................................... 18,580 19,150 20,055 21,005 22,050 23,150 24,335 110,595

92 Exclusion of certain foster care payments .......................................................................................... 35 35 40 40 45 45 50 220

93 Exclusion of parsonage allowances ..................................................................................................... 315 340 360 385 410 440 470 2,065

Health:

94 Exclusion of employer contributions for medical insurance premiums and medical care ..................... 67,920 72,535 77,670 83,095 88,830 94,960 101,520 446,075

95 Self-employed medical insurance premiums ............................................................................................ 765 980 1,310 1,405 1,550 2,055 2,905 9,225

96 Workers’ compensation insurance premiums ........................................................................................... 4,260 4,420 4,585 4,755 4,935 5,120 5,315 24,710

97 Medical Savings Accounts ........................................................................................................................ 15 20 25 25 20 20 15 105

98 Deductibility of medical expenses ............................................................................................................ 3,615 3,775 3,985 4,215 4,475 4,750 5,035 22,460

99 Exclusion of interest on hospital construction bonds .............................................................................. 1,160 1,170 1,185 1,190 1,205 1,220 1,230 6,030

100 Deductibility of charitable contributions (health) ...................................................................................... 2,560 2,630 2,730 2,860 3,000 3,145 3,300 15,035

101 Tax credit for orphan drug research ........................................................................................................ 40 50 55 60 70 80 90 355

02 Special Blue Cross/Blue Shield deduction ............................................................................................... 210 230 250 280 325 290 250 1,395

Income security:

103 Exclusion of railroad retirement system benefits ..................................................................................... 420 420 425 425 430 435 440 2,155

104 Exclusion of workers’ compensation benefits .......................................................................................... 5,140 5,330 5,475 5,940 6,205 6,480 6,755 30,855

105 Exclusion of public assistance benefits (normal tax method) ................................................................. 440 345 360 375 390 405 420 1,950

106 Exclusion of special benefits for disabled coal miners ........................................................................... 85 80 75 70 70 65 60 340

107 Exclusion of military disability pensions ................................................................................................... 120 125 130 135 140 140 145 690

Net exclusion of pension contributions and earnings:

108 Employer plans ..................................................................................................................................... 82,215 82,195 84,350 86,670 89,155 91,810 94,455 446,440

109 Individual Retirement Accounts ............................................................................................................ 10,565 10,770 11,170 11,440 11,550 11,485 11,270 56,915

110 Keogh plans .......................................................................................................................................... 3,930 4,025 4,255 4,495 4,750 5,010 5,285 23,795

Exclusion of other employee benefits:

111 Premiums on group term life insurance .............................................................................................. 2,030 2,075 2,120 2,170 2,220 2,270 2,335 11,115
5. TAX EXPENDITURES 109

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1998 1999 2000 2001 2002 2003 2004 2000–2004

112 Premiums on accident and disability insurance .................................................................................. 175 185 195 205 215 225 235 1,075

113 Income of trusts to finance supplementary unemployment benefits ....................................................... 5 5 5 5 5 5 5 25

114 Special ESOP rules .................................................................................................................................. 920 950 980 1,020 1,060 1,100 1,140 5,300

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

116 Additional deduction for the elderly .......................................................................................................... 1,690 1,720 1,740 1,795 1,880 1,945 2,020 9,380

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

118 Deductibility of casualty losses ................................................................................................................. 225 235 245 255 270 280 290 1,340

119 Earned income tax credit 3 ....................................................................................................................... 6,351 5,118 4,971 5,142 5,275 5,471 5,672 26,531

Social Security:

Exclusion of social security benefits:

120 Social Security benefits for retired workers ......................................................................................... 16,780 17,210 18,125 19,045 20,100 21,260 22,460 100,990

121 Social Security benefits for disabled .................................................................................................... 2,265 2,420 2,615 2,820 3,060 3,325 3,625 15,445

122 Social Security benefits for dependents and survivors ....................................................................... 3,725 3,785 3,910 4,065 4,235 4,405 4,575 21,190

Veterans benefits and services:

123 Exclusion of veterans death benefits and disability compensation ......................................................... 2,820 2,940 3,070 3,210 3,350 3,495 3,650 16,775

124 Exclusion of veterans pensions ................................................................................................................ 65 65 70 75 80 85 85 395

125 Exclusion of GI bill benefits ...................................................................................................................... 65 75 85 90 90 95 100 460

126 Exclusion of interest on veterans housing bonds .................................................................................... 40 40 40 40 40 40 40 200

General purpose fiscal assistance:

127 Exclusion of interest on public purpose bonds ........................................................................................ 20,050 20,250 20,450 20,660 20,865 21,075 21,285 104,335

128 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .................. 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

129 Tax credit for corporations receiving income from doing business in U.S. possessions ...................... 3,960 4,000 4,120 4,245 4,285 4,150 4,215 21,015

Interest:

130 Deferral of interest on U.S. savings bonds .............................................................................................. 965 1,015 1,065 1,115 1,175 1,235 1,295 5,885

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes .......................................................................................... 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

Nonbusiness State and local taxes other than on owner-occupied homes ....................................... 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

Exclusion of interest on:

Public purpose State and local debt .................................................................................................... 20,050 20,250 20,450 20,660 20,865 21,075 21,285 104,335

IDBs for certain energy facilities .......................................................................................................... 110 110 110 115 115 115 115 570

IDBs for pollution control and sewage and waste disposal facilities ................................................. 440 440 445 455 455 460 465 2,280

Small-issue IDBs ................................................................................................................................... 295 300 305 305 305 310 310 1,535

Owner-occupied mortgage revenue bonds .......................................................................................... 860 875 880 885 900 905 915 4,485

State and local debt for rental housing ............................................................................................... 150 150 150 150 155 155 155 765

IDBs for airports, docks, and sports and convention facilities ........................................................... 695 705 710 715 725 730 740 3,620

State and local student loan bonds ..................................................................................................... 235 235 240 245 245 250 250 1,230

State and local debt for private nonprofit educational facilities .......................................................... 560 570 570 575 580 590 595 2,910

State and local debt for private nonprofit health facilities .................................................................. 1,160 1,170 1,185 1,190 1,205 1,220 1,230 6,030

State and local debt for veterans housing .......................................................................................... 40 40 40 40 40 40 40 200

1 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1998 $680; 1999 $725; 2000 $755; 2001 $765; 2002

$790; 2003 $805; and 2004 $830.

2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $0; 1999 $415; 2000 $528; 2001 $496; 2002 $483; 2003

$453; and 2004 $425.

3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $23,239; 1999 $26,273; 2000 $26,882; 2001

$27,667; 2002 $28,632; 2003 $29,566; and 2004 $30,578.

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

All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the table.
110 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1998 1999 2000 2001 2002 2003 2004 2000–

2004 1998 1999 2000 2001 2002 2003 2004 2000–2004

National Defense

1 Exclusion of benefits and allowances to

armed forces personnel ............................. ............ ............ ............ ............ ............ ............ ............ .............. 2,095 2,120 2,140 2,160 2,180 2,200 2,220 10,900

International affairs:

2 Exclusion of income earned abroad by U.S.

citizens ........................................................ ............ ............ ............ ............ ............ ............ ............ .............. 1,990 2,235 2,500 2,800 3,125 3,460 3,830 15,715

3 Exclusion of income of foreign sales corporations ..................................................... 2,150 2,250 2,400 2,550 2,700 2,900 3,100 13,650 ............ ............ ............ ............ ............ ............ .............. ..............

4 Inventory property sales source rules exception .............................................................. 1,000 1,050 1,100 1,150 1,250 1,350 1,450 6,300 ............ ............ ............ ............ ............ ............ .............. ..............

5 Deferral of income from controlled foreign

corporations (normal tax method) ............. 5,500 5,800 6,200 6,600 7,000 7,450 7,900 35,150 ............ ............ ............ ............ ............ ............ .............. ..............

6 Deferred taxes for financial firms on certain

income earned overseas ........................... 400 1,075 65 0 0 0 0 65 ............ ............ ............ ............ ............ ............ .............. ..............

General science, space, and technology:

7 Expensing of research and experimentation

expenditures (normal tax method) ............ 255 325 500 600 665 720 750 3,235 5 5 10 10 10 15 15 60

8 Credit for increasing research activities ........ 2,095 1,625 965 425 180 60 0 1,630 30 30 15 0 0 0 0 15

Energy:

9 Expensing of exploration and development

costs, fuels ................................................. –90 –55 –10 –15 0 25 30 30 –20 –15 0 0 0 5 10 15

10 Excess of percentage over cost depletion,

fuels ............................................................ 200 205 210 215 220 225 235 1,105 50 55 55 55 55 55 55 275

11 Alternative fuel production credit ................... 815 765 720 680 640 420 120 2,580 45 45 40 40 35 15 5 135

12 Exception from passive loss limitation for

working interests in oil and gas properties ............ ............ ............ ............ ............ ............ ............ .............. 30 35 35 35 40 40 40 190

13 Capital gains treatment of royalties on coal ............ ............ ............ ............ ............ ............ ............ .............. 60 65 65 70 70 75 80 360

14 Exclusion of interest on energy facility bonds 30 30 30 30 30 30 30 150 80 80 80 85 85 85 85 420

15 Enhanced oil recovery credit ......................... 130 150 170 195 225 260 300 1,150 10 10 10 15 15 15 20 75

16 New technology credit .................................... 25 30 35 40 40 35 35 185 ............ ............ ............ ............ ............ ............ .............. ..............

17 Alcohol fuel credits 1 ....................................... 10 10 10 10 10 10 10 50 5 5 5 5 5 5 5 25

18 Tax credit and deduction for clean-fuel burning vehicles ................................................ 60 65 75 80 75 60 50 340 15 15 15 15 15 15 10 70

19 Exclusion from income of conservation subsidies provided by public utilities ............... ............ ............ ............ ............ ............ ............ ............ .............. 80 80 80 75 75 75 80 385

Natural resources and environment:

20 Expensing of exploration and development

costs, nonfuel minerals .............................. 20 20 20 20 20 25 25 110 5 5 5 5 5 5 5 25

21 Excess of percentage over cost depletion,

nonfuel minerals ......................................... 180 190 195 205 215 225 235 1,075 45 50 50 50 55 55 60 270

22 Exclusion of interest on bonds for water,

sewage, and hazardous waste facilities ... 115 115 115 120 120 120 120 595 325 325 330 335 335 340 345 1,685

23 Capital gains treatment of certain timber income ........................................................... ............ ............ ............ ............ ............ ............ ............ .............. 60 65 65 70 70 75 80 360

24 Expensing of multiperiod timber growing

costs ........................................................... 300 310 315 330 340 355 365 1,705 185 190 195 200 210 215 225 1,045

25 Investment credit and seven-year amortization for reforestation expenditures ............. ............ ............ ............ ............ ............ ............ ............ .............. 10 10 10 10 15 15 15 65

26 Tax incentives for preservation of historic

structures .................................................... 175 195 210 225 235 250 260 1,180 40 40 45 50 50 55 55 255

Agriculture:

27 Expensing of certain capital outlays .............. 10 10 10 10 10 10 10 50 55 60 60 65 65 70 75 335

28 Expensing of certain multiperiod production

costs ........................................................... 10 10 10 10 10 10 10 50 70 75 75 80 85 90 95 425

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

30 Capital gains treatment of certain income .... ............ ............ ............ ............ ............ ............ ............ .............. 605 630 655 685 715 750 785 3,590

31 Income averaging for farmers ........................ ............ ............ ............ ............ ............ ............ ............ .............. 10 75 75 80 80 80 85 400

32 Deferral of gain on sale of farm refiners ...... 10 10 10 10 10 15 15 60

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ............. 785 840 905 970 1,040 1,120 1,200 5,235 ............ ............ ............ ............ ............ ............ .............. ..............

34 Excess bad debt reserves of financial institutions ................................................. 70 30 10 5 5 5 0 25 ............ ............ ............ ............ ............ ............ .............. ..............

35 Exclusion of interest on life insurance

savings ................................................... 200 210 225 235 250 260 275 1,245 13,265 13,990 14,765 15,575 16,430 17,335 18,565 82,670

36 Special alternative tax on small property

and casualty insurance companies ....... 5 5 5 5 5 5 5 25 ............ ............ ............ ............ ............ ............ .............. ..............

37 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................................................ 210 225 240 260 275 310 325 1,410 ............ ............ ............ ............ ............ ............ .............. ..............
5. TAX EXPENDITURES 111

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1998 1999 2000 2001 2002 2003 2004 2000–

2004 1998 1999 2000 2001 2002 2003 2004 2000–2004

38 Small life insurance company deduction .. 100 100 100 105 105 110 100 520 ............ ............ ............ ............ ............ ............ .............. ..............

Housing:

39 Exclusion of interest on owner-occupied

mortgage subsidy bonds ....................... 225 230 230 230 235 235 240 1,170 635 645 650 655 665 670 675 3,315

40 Exclusion of interest on rental housing

bonds ..................................................... 40 40 40 40 40 40 40 200 110 110 110 110 115 115 115 565

41 Deductibility of mortgage interest on

owner-occupied homes .......................... ............ ............ ............ ............ ............ ............ ............ .............. 51,700 52,990 55,100 57,590 60,415 63,425 66,615 303,145

42 Deductibility of State and local property

tax on owner-occupied homes .............. ............ ............ ............ ............ ............ ............ ............ .............. 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

43 Deferral of income from post-1987 installment sales ............................................. 255 260 265 270 275 280 285 1,375 720 735 750 765 780 795 810 3,900

44 Capital gains exclusion on home sales .... ............ ............ ............ ............ ............ ............ ............ .............. 17,475 18,000 18,540 19,095 19,670 20,260 20,870 98,435

45 Exception from passive loss rules for

$25,000 of rental loss ........................... ............ ............ ............ ............ ............ ............ ............ .............. 4,735 4,455 4,215 4,000 3,785 3,575 3,375 18,950

46 Credit for low-income housing investments 2,340 2,420 2,500 2,615 2,655 2,715 2,710 13,195 780 805 835 870 885 905 905 4,400

47 Accelerated depreciation on rental housing (normal tax method) ........................ 1,650 1,880 2,125 2,845 3,135 3,090 3,155 14,350 755 860 970 1,325 1,455 1,405 1,415 6,570

Commerce:

48 Cancellation of indebtedness ..................... ............ ............ ............ ............ ............ ............ ............ .............. 50 30 20 15 20 20 25 100

49 Exceptions from imputed interest rules ..... ............ ............ ............ ............ ............ ............ ............ .............. 155 160 160 160 165 165 165 815

50 Capital gains (except agriculture, timber,

iron ore, and coal) (normal tax method) ............ ............ ............ ............ ............ ............ ............ .............. 38,275 39,415 40,585 41,795 43,035 44,310 45,625 215,350

51 Capital gains exclusion of small corporation stock ................................................ ............ ............ ............ ............ ............ ............ ............ .............. 0 5 5 5 5 5 5 25

52 Step-up basis of capital gains at death .... ............ ............ ............ ............ ............ ............ ............ .............. 24,570 25,800 27,090 28,240 29,370 30,545 31,765 147,010

53 Carryover basis of capital gains on gifts .. ............ ............ ............ ............ ............ ............ ............ .............. 170 175 185 195 205 210 220 1,015

54 Ordinary income treatment of loss from

small business corporation stock sale .. ............ ............ ............ ............ ............ ............ ............ .............. 35 35 35 40 40 40 40 195

55 Accelerated depreciation of buildings

other than rental housing (normal tax

method) .................................................. 4,635 3,620 2,550 1,785 1,720 1,360 450 7,865 1,635 1,275 880 600 645 515 135 2,775

56 Accelerated depreciation of machinery

and equipment (normal tax method) .... 22,025 24,645 26,800 27,835 28,050 27,790 27,380 137,855 6,860 7,860 8,665 8,995 8,935 8,720 8,475 43,790

57 Expensing of certain small investments

(normal tax method) .............................. 805 840 875 820 1,200 1,125 730 4,750 380 395 400 355 530 480 265 2,030

58 Amortization of start-up costs (normal tax

method) .................................................. 120 125 130 130 130 135 140 665 85 90 90 95 95 95 100 475

59 Graduated corporation income tax rate

(normal tax method) .............................. 5,400 5,360 5,360 5,620 6,120 6,680 7,120 30,900 ............ ............ ............ ............ ............ ............ .............. ..............

60 Exclusion of interest on small issue bonds 75 80 80 80 80 80 80 400 220 220 225 225 225 230 230 1,135

Transportation:

61 Deferral of tax on shipping companies ......... 15 15 15 15 15 15 15 75 ............ ............ ............ ............ ............ ............ .............. ..............

62 Exclusion of reimbursed employee parking

expenses .................................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,560 1,595 1,630 1,690 1,750 1,815 1,885 8,770

63 Exclusion for employer-provided transit

passes ........................................................ ............ ............ ............ ............ ............ ............ ............ .............. 70 80 95 105 130 155 170 655

Community and regional development:

64 Investment credit for rehabilitation of structures (other than historic) .......................... 15 15 15 15 15 15 15 75 15 15 15 15 15 15 15 75

65 Exclusion of interest for airport, dock, and

similar bonds .............................................. 180 185 185 185 190 190 195 945 515 520 525 530 535 540 545 2,675

66 Exemption of certain mutuals’ and cooperatives’ income .............................................. 45 50 50 50 50 50 55 255 ............ ............ ............ ............ ............ ............ .............. ..............

67 Empowerment zones and enterprise communities ........................................................... 135 185 205 190 170 130 115 810 155 195 225 245 245 175 175 1,065

68 Expensing of environmental remediation

costs ........................................................... 75 90 120 50 –10 –20 –30 110 15 20 25 10 0 –5 –5 25

Education, training, employment, and social

services:

Education:

69 Exclusion of scholarship and fellowship income (normal tax method) .................... ............ ............ ............ ............ ............ ............ ............ .............. 910 955 995 1,040 1,085 1,135 1,185 5,440

70 HOPE tax credit ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 200 4,015 4,855 5,325 5,730 5,765 5,950 27,625

71 Lifetime Learning tax credit ....................... ............ ............ ............ ............ ............ ............ ............ .............. 110 2,510 2,655 2,970 3,015 3,355 4,565 16,560

72 Education Individual Retirement Accounts ............ ............ ............ ............ ............ ............ ............ .............. 20 100 230 380 540 710 885 2,745

73 Deductibility of student-loan interest ......... ............ ............ ............ ............ ............ ............ ............ .............. 70 245 265 315 360 385 425 1,750

74 Deferral for State prepaid tuition plans ..... ............ ............ ............ ............ ............ ............ ............ .............. 85 125 180 235 285 330 365 1,395

75 Exclusion of interest on student-loan

bonds ..................................................... 60 60 65 65 65 65 65 325 175 175 175 180 180 185 185 905

76 Exclusion of interest on bonds for private

nonprofit educational facilities ............... 145 150 150 150 150 155 155 760 415 420 420 425 430 435 440 2,150
112 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1998 1999 2000 2001 2002 2003 2004 2000–

2004 1998 1999 2000 2001 2002 2003 2004 2000–2004

77 Credit for holders of zone academy bonds 0 10 20 30 35 35 35 155

78 Exclusion of interest on savings bonds redeemed to finance educational expenses .................................................... ............ ............ ............ ............ ............ ............ ............ .............. 10 10 15 15 15 15 20 80

79 Parental personal exemption for students

age 19 or over ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 875 915 965 1,015 1,055 1,105 1,155 5,295

80 Child credit 2 ............................................... ............ ............ ............ ............ ............ ............ ............ .............. 3,525 18,740 18,725 18,430 18,160 17,745 17,155 90,215

81 Deductibility of charitable contributions

(education) ............................................. 970 970 990 1,020 1,065 1,105 1,160 5,340 1,910 1,970 2,075 2,175 2,285 2,400 2,520 11,455

82 Exclusion of employer-provided educational assistance ................................ ............ ............ ............ ............ ............ ............ ............ .............. 215 215 210 15 0 0 0 225

Training, employment, and social services:

83 Work opportunity tax credit ....................... 145 285 280 135 35 5 0 455 25 50 50 25 5 0 0 80

Welfare-to-work tax credit .......................... 15 30 30 15 10 5 0 60 0 5 5 5 0 0 0 10

85 Exclusion of employer-provided child care ............ ............ ............ ............ ............ ............ ............ .............. 1,325 1,385 1,445 1,510 1,575 1,645 1,715 7,890

86 Adoption assistance ................................... ............ ............ ............ ............ ............ ............ ............ .............. 125 295 345 390 385 235 170 1,525

87 Exclusion of employee meals and lodging

(other than military) ............................... ............ ............ ............ ............ ............ ............ ............ .............. 620 650 680 710 740 775 810 3,715

88 Credit for child and dependent care expenses .................................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,485 2,455 2,425 2,395 2,365 2,340 2,310 11,835

89 Credit for disabled access expenditures ... 15 15 15 15 15 20 20 85 30 35 35 35 40 40 40 190

90 Expensing of costs of removing certain

architectural barriers to the handicapped ................................................... 0 5 5 5 5 5 5 25

91 Deductibility of charitable contributions,

other than education and health ........... 1,190 1,190 1,215 1,255 1,310 1,360 1,425 6,565 17,390 17,960 18,840 19,750 20,740 21,790 22,910 104,030

92 Exclusion of certain foster care payments ............ ............ ............ ............ ............ ............ ............ .............. 35 35 40 40 45 45 50 220

93 Exclusion of parsonage allowances .......... ............ ............ ............ ............ ............ ............ ............ .............. 315 340 360 385 410 440 470 2,065

Health:

94 Exclusion of employer contributions for medical insurance premiums and medical care ............ ............ ............ ............ ............ ............ ............ .............. 67,920 72,535 77,670 83,095 88,830 94,960 101,520 446,075

95 Self-employed medical insurance premiums ............ ............ ............ ............ ............ ............ ............ .............. 765 980 1,310 1,405 1,550 2,055 2,905 9,225

96 Workers’ compensation insurance premiums ............ ............ ............ ............ ............ ............ ............ .............. 4,260 4,420 4,585 4,755 4,935 5,120 5,315 24,710

97 Medical Savings Accounts ............................. ............ ............ ............ ............ ............ ............ ............ .............. 15 20 25 25 20 20 15 105

98 Deductibility of medical expenses ................. ............ ............ ............ ............ ............ ............ ............ .............. 3,615 3,775 3,985 4,215 4,475 4,750 5,035 22,460

99 Exclusion of interest on hospital construction

bonds .......................................................... 305 305 310 310 315 320 320 1,575 855 865 875 880 890 900 910 4,455

100 Deductibility of charitable contributions

(health) ....................................................... 610 610 620 640 670 695 730 3,355 1,950 2,020 2,110 2,220 2,330 2,450 2,570 11,680

101 Tax credit for orphan drug research ............. 40 50 55 60 70 80 90 355 ............ ............ ............ ............ ............ ............ .............. ..............

102 Special Blue Cross/Blue Shield deduction .... 210 230 250 280 325 290 250 1,395 ............ ............ ............ ............ ............ ............ .............. ..............

Income security:

103 Exclusion of railroad retirement system benefits ............................................................. ............ ............ ............ ............ ............ ............ ............ .............. 420 420 425 425 430 435 440 2,155

104 Exclusion of workers’ compensation benefits ............ ............ ............ ............ ............ ............ ............ .............. 5,140 5,330 5,475 5,940 6,205 6,480 6,755 30,855

105 Exclusion of public assistance benefits (normal tax method) ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 440 345 360 375 390 405 420 1,950

106 Exclusion of special benefits for disabled

coal miners ................................................. ............ ............ ............ ............ ............ ............ ............ .............. 85 80 75 70 70 65 60 340

107 Exclusion of military disability pensions ........ ............ ............ ............ ............ ............ ............ ............ .............. 120 125 130 135 140 140 145 690

Net exclusion of pension contributions and

earnings:

108 Employer plans .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 82,215 82,195 84,350 86,670 89,155 91,810 94,455 446,440

109 Individual Retirement Accounts ................. ............ ............ ............ ............ ............ ............ ............ .............. 10,565 10,770 11,170 11,440 11,550 11,485 11,270 56,915

110 Keogh plans ............................................... ............ ............ ............ ............ ............ ............ ............ .............. 3,930 4,025 4,255 4,495 4,750 5,010 5,285 23,795

Exclusion of other employee benefits:

111 Premiums on group term life insurance .... ............ ............ ............ ............ ............ ............ ............ .............. 2,030 2,075 2,120 2,170 2,220 2,270 2,335 11,115

112 Premiums on accident and disability insurance ....................................................... ............ ............ ............ ............ ............ ............ ............ .............. 175 185 195 205 215 225 235 1,075

113 Income of trusts to finance supplementary

unemployment benefits .............................. ............ ............ ............ ............ ............ ............ ............ .............. 5 5 5 5 5 5 5 25

114 Special ESOP rules ........................................ 660 680 700 730 760 790 820 3,800 260 270 280 290 300 310 320 1,500

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

116 Additional deduction for the elderly ............... ............ ............ ............ ............ ............ ............ ............ .............. 1,690 1,720 1,740 1,795 1,880 1,945 2,020 9,380

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

118 Deductibility of casualty losses ...................... ............ ............ ............ ............ ............ ............ ............ .............. 225 235 245 255 270 280 290 1,340

119 Earned income tax credit 3 ............................. ............ ............ ............ ............ ............ ............ ............ .............. 6,351 5,118 4,971 5,142 5,275 5,471 5,672 26,531

Social Security:

Exclusion of social security benefits:

120 Social Security benefits for retired workers ............ ............ ............ ............ ............ ............ ............ .............. 16,780 17,210 18,125 19,045 20,100 21,260 22,460 100,990

121 Social Security benefits for disabled ......... ............ ............ ............ ............ ............ ............ ............ .............. 2,265 2,420 2,615 2,820 3,060 3,325 3,625 15,445
5. TAX EXPENDITURES 113

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1998 1999 2000 2001 2002 2003 2004 2000–

2004 1998 1999 2000 2001 2002 2003 2004 2000–2004

122 Social Security benefits for dependents

and survivors ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 3,725 3,785 3,910 4,065 4,235 4,405 4,575 21,190

Veterans benefits and services:

123 Exclusion of veterans death benefits and

disability compensation .............................. ............ ............ ............ ............ ............ ............ ............ .............. 2,820 2,940 3,070 3,210 3,350 3,495 3,650 16,775

124 Exclusion of veterans pensions ..................... ............ ............ ............ ............ ............ ............ ............ .............. 65 65 70 75 80 85 85 395

125 Exclusion of GI bill benefits ........................... ............ ............ ............ ............ ............ ............ ............ .............. 65 75 85 90 90 95 100 460

126 Exclusion of interest on veterans housing

bonds .......................................................... 10 10 10 10 10 10 10 50 30 30 30 30 30 30 30 150

General purpose fiscal assistance:

127 Exclusion of interest on public purpose

bonds .......................................................... 5,240 5,295 5,345 5,400 5,455 5,510 5,565 27,275 14,810 14,955 15,105 15,260 15,410 15,565 15,720 77,060

128 Deductibility of nonbusiness State and local

taxes other than on owner-occupied

homes ......................................................... ............ ............ ............ ............ ............ ............ ............ .............. 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

129 Tax credit for corporations receiving income

from doing business in U.S. possessions 3,960 4,000 4,120 4,245 4,285 4,150 4,215 21,015 ............ ............ ............ ............ ............ ............ .............. ..............

Interest:

130 Deferral of interest on U.S. savings bonds ... ............ ............ ............ ............ ............ ............ ............ .............. 965 1,015 1,065 1,115 1,175 1,235 1,295 5,885

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ............ ............ ............ ............ ............ ............ ............ .............. 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

Nonbusiness State and local taxes other

than on owner-occupied homes ............ ............ ............ ............ ............ ............ ............ ............ .............. 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

Exclusion of interest on:

Public purpose State and local debt ......... 5,240 5,295 5,345 5,400 5,455 5,510 5,565 27,275 14,810 14,955 15,105 15,260 15,410 15,565 15,720 77,060

IDBs for certain energy facilities ............... 30 30 30 30 30 30 30 150 80 80 80 85 85 85 85 420

IDBs for pollution control and sewage and

waste disposal facilities ......................... 115 115 115 120 120 120 120 595 325 325 330 335 335 340 345 1,685

Small-issue IDBs ........................................ 75 80 80 80 80 80 80 400 220 220 225 225 225 230 230 1,135

Owner-occupied mortgage revenue bonds 225 230 230 230 235 235 240 1,170 635 645 650 655 665 670 675 3,315

State and local debt for rental housing .... 40 40 40 40 40 40 40 200 110 110 110 110 115 115 115 565

IDBs for airports, docks, and sports and

convention facilities ................................ 180 185 185 185 190 190 195 945 515 520 525 530 535 540 545 2,675

State and local student loan bonds .......... 60 60 65 65 65 65 65 325 175 175 175 180 180 185 185 905

State and local debt for private nonprofit

educational facilities ............................... 145 150 150 150 150 155 155 760 415 420 420 425 430 435 440 2,150

State and local debt for private nonprofit

health facilities ....................................... 305 305 310 310 315 320 320 1,575 855 865 875 880 890 900 910 4,455

State and local debt for veterans housing 10 10 10 10 10 10 10 50 30 30 30 30 30 30 30 150

1 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1998 $680; 1999 $725; 2000 $755; 2001 $765;

2002 $790; 2003 $805; and 2004 $830.

2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $0; 1999 $415; 2000 $528; 2001 $496; 2002 $483; 2003

$453; and 2004 $425.

3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $23,239; 1999 $26,273; 2000 $26,882; 2001

$27,667; 2002 $28,632; 2003 $29,566; and 2004 $30,578.

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

All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the table.
114 ANALYTICAL PERSPECTIVES

Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2000 REVENUE LOSS

(In millions of dollars)

Provision 2000 2000–2004

Net exclusion of pension contributions and earnings: Employer plans ......................................................................... 84,350 446,440

Exclusion of employer contributions for medical insurance premiums and medical care ............................................ 77,670 446,075

Deductibility of mortgage interest on owner-occupied homes ....................................................................................... 55,100 303,145

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ..................................................... 40,585 215,350

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ......................................... 37,000 209,840

Accelerated depreciation of machinery and equipment (normal tax method) ............................................................... 35,465 181,645

Step-up basis of capital gains at death .......................................................................................................................... 27,090 147,010

Deductibility of charitable contributions, total .................................................................................................................. 25,850 142,425

Exclusion of interest on public purpose bonds .............................................................................................................. 20,450 104,335

Deductibility of State and local property tax on owner-occupied homes ...................................................................... 19,495 107,935

Child credit 2 ..................................................................................................................................................................... 18,725 90,215

Capital gains exclusion on home sales .......................................................................................................................... 18,540 98,435

Exclusion of Social Security benefits for retired workers ............................................................................................... 18,125 100,990

Exclusion of interest on life insurance savings .............................................................................................................. 14,990 83,915

Net exclusion of pension contributions and earnings: Individual Retirement Accounts ............................................... 11,170 56,915

Deferral of income from controlled foreign corporations (normal tax method) ............................................................. 6,200 35,150

Exclusion of workers’ compensation benefits ................................................................................................................. 5,475 30,855

Graduated corporation income tax rate (normal tax method) ........................................................................................ 5,360 30,900

Earned income tax credit 3 .............................................................................................................................................. 4,971 26,531

HOPE tax credit ............................................................................................................................................................... 4,855 27,625

Exclusion of interest on non-public purpose State and local debt ................................................................................ 4,635 23,625

Workers’ compensation insurance premiums ................................................................................................................. 4,585 24,710

Net exclusion of pension contributions and earnings: Keogh plans .............................................................................. 4,255 23,795

Exception from passive loss rules for $25,000 of rental loss ....................................................................................... 4,215 18,950

Tax credit for corporations receiving income from doing business in U.S. possessions ............................................. 4,120 21,015

Deductibility of medical expenses ................................................................................................................................... 3,985 22,460

Exclusion of Social Security benefits for dependents and survivors ............................................................................. 3,910 21,190

Accelerated depreciation of buildings other than rental housing (normal tax method) ................................................ 3,430 10,640

Credit for low-income housing investments .................................................................................................................... 3,335 17,595

Accelerated depreciation on rental housing (normal tax method) ................................................................................. 3,095 20,920

Exclusion of veterans death benefits and disability compensation ............................................................................... 3,070 16,775

Lifetime Learning tax credit ............................................................................................................................................. 2,655 16,560

Exclusion of Social Security benefits for disabled ......................................................................................................... 2,615 15,445

Exclusion of income earned abroad by U.S. citizens .................................................................................................... 2,500 15,715

Credit for child and dependent care expenses .............................................................................................................. 2,425 11,835

Exclusion of income of foreign sales corporations ......................................................................................................... 2,400 13,650

Exclusion of benefits and allowances to armed forces personnel ................................................................................ 2,140 10,900

Exclusion of other employee benefits: Premiums on group term life insurance .......................................................... 2,120 11,115

Additional deduction for the elderly ................................................................................................................................. 1,740 9,380

Exclusion of reimbursed employee parking expenses ................................................................................................... 1,630 8,770

Exclusion of employer-provided child care ..................................................................................................................... 1,445 7,890

Self-employed medical insurance premiums .................................................................................................................. 1,310 9,225

Expensing of certain small investments (normal tax method) ....................................................................................... 1,275 6,780

Inventory property sales source rules exception ............................................................................................................ 1,100 6,300

Deferral of interest on U.S. savings bonds .................................................................................................................... 1,065 5,885

Deferral of income from post-1987 installment sales ..................................................................................................... 1,015 5,275

Exclusion of scholarship and fellowship income (normal tax method) .......................................................................... 995 5,440

Credit for increasing research activities .......................................................................................................................... 980 1,645

Special ESOP rules ......................................................................................................................................................... 980 5,300

Parental personal exemption for students age 19 or over ............................................................................................ 965 5,295

Exemption of credit union income ................................................................................................................................... 905 5,235

Alternative fuel production credit ..................................................................................................................................... 760 2,715

Exclusion of employee meals and lodging (other than military) .................................................................................... 680 3,715

Capital gains treatment of certain income ...................................................................................................................... 655 3,590

Expensing of research and experimentation expenditures (normal tax method) .......................................................... 510 3,295

Expensing of multiperiod timber growing costs .............................................................................................................. 510 2,750

Excess of percentage over cost depletion, fuels and nonfuel minerals ........................................................................ 510 2,725

Empowerment zones and enterprise communities ......................................................................................................... 430 1,875

Exclusion of railroad retirement system benefits ............................................................................................................ 425 2,155

Exclusion of parsonage allowances ................................................................................................................................ 360 2,065

Exclusion of public assistance benefits (normal tax method) ........................................................................................ 360 1,950

Adoption assistance ......................................................................................................................................................... 345 1,525

Work opportunity tax credit ............................................................................................................................................. 330 535

Deductibility of student-loan interest ............................................................................................................................... 265 1,750

Tax incentives for preservation of historic structures ..................................................................................................... 255 1,435

Special Blue Cross/Blue Shield deduction ...................................................................................................................... 250 1,395

Deductibility of casualty losses ....................................................................................................................................... 245 1,340

Tax exemption of certain insurance companies owned by tax-exempt organizations .................................................. 240 1,410

Education Individual Retirement Accounts ...................................................................................................................... 230 2,745
5. TAX EXPENDITURES 115

Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2000 REVENUE LOSS—

Continued

(In millions of dollars)

Provision 2000 2000–2004

Amortization of start-up costs (normal tax method) ....................................................................................................... 220 1,140

Exclusion of employer-provided educational assistance ................................................................................................ 210 225

Exclusion of other employee benefits: Premiums on accident and disability insurance .............................................. 195 1,075

Carryover basis of capital gains on gifts ........................................................................................................................ 185 1,015

Deferral for State prepaid tuition plans ........................................................................................................................... 180 1,395

Enhanced oil recovery credit ........................................................................................................................................... 180 1,225

Exceptions from imputed interest rules ........................................................................................................................... 160 815

Expensing of environmental remediation costs .............................................................................................................. 145 135

Exclusion of military disability pensions .......................................................................................................................... 130 690

Small life insurance company deduction ........................................................................................................................ 100 520

Exclusion for employer-provided transit passes ............................................................................................................. 95 655

Tax credit and deduction for clean-fuel burning vehicles .............................................................................................. 90 410

Exclusion of GI bill benefits ............................................................................................................................................. 85 460

Expensing of certain multiperiod production costs ......................................................................................................... 85 475

Exclusion from income of conservation subsidies provided by public utilities .............................................................. 80 385

Exclusion of special benefits for disabled coal miners .................................................................................................. 75 340

Income averaging for farmers ......................................................................................................................................... 75 400

Exclusion of veterans pensions ....................................................................................................................................... 70 395

Expensing of certain capital outlays ............................................................................................................................... 70 385

Capital gains treatment of certain timber income .......................................................................................................... 65 360

Deferred taxes for financial firms on certain income earned overseas ........................................................................ 65 65

Capital gains treatment of royalties on coal ................................................................................................................... 65 360

Tax credit for orphan drug research ............................................................................................................................... 55 355

Credit for disabled access expenditures ......................................................................................................................... 50 275

Exemption of certain mutuals’ and cooperatives’ income .............................................................................................. 50 255

Exclusion of certain foster care payments ...................................................................................................................... 40 220

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

Exception from passive loss limitation for working interests in oil and gas properties ................................................ 35 190

New technology credit ..................................................................................................................................................... 35 185

Ordinary income treatment of loss from small business corporation stock sale .......................................................... 35 195

Welfare-to-work tax credit ................................................................................................................................................ 35 70

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

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

Medical Savings Accounts ............................................................................................................................................... 25 105

Expensing of exploration and development costs, nonfuel minerals ............................................................................. 25 135

Cancellation of indebtedness .......................................................................................................................................... 20 100

Credit for holders of zone academy bonds .................................................................................................................... 20 155

Deferral of tax on shipping companies ........................................................................................................................... 15 75

Exclusion of interest on savings bonds redeemed to finance educational expenses .................................................. 15 80

Alcohol fuel credits 1 ........................................................................................................................................................ 15 75

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

Excess bad debt reserves of financial institutions ......................................................................................................... 10 25

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

Investment credit and seven-year amortization for reforestation expenditures ............................................................. 10 65

Capital gains exclusion of small corporation stock ........................................................................................................ 5 25

Expensing of costs of removing certain architectural barriers to the handicapped ...................................................... 5 25

Income of trusts to finance supplementary unemployment benefits ............................................................................. 5 25

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

Expensing of exploration and development costs, fuels ................................................................................................ (10) 45

1 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows:

1998 $680; 1999 $725; 2000 $755; 2001 $765; 2002 $790; 2003 $805; and 2004 $830 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $0; 1999

$415; 2000 $528; 2001 $496; 2002 $483; 2003 $453; and 2004 $425. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998

$23,239; 1999 $26,273; 2000 $26,882; 2001 $27,667; 2002 $28,632; 2003 $29,566; and 2004 $30,578.

Note: Provisions with estimates denoted ‘‘normal tax method’’ have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the able.

Note: Three categories in the table are aggregated: Deductibility of chartable contributions, exclusion of interest for non-public purpose State and local

debt, and excess of percentage over cost depletion, fuels and nonfuel minerals.
116 ANALYTICAL PERSPECTIVES

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

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

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

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

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

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

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

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

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

CALENDAR YEAR 1998

(In millions of dollars)

Provision

Present

Value of

Revenue

Loss

1 Deferral of income from controlled foreign corporations (normal tax method) .................................................. 5,700

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 550

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

4 Expensing of exploration and development costs—fuels .................................................................................... 90

5 Expensing of exploration and development costs—nonfuels .............................................................................. 20

6 Expensing of multiperiod timber growing costs ................................................................................................... 250

7 Expensing of certain multiperiod production costs—agriculture .......................................................................... 90

8 Expensing of certain capital outlays—agriculture ................................................................................................ 75

9 Deferral of income on life insurance and annuity contracts ............................................................................... 20,615

10 Accelerated depreciation of rental housing (normal tax method) ....................................................................... 3,415

11 Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................... 560

12 Accelerated depreciation of machinery and equipment (normal tax method) .................................................... 39,670

13 Expensing of certain small investments (normal tax method) ............................................................................ 1,375

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

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

16 Credit for holders of zone academy bonds ......................................................................................................... 180

17 Credit for low-income housing investments ......................................................................................................... 2,745

18 Exclusion of pension contributions—employer plans ........................................................................................... 84,430

19 Exclusion of IRA contributions and earnings ....................................................................................................... 13,285

20 Exclusion of contributions and earnings for Keogh plans ................................................................................... 3,555

21 Exclusion of interest on public-purpose bonds .................................................................................................... 22,360

22 Exclusion of interest on non-public purpose bonds ............................................................................................ 3,435

23 Deferral of interest on U.S. savings bonds ......................................................................................................... 390

Outlay Equivalents

The concept of ‘‘outlay equivalents’’ complements

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

tax expenditures. It is the amount of outlay that would

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

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

The measure is larger than the revenue loss estimate

when the tax expenditure is judged to function as a

Government payment for service. This occurs because

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

revenue loss equals the outlay equivalent measure. This

occurs when the tax expenditure is judged to function

like a price reduction or tax deferral that does not

directly enter the taxpayer’s pre-tax income.1
5. TAX EXPENDITURES 117

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

(In millions of dollars)

Outlay Equivalents

1998 1999 2000 2001 2002 2003 2004 2000–2004

National Defense:

1 Exclusion of benefits and allowances to armed forces personnel .......................................................... 2,445 2,470 2,495 2,520 2,545 2,570 2,595 12,725

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ............................................................................. 2,640 2,965 3,315 3,710 4,145 4,590 5,080 20,840

3 Exclusion of income of foreign sales corporations .................................................................................. 3,310 3,460 3,700 3,920 4,150 4,460 4,770 21,000

4 Inventory property sales source rules exception ..................................................................................... 1,550 1,620 1,690 1,770 1,920 2,080 2,230 9,690

5 Deferral of income from controlled foreign corporations (normal tax method) ....................................... 5,500 5,800 6,200 6,600 7,000 7,450 7,900 35,150

6 Deferred taxes for financial firms on income earned overseas .............................................................. 400 1,075 65 0 0 0 0 65

General science, space, and technology:

7 Expensing of research and experimentation expenditures (normal tax method) ................................... 260 330 510 610 675 735 765 3,295

8 Credit for increasing research activities ................................................................................................... 3,270 2,550 1,500 650 275 90 15 2,530

Energy:

9 Expensing of exploration and development costs, fuels ......................................................................... (130) (90) (20) (25) 0 40 45 40

10 Excess of percentage over cost depletion, fuels ..................................................................................... 285 295 300 310 320 325 335 1,590

11 Alternative fuel production credit .............................................................................................................. 1,100 1,030 975 915 860 555 165 3,470

12 Exception from passive loss limitation for working interests in oil and gas properties ......................... 30 35 35 35 40 40 40 190

13 Capital gains treatment of royalties on coal ............................................................................................ 80 85 85 95 95 100 105 480

14 Exclusion of interest on energy facility bonds ......................................................................................... 155 155 155 165 165 165 165 815

15 Enhanced oil recovery credit .................................................................................................................... 215 245 285 325 375 425 490 1,900

16 New technology credit ............................................................................................................................... 30 40 45 50 55 55 40 245

17 Alcohol fuel credits 1 ................................................................................................................................. 15 15 15 15 15 15 15 75

18 Tax credit and deduction for clean-fuel burning vehicles ....................................................................... 95 105 115 130 120 95 65 525

19 Exclusion from income of conservation subsidies provided by public utilities ....................................... 110 110 105 105 100 105 105 520

Natural resources and environment:

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

21 Excess of percentage over cost depletion, nonfuel minerals ................................................................. 275 280 300 310 325 340 350 1,625

22 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .............................. 630 630 640 650 650 655 665 3,260

23 Capital gains treatment of certain timber income .................................................................................... 80 85 85 95 95 100 105 480

24 Expensing of multiperiod timber growing costs ....................................................................................... 485 500 510 530 550 570 590 2,750

25 Investment credit and seven-year amortization for reforestation expenditures ...................................... 15 15 15 15 15 15 15 75

26 Tax incentives for preservation of historic structures .............................................................................. 215 235 255 275 285 305 315 1,435

Agriculture:

27 Expensing of certain capital outlays ......................................................................................................... 65 70 70 75 75 80 85 385

28 Expensing of certain multiperiod production costs .................................................................................. 80 85 85 90 95 100 105 475

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

30 Capital gains treatment of certain income ............................................................................................... 805 840 875 915 955 1,000 1,045 4,790

31 Income averaging for farmers ................................................................................................................... 10 75 75 80 80 80 85 400

32 Deferral of gain on sale of farm refiners ................................................................................................. 10 10 10 10 10 15 15 60

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ....................................................................................................... 1,000 1,070 1,150 1,235 1,325 1,425 1,530 6,665

34 Excess bad debt reserves of financial institutions .............................................................................. 70 30 10 5 5 5 0 25

35 Exclusion of interest on life insurance savings ................................................................................... 13,465 14,200 14,990 15,810 16,680 17,595 18,840 83,915

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations ...................... 290 315 335 345 365 415 450 1,910

38 Small life insurance company deduction ............................................................................................. 140 140 140 150 150 150 150 740

Housing:

39 Exclusion of interest on owner-occupied mortgage subsidy bonds .................................................... 1,230 1,255 1,260 1,270 1,290 1,295 1,315 6,430

40 Exclusion of interest on rental housing bonds .................................................................................... 215 215 215 215 220 220 220 1,090

41 Deductibility of mortgage interest on owner-occupied homes ............................................................ 51,700 52,990 55,100 57,590 60,415 63,425 66,615 303,145

42 Deductibility of State and local property tax on owner-occupied homes ........................................... 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

43 Deferral of income from post-1987 installment sales .......................................................................... 975 995 1,015 1,035 1,055 1,075 1,095 5,275

44 Capital gains exclusion on home sales ............................................................................................... 21,845 22,500 23,175 23,870 24,590 25,325 26,090 123,050

45 Exception from passive loss rules for $25,000 of rental loss ............................................................ 4,735 4,455 4,215 4,000 3,785 3,575 3,375 18,950

46 Credit for low-income housing investments ......................................................................................... 4,065 4,210 4,340 4,540 4,610 4,720 4,705 22,915

47 Accelerated depreciation on rental housing (normal tax method) ...................................................... 2,405 2,740 3,095 4,170 4,590 4,495 4,570 20,920

Commerce:

48 Cancellation of indebtedness ............................................................................................................... 50 30 20 15 20 20 25 100

49 Exceptions from imputed interest rules ............................................................................................... 155 160 160 160 165 165 165 815

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................... 51,035 52,555 54,115 55,725 57,380 59,080 60,835 287,135

51 Capital gains exclusion of small corporation stock ............................................................................. 0 5 5 5 5 5 5 25

52 Step-up basis of capital gains at death ............................................................................................... 32,760 34,400 36,120 37,655 39,160 40,725 42,355 196,015

53 Carryover basis of capital gains on gifts ............................................................................................. 170 175 185 195 205 210 220 1,015

54 Ordinary income treatment of loss from small business corporation stock sale ............................... 45 45 45 55 55 55 55 265

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ..................... 6,270 4,895 3,430 2,385 2,365 1,875 585 10,640
118 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Outlay Equivalents

1998 1999 2000 2001 2002 2003 2004 2000–2004

56 Accelerated depreciation of machinery and equipment (normal tax method) .................................... 28,885 32,505 35,465 36,830 36,985 36,510 35,855 181,645

57 Expensing of certain small investments (normal tax method) ............................................................ 1,185 1,235 1,275 1,175 1,730 1,605 995 6,780

58 Amortization of start-up costs (normal tax method) ............................................................................ 205 215 220 225 225 230 240 1,140

59 Graduated corporation income tax rate (normal tax method) ............................................................. 7,400 7,340 7,340 7,700 8,385 9,150 9,755 42,330

60 Exclusion of interest on small issue bonds ......................................................................................... 425 430 435 435 435 445 445 2,195

Transportation:

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

62 Exclusion of reimbursed employee parking expenses ............................................................................ 2,010 2,060 2,105 2,180 2,260 2,345 2,430 11,320

63 Exclusion for employer-provided transit passes ...................................................................................... 95 115 130 150 180 215 240 915

Community and regional development:

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

65 Exclusion of interest for airport, dock, and similar bonds ....................................................................... 995 1,010 1,015 1,025 1,040 1,045 1,060 5,185

66 Exemption of certain mutuals’ and cooperatives’ income ....................................................................... 45 50 50 50 50 50 55 255

67 Empowerment zones and enterprise communities .................................................................................. 290 380 430 435 415 305 290 1,875

68 Expensing of environmental remediation costs ....................................................................................... 120 145 195 80 (15) (35) (45) 180

Education, training, employment, and social services:

Education:

69 Exclusion of scholarship and fellowship income (normal tax method) ............................................... 1,015 1,060 1,105 1,155 1,210 1,265 1,320 6,055

70 HOPE tax credit .................................................................................................................................... 255 5,150 6,225 6,830 7,345 7,390 7,625 35,415

71 Lifetime Learning tax credit .................................................................................................................. 140 3,215 3,405 3,805 3,865 4,305 5,850 21,230

72 Education Individual Retirement Accounts ........................................................................................... 25 125 295 480 685 895 1,120 3,475

73 Deductibility of student-loan interest .................................................................................................... 90 305 330 390 450 485 530 2,185

74 Deferral for State prepaid tuition plans ................................................................................................ 85 125 180 235 285 330 365 1,395

75 Exclusion of interest on student-loan bonds ....................................................................................... 340 340 345 350 350 360 360 1,765

76 Exclusion of interest on bonds for private nonprofit educational facilities ......................................... 800 820 820 825 835 845 850 4,175

77 Credit for holders of zone academy bonds ......................................................................................... 0 15 30 45 50 50 50 225

78 Exclusion of interest on savings bonds redeemed to finance educational expenses ....................... 15 15 20 20 20 20 30 110

79 Parental personal exemption for students age 19 or over ................................................................. 970 1,010 1,070 1,125 1,165 1,225 1,280 5,865

80 Child credit 2 .......................................................................................................................................... 4,700 24,985 24,965 24,575 24,215 23,660 22,875 120,290

81 Deductibility of charitable contributions (education) ............................................................................ 3,995 4,090 4,250 4,435 4,650 4,870 5,125 23,330

82 Exclusion of employer-provided educational assistance ..................................................................... 270 270 260 20 0 0 0 280

Training, employment, and social services:

83 Work opportunity tax credit .................................................................................................................. 170 335 330 160 40 5 0 535

84 Welfare-to-work tax credit ..................................................................................................................... 15 35 35 20 10 5 0 70

85 Exclusion of employer-provided child care .......................................................................................... 1,765 1,845 1,925 2,015 2,100 2,195 2,285 10,520

86 Adoption assistance .............................................................................................................................. 155 355 415 470 460 285 205 1,835

87 Exclusion of employee meals and lodging (other than military) ......................................................... 760 795 830 865 905 945 990 4,535

88 Credit for child and dependent care expenses ................................................................................... 3,315 3,275 3,235 3,195 3,155 3,115 3,080 15,780

89 Credit for disabled access expenditures .............................................................................................. 60 65 65 65 75 80 85 370

90 Expensing of costs of removing certain architectural barriers to the handicapped ........................... 0 5 5 5 5 5 5 25

91 Deductibility of charitable contributions, other than education and health ......................................... 25,000 25,780 27,015 28,320 29,770 31,310 32,980 149,395

92 Exclusion of certain foster care payments .......................................................................................... 45 45 50 50 50 55 60 265

93 Exclusion of parsonage allowances ..................................................................................................... 390 415 445 475 505 540 580 2,545

Health:

94 Exclusion of employer contributions for medical insurance premiums and medical care ..................... 86,925 92,985 99,735 106,890 114,465 122,580 131,280 574,950

95 Self-employed medical insurance premiums ............................................................................................ 935 1,195 1,600 1,715 1,890 2,505 3,545 11,255

96 Workers’ compensation insurance premiums ........................................................................................... 5,320 5,520 5,730 5,945 6,170 6,400 6,645 30,890

97 Medical Savings Accounts ........................................................................................................................ 20 30 30 35 30 30 25 150

98 Deductibility of medical expenses ............................................................................................................ 3,615 3,775 3,985 4,215 4,475 4,750 5,035 22,460

99 Exclusion of interest on hospital construction bonds .............................................................................. 1,665 1,680 1,695 1,705 1,725 1,750 1,765 8,640

100 Deductibility of charitable contributions (health) ...................................................................................... 3,520 3,600 3,760 3,930 4,120 4,330 4,560 20,700

101 Tax credit for orphan drug research ........................................................................................................ 60 75 80 90 105 115 130 520

102 Special Blue Cross/Blue Shield deduction ............................................................................................... 280 310 335 375 435 385 335 1,865

Income security:

103 Exclusion of railroad retirement system benefits ..................................................................................... 420 420 425 425 430 435 440 2,155

104 Exclusion of workers’ compensation benefits .......................................................................................... 5,140 5,330 5,475 5,940 6,205 6,480 6,755 30,855

105 Exclusion of public assistance benefits (normal tax method) ................................................................. 440 345 360 375 390 405 420 1,950

106 Exclusion of special benefits for disabled coal miners ........................................................................... 85 80 75 70 70 65 60 340

107 Exclusion of military disability pensions ................................................................................................... 120 125 130 135 140 140 145 690

Net exclusion of pension contributions and earnings:

108 Employer plans ..................................................................................................................................... 106,170 106,840 109,760 112,750 116,015 119,475 122,975 580,975

109 Individual Retirement Accounts ............................................................................................................ 14,115 14,475 15,095 15,570 15,855 15,940 15,845 78,305

110 Keogh plans .......................................................................................................................................... 5,010 5,105 5,400 5,705 6,025 6,360 6,710 30,200

Exclusion of other employee benefits:

111 Premiums on group term life insurance .............................................................................................. 2,690 2,750 2,815 2,880 2,945 3,015 3,085 14,740
5. TAX EXPENDITURES 119

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

(In millions of dollars)

Outlay Equivalents

1998 1999 2000 2001 2002 2003 2004 2000–2004

112 Premiums on accident and disability insurance .................................................................................. 225 235 250 260 275 290 305 1,380

113 Income of trusts to finance supplementary unemployment benefits ....................................................... 5 5 5 5 5 5 5 25

114 Special ESOP rules .................................................................................................................................. 1,280 1,320 1,360 1,415 1,470 1,530 1,585 7,360

115 Additional deduction for the blind ............................................................................................................. 35 35 35 35 40 40 45 195

116 Additional deduction for the elderly .......................................................................................................... 2,045 2,085 2,105 2,175 2,275 2,355 2,440 11,350

117 Tax credit for the elderly and disabled .................................................................................................... 50 50 50 50 50 50 55 255

118 Deductibility of casualty losses ................................................................................................................. 245 260 270 285 295 310 320 1,480

119 Earned income tax credit 3 ....................................................................................................................... 7,056 5,687 5,523 5,714 5,861 6,079 6,303 29,480

Social Security:

Exclusion of social security benefits:

120 Social Security benefits for retired workers ......................................................................................... 16,780 17,210 18,125 19,045 20,100 21,260 22,460 100,990

121 Social Security benefits for disabled .................................................................................................... 2,265 2,420 2,615 2,820 3,060 3,325 3,625 15,445

122 Social Security benefits for dependents and survivors ....................................................................... 3,725 3,785 3,910 4,065 4,235 4,405 4,575 21,190

Veterans benefits and services:

123 Exclusion of veterans death benefits and disability compensation ......................................................... 2,820 2,940 3,070 3,210 3,350 3,495 3,650 16,775

124 Exclusion of veterans pensions ................................................................................................................ 65 65 70 75 80 85 85 395

125 Exclusion of GI bill benefits ...................................................................................................................... 65 75 85 90 90 95 100 460

126 Exclusion of interest on veterans housing bonds .................................................................................... 60 60 60 60 60 60 60 300

General purpose fiscal assistance:

127 Exclusion of interest on public purpose bonds ........................................................................................ 28,720 29,005 29,290 29,595 29,890 30,190 30,490 149,455

128 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .................. 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

129 Tax credit for corporations receiving income from doing business in U.S. possessions ...................... 3,960 4,000 4,120 4,245 4,285 4,150 4,215 21,015

Interest:

130 Deferral of interest on U.S. savings bonds .............................................................................................. 965 1,015 1,065 1,115 1,175 1,235 1,295 5,885

Addendum—Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes .......................................................................................... 17,770 18,595 19,495 20,535 21,625 22,635 23,645 107,935

Nonbusiness State and local taxes other than on owner-occupied homes ....................................... 32,795 34,925 37,000 39,235 41,715 44,490 47,400 209,840

Exclusion of interest on:

Public purpose State and local debt .................................................................................................... 28,720 29,005 29,290 29,595 29,890 30,190 30,490 149,455

IDBs for certain energy facilities .......................................................................................................... 155 155 155 165 165 165 165 815

IDBs for pollution control and sewage and waste disposal facilities ................................................. 630 630 640 650 650 655 665 3,260

Small-issue IDBs ................................................................................................................................... 425 430 435 435 435 445 445 2,195

Owner-occupied mortgage revenue bonds .......................................................................................... 1,230 1,255 1,260 1,270 1,290 1,295 1,315 6,430

State and local debt for rental housing ............................................................................................... 215 215 215 215 220 220 220 1,090

IDBs for airports, docks, and sports and convention facilities ........................................................... 995 1,010 1,015 1,025 1,040 1,045 1,060 5,185

State and local student loan bonds ..................................................................................................... 340 340 345 350 350 360 360 1,765

State and local debt for private nonprofit educational facilities .......................................................... 800 820 820 825 835 845 850 4,175

State and local debt for private nonprofit health facilities .................................................................. 1,665 1,680 1,695 1,705 1,725 1,750 1,765 8,640

State and local debt for veterans housing .......................................................................................... 60 60 60 60 60 60 60 300

1 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1998 $680; 1999 $725; 2000 $755; 2001 $765; 2002

$790; 2003 $805; and 2004 $830.

2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $0; 1999 $415; 2000 $528; 2001 $496; 2002 $483; 2003

$453; and 2004 $425.

3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1998 $23,240; 1999 $25,650; 2000 $26,525; 2001

$27,265; 2002 $27,975; 2003 $28,705; and 2004 $29,655.

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

All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the table.

Tax Expenditure Baselines

A tax expenditure is a preferential exception to the

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

baseline provisions of the tax law. Deciding whether

provisions are preferential exceptions, therefore, is a

matter of judgement. As in prior years, this year’s tax

expenditure estimates are presented using two baselines: the normal tax baseline, which is used by the

Joint Committee on Taxation, and the reference tax

law baseline, which has been reported by the Administration since 1983.

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

sum of consumption and the change in net wealth in

a given period of time. The normal tax baseline allows

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

is not limited to a particular structure of tax rates,

or by a specific definition of the taxpaying unit.

The reference tax law baseline is also patterned on

a comprehensive income tax, but in practice is closer

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

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

such as social security benefits. 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.

programmatic functions. These functions correspond to

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

the reference law baseline are generally tax expenditures under the normal tax baseline, the reverse is

not always true.

Both the normal and reference tax baselines allow

several major departures from a pure comprehensive

income tax. For example:

• Income is taxable when realized in exchange.

Thus, neither the deferral of tax on unrealized

capital gains nor the tax exclusion of imputed income (such as the rental value of owner-occupied

housing or farmers’ consumption of their own

produce) is regarded as a tax expenditure. Both

accrued and imputed income would be taxed under

a comprehensive income tax.

• There is a separate corporation income tax. Under

a comprehensive income tax, corporate income

would be taxed only once—at the shareholder

level, whether or not distributed in the form of

dividends.

• Values of assets and debt are not adjusted for

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

changes in the price level during the time the

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

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

and failure to take account of inflation in measuring interest costs would be regarded as a positive

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

While the reference law and normal tax baselines

are generally similar, areas of difference include:

• Tax rates. The separate schedules applying to the

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

below the maximum statutory rate do not give

rise to a tax expenditure. The normal tax baseline

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

$10 million of corporate income are thus regarded

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

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

ore royalties and the sale of timber and certain

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

part of the baseline rate structure under both the

reference and normal tax methods.

• Income subject to the tax. Income subject to tax

is defined as gross income less the costs of earning

that income. The Federal income tax defines gross

income to include: (1) consideration received in

the exchange of goods and services, including labor

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

of gross or net income earned and/or reported by

another entity (such as a partnership). Under the

reference tax rules, therefore, gross income does

not include gifts—defined as receipts of money or

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

thought of as gifts from the Government.2 The

normal tax baseline also excludes gifts between

individuals from gross income. Under the normal

tax baseline, however, all cash transfer payments

from the Government to private individuals are

counted in gross income, and exemptions of such

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

deductible in determining taxable income under

both the reference and normal tax baselines.3

• Capital recovery. Under the reference tax law

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

the depreciation allowance for machinery and

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

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

tax baseline for real property is computed using

40-year straight-line depreciation.

• Treatment of foreign income. Both the normal and

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

income taxes that would otherwise be due), which

prevents double taxation of income earned abroad.

Under the normal tax method, however, controlled

foreign corporations (CFCs) are not regarded as

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

under this method. In contrast, except for tax

haven activities, the reference law baseline follows

current law in treating CFCs as separate taxable

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

until distributed to U.S. taxpayers. Under this

baseline, deferral of tax on CFC income is not

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

income.

In addition to these areas of difference, the Joint

Committee on Taxation considers a somewhat broader

set of tax expenditures under its normal tax baseline

than is considered here.
5. TAX EXPENDITURES 121

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

Results Act of 1993’’ (Report 103–58, 1993). 5Director of the Office of Management and Budget, ‘‘The Government Performance and

Results Act,’’ Report to the President and the Congress, May 1997. 6 Joint Committee on Taxation, ‘‘Estimates of Federal Tax Expenditures for Fiscal Years

1999–1993,’’ JCS-7–98, December 14, 1998; and Committee on the Budget, United States

Senate, ‘‘Tax Expenditures: Compendium of Background Material on Individual Provisions,’’

prepared by the Congressional Research Service (S. Prt. 104–69, December 1996).

7While this section focuses upon tax expenditures under the income tax, tax preferences

also arise under the unified transfer, payroll, and excise tax systems. Such preferences

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.

Performance Measures and the Economic

Effects of Tax Expenditures

Under the Government Performance and Results Act

of 1993 (GPRA), Federal agencies are directed to develop both strategic and annual plans for their programs and activities. These plans set out performance

objectives to be achieved over a specific time period.

Achieving most of these objectives will largely be the

result of direct expenditures of funds. However, tax

expenditures may also contribute to goal achievement.

The Senate Governmental Affairs Committee report

on this Act4 called on the Executive branch to undertake a series of analyses to assess the effect of specific

tax expenditures on the achievement of the goals and

objectives in these strategic and annual plans. As described in OMB’s May 1997 report on this Act,5 Treasury in 1997 initiated pilot studies of three specific tax

expenditures in order to explore evaluation methods

and resource needs associated with evaluating the relationship between tax expenditures and performance

goals. Tax expenditures were selected within the Office

of Tax Analysis in each of the three main areas—individual, business, and international taxation. The specific provisions considered were: the tax exemption for

worker’s compensation benefits; the tax credit for nonconventional fuels; and the tax exclusion for certain

amounts of income earned by Americans living abroad.

The results of these studies are summarized in the

context of the three specific provisions in the section

that follows, which provides provision descriptions.

Over the next few years, the Administration’s plan

is to undertake additional studies that will focus on

the availability of the data needed to assess the effects

of selected significant tax expenditures, primarily those

designed to increase savings. In addition, summarized

data on the beneficiaries and other economic properties

of such provisions will be developed where feasible. This

effort will complement information published by the

Joint Committee on Taxation and the Senate Budget

Committee on the rationale, beneficiaries, and effects

of tax expenditures.6 One finding of the pilot studies

is that much of the data needed for thorough analysis

is not currently available. Hence, assessment of data

needs and availability from Federal statistical agencies,

program-agency studies, or private-sector sources, and,

when feasible, publication of data on selected tax expenditures should prove valuable to broader efforts to

assess the effects tax expenditures and to compare their

effectiveness with outlay, regulatory and other tax polices as means of achieving objectives.

Comparisons 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.7

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, though not all,

cases. In addition, tax expenditures may help simplify

the tax system, as where they leave certain income

sources untaxed (e.g, exemptions for employer fringe

benefits or exclusions for up to $500,000 of capital gains

on home sales). Tax expenditures also implicitly subsidize certain activities, which benefit recipients; the

beneficiaries experience reduced taxes that are offset

by higher taxes (or spending reductions) elsewhere.

Regulatory or tax-disincentive policies, which can also

modify behavior, would have a different distributional

impact. Finally, a variety of tax expenditure tools can

be used—e.g., deductions, credits, exemptions and deferrals; floors and ceilings; and phase-ins and phaseouts, dependent on income, expenses, or demographic

characteristics (age, number of family members, etc.).

This wide range means that tax expenditures can be

flexible and can have very different distributional and

cost-effectiveness properties.

Tax expenditures also have limitations. In some cases

they can add to the complexity of the tax system, which

can raise both administrative and compliance costs; for

example, various holding periods and tax rates for capital gains can complicate filing and decisionmaking.

Also, the income tax system does not gather information on wealth, in contrast to certain loan programs

that are based on recipients’ assets and income. In addition, the tax system may have little or no contact

with persons who have no or very low incomes, and

incentives for such persons may need to take the form

of refunds. These features may reduce the effectiveness

of tax expenditures for addressing certain income-transfer objectives. Tax expenditures also generally do not

enable the same degree of agency discretion as an outlay program; for example, grant or direct Federal service delivery programs can prioritize which activities are

addressed with what amount of resources in a way

that is difficult to emulate with tax expenditures. Finally, tax expenditures tend to escape the budget scrutiny afforded to other programs. For instance, a program funded by a tax expenditure does not increase

government outlays as a share of national product and

it may even decrease receipts as a share of output.

However, the effective government compensation to a

service provider can be identical to that of a spending

program under which the outlay (and possibly the receipts) share of GDP may increase.

Outlay programs, in contrast, have advantages where

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

forces or administering the system of justice. Outlay
122 ANALYTICAL PERSPECTIVES

programs may also be specifically designed to meet the

needs of low-income families who would not otherwise

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

Outlay programs may also receive more year-to-year

oversight and fine tuning, through the legislative and

executive budget process. In addition, many different

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

and local governments, the private sector, or individuals

in the form of grants or contracts—provide flexibility

for policy design. On the other hand, certain outlay

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

private-market provision than tax incentives, which

may reduce the relative efficiency of spending programs

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

to changing activity levels and economic conditions than

tax expenditures.

Regulations have a key distributional difference from

outlay and tax-expenditure programs in that the immediate distributional burden of the regulation typically

falls on the regulated party (i.e., the intended actor)—

generally in the private sector. While the regulated parties can pass costs along through product or input

prices, the initial incidence is on the regulated party.

Regulations can be fine-tuned more quickly than tax

expenditures, as they can generally be changed by the

executive branch without legislation. Like tax expenditures, regulations often largely rely upon voluntary

compliance, rather than detailed inspections and policing. As such, the public administrative costs tend to

be modest, relative to the private resource costs associated with modifying activities. Historically, regulations

have tended to rely on proscriptive measures, as opposed to economic incentives. This reliance can diminish their economic efficiency, though 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 the Federal budget and outlays and receipts as

a percentage of national output. Thus, like tax expenditures, they may escape the type of scrutiny that outlay

programs receive. However, most regulations are subjected to a formal type of benefit-cost analysis that goes

well beyond the analysis required for outlay and taxexpenditure programs. To some extent, the GPRA requirement for performance evaluation will address this

lack of formal analysis.

There are examples of policy objectives that employ

multiple approaches. Minimum wage legislation, the

earned income tax credit, and the food stamp program

are examples of programs that utilize regulatory, tax

expenditure, and direct outlay approaches, respectively,

in order to improve the economic welfare of low-wage

workers. Their relative strengths and weaknesses have

merited significant attention.

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

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

saving for retirement or investing in certain sectors);

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

private compliance costs and government administrative costs (e.g., favorable treatment of certain employerprovided fringe benefits); 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,

favorable treatment of employer-provided pensions

might be argued to have aspects of most, or even all,

of the goals mentioned above. In addition, the economic

effects of particular provisions can extend beyond their

intended objectives (e.g., a provision intended to promote an activity or raise certain incomes may have

positive or negative effects on tax neutrality).

Performance measurement is generally concerned

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

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

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

society, or environment that are the ultimate goals of

programs.

Thus, for a provision that reduces taxes on certain

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

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

inequity or unintended consequence in the tax code,

an important performance measure might be how they

change effective tax rates (the discounted present-value

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

distortions caused by taxes). Distributional effects on

incomes 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 of the provisions for some time. In addition, such assessments can

raise significant challenges in economic modeling. For

these reasons, and related time, staffing, and resource

constraints, the evaluation process is likely to take a

number of years and to include qualitative assessments
5. TAX EXPENDITURES 123

and estimated ranges of effects, in many cases, as opposed to point estimates.

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 promoting U.S. exports. These include the

exclusion for income earned abroad by nongovernmental

employees and preferences for income from exports and

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

In addition to determining their effectiveness in markets of the benefitting firms, analysis should consider

the extent to which macroeconomic factors lead to offsetting effects, such as increased imports, which could

moderate any net effects on employment, national output, and trade deficits. Similar issues arise in the case

of export promotion programs supported by outlays.

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—such as research spending, exploration activity, or equipment—could 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 degree of tax subsidy provided. Measures could also indicate the provisions’ effects on production from these investments—such as

numbers or values of patents, energy production and

reserves, and industrial production. Issues to be considered include the extent to which the preferences increase production (as opposed to benefitting existing

output) and their cost-effectiveness relative to other

policies. Analysis could also consider objectives that are

more difficult to measure but still are ultimate goals,

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

growth. Such an assessment is likely to involve tax

analysis as well as consideration of non-tax matters

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

of various energy sources on the environment).

Housing investment also benefits from tax expenditures, including the mortgage interest deduction and

preferential treatment of capital gains on homes. Measures of the effectiveness of these provisions could include their effects on increasing the extent of home

ownership and the quality of housing. In addition, the

mortgage interest deduction offsets the taxable nature

of investment income received by homeowners, so the

relationship between the deduction and such earnings

is also relevant to evaluation of this provision. Similarly, analysis of the extent of accumulated inflationary

gains is likely to be relevant to evaluation of the capital

gains preference for home sales. Deductibility of State

and local property taxes assists with making housing

more affordable as well as easing the cost of providing

community services through these taxes. Provisions intended to promote investment in rental housing could

be evaluated for their effects on making such housing

more available and affordable. These provisions should

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

Transportation.—Employer-provided parking is a

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

taxation. The tax expenditure revenue loss 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 employerprovided 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 grant 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
124 ANALYTICAL PERSPECTIVES

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 the distribution of this coverage across different

income groups. 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. The distribution of employer-provided health

insurance is not readily evident from tax return information; thus, the distribution of benefits from this exclusion must be imputed using tax as well as other

forms of information.

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). In considering

the provisions’ distributional effects, it may be useful

to consider beneficiaries’ incomes while retired and over

their entire lifetimes. Interactions with other programs,

including social security, also may merit analysis. As

in the case of employer-provided health insurance, analysis of employer-provided pension programs requires

imputing the benefits of the firm-level contributions

back to individuals.

Other provisions principally have income distribution,

rather than incentive, effects. 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 distribution of these benefits may be a useful performance

measure. The earned-income tax credit, in contrast,

should be evaluated both for its effects on labor force

participation and its distributional properties.

General purpose fiscal assistance and interest.—

The tax-exemption for public purpose State and local

bonds reduces the costs of borrowing for a variety of

purposes; borrowing for non-public purposes is reflected

under other budget functions. The deductibility of certain State and local taxes reflected under this function

primarily relates to personal income taxes; property tax

deductibility is reflected under the commerce and housing function. Tax preferences for Puerto Rico and other

U.S. possessions are also included here. These provisions can be compared with other tax and spending

policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings

bonds benefits savers who invest in these instruments;

the extent of these benefits and any effects on Federal

borrowing costs could be evaluated.

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

and the many that are not explicitly cited. Developing

a framework that is sufficiently comprehensive, accurate, and flexible to reflect the objectives and effects

of the wide range of tax expenditures will be a significant challenge. OMB, Treasury, and other agencies will

work together, as appropriate, to address this challenge.

Particularly over the next few years, a significant portion of this effort is likely to be devoted to data issues.

Because the compilation of data is resource intensive,

and must be balanced with other objectives (including

minimizing information collection burdens), careful

planning will be essential. Given the challenges inherent in this work, the nature of the analyses is likely

to evolve and improve over the next several years.

Other Considerations

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

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

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

also affect social insurance benefits. Certain targeted

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

an appropriate baseline.

Descriptions of Income Tax Provisions

Descriptions of the individual and corporate income

tax expenditures reported upon in this chapter follow.

National Defense

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.—In 1998, a U.S. citizen

or resident alien who resides or stays overseas for at

least 11 of the past 12 months may exclude $72,000

per year of foreign-earned income. The exclusion limit

increases in $2,000 annual increments until it reaches

$80,000 in 2002. Eligible taxpayers also may exclude

or deduct reasonable housing costs in excess of onesixth of the salary of a civil servant at grade GS-14,
5. TAX EXPENDITURES 125

8Section 911 was also the subject of a January 1993 Treasury report to Congress, ‘‘Taxation of Americans Working Overseas.’’

step 1 ($61,656 in 1998). Federal employees working

abroad are not eligible for the foreign-earned income

exclusion. Federal employees, however, may exclude

certain allowances from their taxable income.

The exclusion for certain income earned abroad was

one of the tax expenditures examined by the Department of the Treasury in its pilot performance evaluations this year. This tax expenditure consists of two

specific components: section 911 of the tax code, which

covers private-sector employees, and section 912, which

covers civilian government employees.8

The benefits for private-sector employees account for

about 85 percent of the combined revenue loss from

the two tax expenditures. The private-sector provision

is intended to promote U.S. exports, help make U.S.

companies competitive when doing business abroad,

and to offset the costs of living abroad, which can be

higher than costs in the United States. Because American workers in higher-tax nations can offset their U.S.

taxes through use of the foreign tax credit, in practice

the provision primarily benefits U.S. citizens who work

in nations with income taxes that are lower than U.S.

taxes. Using tax-return data from 1987, Treasury finds

that 70 percent of the benefit of the provision goes

to taxpayers with income (defined here as adjusted

gross income plus the exclusion) above $50,000; over

98 percent of the housing exclusion, went to this group

of taxpayers.

The provision benefitting civilian government employees is intended to help them maintain their standard

of living when stationed abroad by compensating them

for the higher costs of living abroad. To the extent

that this compensation is carried out via the tax code,

as opposed to agency appropriations, costs are shifted

from outlays to revenue losses.

3. Income of Foreign Sales Corporations.—The

Foreign Sales Corporation (FSC) provisions exempt

from tax a portion of U.S. exporters’ foreign trading

income to reflect the FSC’s sales functions as foreign

corporations. These provisions conform to the General

Agreement on Tariffs and Trade.

4. 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.

5. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled

by U.S. shareholders is not subject to U.S. taxation.

The income becomes taxable only when the controlling

U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal

tax method, the currently attributable foreign source

pre-tax income from such a controlling interest is subject to U.S. taxation, whether or not distributed. Thus,

the normal tax method considers the amount of controlled foreign corporation income not distributed to a

U.S. shareholder as tax-deferred income.

6. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. This provision was originally enacted in the Taxpayer Relief Act

of 1997, was canceled by a line-item veto by the President, and was restored by the Supreme Court decision

declaring the line-item veto unconstitutional.

General Science, Space, and Technology

7. 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.

8. R&E credit.—The research and experimentation

(R&E) credit, which expired on June 30, 1998, was

reinstated (retroactively) in the Tax and Trade Relief

Extension Act of 1998 for one year (through June 30,

1999). The tax credit is 20 percent of qualified research

expenditures in excess of a base amount. The base

amount is generally determined by multiplying a ‘‘fixedbase percentage’’ (limited to a maximum of .16) by the

average amount of the company’s gross receipts for the

1984 to 1988 period. Certain start-up companies are

assigned a fixed-base percentage of .03 for the first

five taxable years, which is gradually phased out in

years 6 through 10 and replaced by the firm’s actual

fixed-base percentage. Taxpayers may also elect an alternative credit regime. Under the alternative credit

regime, the credit rate is reduced and the taxpayer

is assigned a three-tiered fixed-base percentage that

is lower than the fixed-base percentage that would otherwise apply. A credit with a separate threshold is provided for a taxpayer’s payments to universities for basic

research.

Energy

9. 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.
126 ANALYTICAL PERSPECTIVES

10. 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.

11. Alternative fuel production credit.—A nontaxable credit of $3 per barrel (in 1979 dollars) of oilequivalent production is provided for several forms of

alternative fuels. The credit is generally available if

the price of oil stays below $29.50 (in 1979 dollars).

The credit generally expires on December 31, 2002.

Treasury reviewed the nonconventional fuel production tax credit as one of its pilot studies of tax expenditures under the Government Performance and Results

Act. The provision provides a significant credit—currently about $6 per barrel of oil equivalent or $1 per

thousand cubic feet of natural gas, or roughly half of

the wellhead price of gas. Coalbed methane (natural

gas) and gas from tight formations currently account

for most of the credit. While the credit has been effective in stimulating the coalbed methane industry, increased domestic production of natural gas tends to

discourage imports from stable suppliers (in particular,

Canada), so there is relatively little benefit to U.S. energy security. In addition, there are indications that

credit-qualified gas displaced some non-qualified domestic gas.

12. 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.

13. Capital gains treatment of royalties on

coal.—Sales of certain coal under royalty contracts can

be treated as capital gains rather than ordinary income.

14. 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.

15. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for

tertiary oil recovery on U.S. projects. Qualifying costs

include tertiary injectant expenses, intangible drilling

and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property.

16. New technology credits.—A credit of 10 percent

is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from

renewable resources such as wind and biomass. The

renewable resources credit applies only to electricity

produced by a facility placed in service before July 1,

1999.

17. Alcohol fuel credits.—An income tax credit is

provided for ethanol that is derived from renewable

sources and used as fuel. The credit equals 54 cents

per gallon in 1998, 1999, and 2000. The Transportation

Equity Act of the 21st Century made the credit 53

cents per gallon in 2001 and 2002; 52 cents per gallon

in 2003 and 2004; and 51 cents per gallon in 2005,

2006, and 2007. To the extent that ethanol is mixed

with taxable motor fuel to create gasohol, taxpayers

may claim an exemption of the federal excise tax rather

than the income tax credit. In addition, small ethanol

producers are eligible for a separate 10 cents per gallon

credit.

18. Credit and deduction for clean-fuel vehicles

and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles

and owners of clean-fuel refueling property may deduct

part of their expenditures. The credit and deduction

are phased out from 2002 through 2005.

19. Exclusion of utility conservation subsidies.—

Subsidies by public utilities for non-business customer

expenditures on energy conservation measures are excluded from the gross income of the customer.

Natural Resources and Environment

20. 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.

21. Percentage depletion.—Most nonfuel mineral

extractors may use percentage depletion rather than

cost depletion, with percentage depletion rates ranging

from 22 percent for sulphur to 5 percent for sand and

gravel.

22. Sewage, water, and hazardous waste

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.

23. Capital gains treatment of certain timber.—

Certain timber sold under a royalty contract can be

treated as capital gains rather than ordinary income.

24. 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
5. TAX EXPENDITURES 127

9The insolvent taxpayer’s carryover losses and unused credits are extinguished first,

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

the remainder of the forgiven debt is excluded from tax.

costs are capitalized under the uniform capitalization

rules.

25. Credit and seven-year amortization for reforestation.—A 10-percent investment tax credit is allowed for up to $10,000 invested annually to clear land

and plant trees for the production of timber. Up to

$10,000 in forestation investment may also be amortized over a seven-year period rather than capitalized

and deducted when the trees are sold or harvested.

The amount of forestation investment that is amortizable is not reduced by any of the allowable investment

credit.

26. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20-

percent investment credit, but the depreciable basis

must be reduced by the full amount of the credit taken.

Agriculture

27. Expensing certain capital outlays.—Farmers,

except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for

feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though

these expenditures are for inventories held beyond the

end of the year, or for capital improvements that would

otherwise be capitalized.

28. Expensing multiperiod livestock and crop

production costs.—The production of livestock and

crops with a production period of less than two years

is exempt from the uniform cost capitalization rules.

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale

with a production period of two years or more may

elect not to capitalize costs. If they do, they must apply

straight-line depreciation to all depreciable property

they use in farming.

29. Loans forgiven solvent farmers.—Farmers are

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

the property to which the loan relates. If the debtor

elects to reduce basis and the amount of forgiveness

exceeds his basis in the property, the excess forgiveness

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

the amount of loan forgiveness never results in an income tax liability.9 Farmers with forgiven debt are considered insolvent for tax purposes, and thus qualify

for income tax forgiveness.

30. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops,

can be treated as capital gains rather than ordinary

income.

31. Income averaging for farmers.—The Tax and

Trade Relief Extension Act of 1998 permanently extended the provision that allows taxpayers to lower

their tax liability by averaging, over the prior threeyear period, their taxable income from farming. Without

extension, the provision generally would have expired

on December 31, 2000.

32. Deferral of gain on sales of farm refiners.—

A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement

property. This provision was originally enacted in the

Taxpayer Relief Act of 1997, was canceled by a lineitem veto by the President, and was restored by the

Supreme Court decision declaring the line-item veto unconstitutional.

Commerce and Housing

This category includes a number of tax expenditure

provisions that also affect economic activity in other

functional categories. For example, provisions related

to investment, such as accelerated depreciation, could

be classified under the energy, natural resources and

environment, agriculture, or transportation categories.

33. Credit union income.—The earnings of credit

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

34. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings

banks, and savings and loan associations may deduct

additions to bad debt reserves in excess of actually

experienced losses.

35. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided

for investment income within qualified life insurance

and annuity contracts. Investment income earned on

qualified life insurance contracts held until death is

permanently exempt from income tax. Investment income distributed prior to the death of the insured is

tax-deferred, if not tax-exempt. Investment income

earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits

from tax deferral without annual contribution or income

limits generally applicable to other tax-favored retirement income plans.

36. Small property and casualty insurance companies.— Insurance companies that have annual net

premium incomes of less than $350,000 are exempt

from tax; those with $350,000 to $2,100,000 of net premium incomes may elect to pay tax only on the income

earned by their investment portfolio.

37. Insurance companies owned by exempt organizations.—Generally, the income generated by life

and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations

conducted by such exempt organizations as fraternal

societies and voluntary employee benefit associations,

however, are exempt from tax.

38. Small life insurance company deduction.—Small

life insurance companies (gross assets of less than $500

million) can deduct 60 percent of the first $3 million

of otherwise taxable income. The deduction phases out

for otherwise taxable income between $3 million and

$15 million.
128 ANALYTICAL PERSPECTIVES

10For example, if a borrower on December 31, 1997 issues a promise to pay $1,000

plus interest at 10 percent on December 30, 1999, for a total repayment of $1,100 and

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

(a) recognize that $900 is the amount lent, so that the effective loan interest rate is

not the stated 10 percent but is 22.2 percent, and (b) report $200 as interest paid or

received in 1999.

39. Mortgage housing bonds.—Interest earned on

state and local bonds used to finance homes purchased

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of state and local tax-exempt bonds

that can be issued to finance such private activity is

limited. The combined volume cap for mortgage housing

bonds, rental housing bonds, student loan bonds, and

industrial development bonds is $50 per capita ($150

million minimum) per state. The Tax and Trade Relief

Extension Act of 1998 increased the volume cap to $55

per capita ($165 million minimum) in 2003 and ratably

annually thereafter until the cap reaches $75 per capita

($225 million minimum) in 2007. States may issue

mortgage credit certificates (MCCs) in lieu of mortgage

revenue bonds. MCCs entitle home buyers to income

tax credits for a specified percentage of interest on

qualified mortgages. The total amount of MCCs issued

by a state cannot exceed 25 percent of its annual ceiling

for mortgage-revenue bonds.

40. Rental housing bonds.—Interest earned on

state and local government bonds used to finance multifamily rental housing projects is tax-exempt. At least

20 percent (15 percent in targeted areas) of the units

must be reserved for families whose income does not

exceed 50 percent of the area’s median income; or 40

percent for families with incomes of no more than 60

percent of the area median income. Other tax-exempt

bonds for multifamily rental projects are generally

issued with the requirement that all tenants must be

low or moderate income families. Rental housing bonds

are subject to the volume cap discussed in the mortgage

housing bond section above.

41. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on

their primary and secondary residences as itemized

nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the

owner’s basis in the residence and, for debt incurred

after October 13, 1987, it is limited to no more than

$1 million. Interest on up to $100,000 of other debt

secured by a lien on a principal or second residence

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market

value of the residence. Mortgage interest deductions

on personal residences are tax expenditures because

the taxpayers are not required to report the value of

owner-occupied housing services as gross income.

42. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their

primary and secondary residences even though they are

not required to report the value of owner-occupied housing services as gross income.

43. Installment sales.—Dealers in real and personal

property (i.e., sellers that 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

$5,000,000 is, therefore, a tax expenditure.

44. Capital gains exclusion on home sales.—A

homeowner can exclude from tax up to $500,000

($250,000 for singles) of the capital gains from the sale

of a principal residence. The exclusion may not be used

more than once every two years.

45. Passive loss real estate exemption.—In general, passive losses may not offset income from other

sources. Losses up to $25,000 attributable to certain

rental real estate activity, however, are exempt from

this rule.

46. Low-income housing credit.—Taxpayers who

invest in certain low-income housing are eligible for

a tax credit. The credit rate is set so that the present

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other

Federal benefits (such as tax-exempt bond financing),

or (2) substantially rehabilitated existing housing. The

credit is allowed in equal amounts over 10 years. State

agencies determine who receives the credit; states are

limited in the amount of credit they may authorize

annually to $1.25 per resident.

47. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of

the reference law rules, and thus do not cause tax

expenditures under the reference method. Under the

normal tax method, however, a 40-year tax life for depreciable real property is the norm. Thus, statutory

depreciation period for rental property of 27.5 years

is a tax expenditure. In addition, tax expenditures arise

from pre-1987 tax allowances for rental property.

48. Cancellation of indebtedness.—Individuals are

not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not

reported as current income, however, the basis of the

underlying property must be reduced by the amount

canceled.

49. Imputed interest rules.—Holders (issuers) of

debt instruments are generally required to report interest earned (paid) in the period it accrues, not when

paid. In addition, the amount of interest accrued is

determined by the actual price paid, not by the stated

principal and interest stipulated in the instrument.10

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
5. TAX EXPENDITURES 129

farms and small businesses worth between $250,000

and $1 million.

50. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held

for more than 1 year are taxed at a lower rate than

ordinary income. The lower rate on capital gains is

considered a tax expenditure under the normal tax

method but not under the reference law method.

For assets held for more than 1 year and sold after

December 31, 1997, the top tax rate is 20 percent (10

percent for taxpayers who would otherwise pay capital

gains tax at the 15-percent rate). The IRS Restructuring and Reform Act of 1998 eliminated the 28-percent

capital gains rate by lowering the holding period for

the 20-percent capital gains rate from 15 years to 1

year.

In addition, for assets acquired after December 31,

2000, the maximum capital gains tax rates for assets

held more than 5 years are 8 percent and 18 percent

(rather than 10 percent and 20 percent). On January

1, 2001, taxpayers may mark-to-market existing assets

to start the 5-year holding period.

51. Capital gains exclusion for small business

stock.—An exclusion of 50 percent is provided for capital gains from qualified small business stock held by

individuals for more than 5 years. A qualified small

business is a corporation whose gross assets do not

exceed $50 million as of the date of issuance of the

stock.

52. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are

not subject to capital gains taxes. The cost basis of

the appreciated assets is adjusted upward to the market value at the owner’s date of death. The step-up

in the heir’s cost basis means that, in effect, the tax

on the capital gain is forgiven.

53. Carryover basis of capital gains on gifts.—

When a gift is made, the transferred property carries

to the donee the donor’s basis—the cost that was incurred when the property was first acquired. The carryover of the donor’s basis allows a continued deferral

of unrealized capital gains.

54. Ordinary income treatment of losses from

sale of small business corporate stock shares.—

Up to $100,000 in losses from the sale of small business

corporate stock (capitalization less than $1 million) may

be treated as ordinary losses. Such losses would, thus,

not be subject to the $3,000 annual capital loss writeoff limit.

55. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus

do not cause tax expenditures under reference law.

Under normal law, however, a 40-year life for nonrental-housing buildings is the norm. Thus, the 39-year

depreciation period for property placed in service after

February 25, 1993, the 31.5-year depreciation period

for property placed in service from 1987 to February

25, 1993, and the pre-1987 depreciation periods create

a tax expenditure.

56. Accelerated depreciation of machinery and

equipment.—The tax depreciation allowance provisions

are part of the reference law rules, and thus do not

cause tax expenditures under reference law. Statutory

depreciation of machinery and equipment, however, is

accelerated somewhat relative to the normal tax baseline, creating a tax expenditure.

57. Expensing of certain small investments.—In

1998, qualifying investments in tangible property up

to $18,500 can be expensed rather than depreciated

over time. (The expensing limit increases annually until

2003, when it reaches $25,000). To the extent that

qualifying investment during the year exceeds

$200,000, the amount eligible for expensing is decreased. In 1998, the amount expensed is completely

phased out when qualifying investments exceed

$218,500.

58. Business start-up costs.—When taxpayers enter

into a new business, certain start-up expenses, such

as the cost of legal services, are normally incurred.

Taxpayers may elect to amortize these outlays over 60

months even though they are similar to other payments

made for nondepreciable intangible assets that are not

recoverable until the business is sold. The normal tax

method treats this amortization as a tax expenditure;

the reference tax method does not.

59. Graduated corporation income tax rate

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000

of taxable income, 25 percent on the next $25,000, and

34 percent on the next $9.925 million. Compared with

a flat 34-percent rate, the lower rates provide an

$11,750 reduction in tax liability for corporations with

taxable income of $10 million. This benefit is recaptured for corporations with taxable incomes exceeding

$100,000 by a 5-percent additional tax on corporate

incomes in excess of $100,000, but less than $335,000.

The corporate tax rate is 35 percent on income over

$10 million. Compared with a flat 35-percent tax rate,

the 34-percent rate provides a $100,000 reduction in

tax liability for corporations with taxable incomes of

$10 million. This benefit is recaptured for corporations

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but

less than $18.33 million. Because the corporate rate

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method.

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower

rates is considered a tax expenditure under this concept.

60. Small issue industrial development bonds.—

Interest earned on small issue industrial development

bonds (IDBs) issued by state and local governments

to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must

be depreciated, however, using the straight-line method.

The annual volume of small issue IDBs is subject to

the unified volume cap discussed in the mortgage housing bond section above.
130 ANALYTICAL PERSPECTIVES

Transportation

61. Deferral of tax on U.S. shipping companies.—

Certain companies that operate U.S. flag vessels can

defer income taxes on that portion of their income used

for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment

of loans to finance these investments. Once indefinite,

the deferral has been limited to 25 years since January

1, 1987.62. Exclusion of reimbursed employee parking expenses.—Parking at or near an employer’s business premises that is paid for by the employer is excludable from the income of the employee. In 1998,

the maximum amount of the parking exclusion is $175

(indexed, except in 1999) per month. The tax expenditure estimate does not include parking at facilities

owned by the employer.

63. Exclusion of employer-provided transit

passes.—Transit passes, tokens, and fare cards provided by an employer to defray an employee’s commuting costs are excludable from the employee’s income

if the total value of the benefit does not exceed the

transit limit. In 1998, the limit is $65 (indexed, except

in 1999) per month.

Community and Regional Development

64. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation

of buildings that are used for business or productive

activities and that were erected before 1936 for other

than residential purposes. The taxpayer’s recoverable

basis must be reduced by the amount of the credit.

65. Airport, dock, and similar facility bonds.—

Interest earned on state and local bonds issued to finance high-speed rail facilities and government-owned

airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to

a volume cap.

66. Exemption of income of mutuals and cooperatives.—The incomes of mutual and cooperative telephone and electric companies are exempt from tax if

at least 85 percent of their revenues are derived from

patron service charges.

67. Empowerment zones and enterprise 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, and

accelerated depreciation. A tax credit for contributions

to certain community development corporations can also

be available. In addition, certain first-time buyers of

a principal residence in the District of Columbia can

receive a tax credit, and investors in certain D.C. property can receive a capital gains break.

68. Expensing of environmental remediation

costs.— Taxpayers who clean up hazardous substances

at a qualified site may expense the clean-up costs, rather than capitalize the costs, even though the expenses

will generally increase the value of the property significantly or appreciably prolong the life of the property.

he expensing only applies to clean-up costs incurred

after August 5, 1997 and before January 1, 2001.

Education, Training, Employment, and Social

Services

69. 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).

70. HOPE tax credit.— The non-refundable HOPE

tax credit allows a credit for 100 percent of an eligible

student’s first $1,000 of tuition and fees and 50 percent

of the next $1,000 of tuition and fees. The credit only

covers tuition and fees paid during the first two years

of a student’s post-secondary education. The credit is

phased out ratably for taxpayers with modified AGI

between $80,000 and $100,000 ($40,000 and $50,000

for singles).

71. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for

20 percent of an eligible student’s tuition and fees. For

tuition and fees paid between July 1, 1998 and December 31, 2002, the maximum credit per return is $1,000.

For tuition and fees paid after December 31, 2002, the

maximum credit per return is $2,000. The credit is

phased out ratably for taxpayers with modified AGI

between $80,000 and $100,000 ($40,000 and $50,000

for singles). The credit applies to both undergraduate

and graduate students.

72. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is

not taxed when earned, and investment income from

an education IRA is tax-exempt when withdrawn to

pay for a student’s tuition and fees. The maximum contribution to an education IRA is $500 per year per

beneficiary. The maximum contribution is phased down

ratably for taxpayers with modified AGI between

$150,000 and $160,000 ($95,000 and $110,000 for singles). Contributions may not be made to an education

IRA in any year in which a contribution has been made

to a state tuition plan for the same beneficiary.

73. Student-loan interest.—Taxpayers may claim

an above-the-line deduction of up to $2,500 ($1,000 in

1998, $1,500 in 1999, and $2,000 in 2000) on interest

paid on an education loan. Interest may only be deducted for the first five years in which interest pay-
5. TAX EXPENDITURES 131

ments are required. The maximum deduction is phased

down ratably for taxpayers with modified AGI between

$60,000 and $75,000 ($40,000 and $55,000 for singles).

Only interest paid and due after December 31, 1997

may be deducted.

74. State prepaid tuition plans.—Some states have

adopted prepaid tuition plans and prepaid room and

board plans, which allow persons to pay in advance

for college expenses for designated beneficiaries. Taxes

on the earnings from these plans are paid by the beneficiaries and are deferred until the tuition is actually

paid.

75. 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.

76. 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. The aggregate volume of all such private

activity bonds that each state may issue during any

calendar year is limited.

77. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds

receive a non-refundable tax credit rather than interest.

The credit is included in gross income. Proceeds from

zone academy bonds may only be use to improve impoverished schools. The total amount of zone academy

bonds that may be issued is limited to $800 million;

no bonds may be issued before January 1, 1998.

78. 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 $78,350 and $108,350 ($52,250 and

$67,250 for singles) in 1998.

79. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent

children age 19 or over who (1) receive parental support

payments of $1,000 or more per year, (2) are full-time

students, and (3) do not claim a personal exemption

on their own tax returns.

80. Child credit.—Taxpayers with children under

age 17 can qualify for a $500 child credit beginning

January 1, 1999 ($400 in 1998). The credit is phased

out for taxpayers at the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 for singles). The child

credit is refundable for taxpayers with three or more

children.

81. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the assets’ current value without being taxed on

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent

of adjusted gross income; a corporation’s total charitable

contributions generally may not exceed 10 percent of

pre-tax income.

82. Employer-provided educational assistance.—

Employer-provided educational assistance is excluded

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. This exclusion applies only to non-graduate courses beginning before July 1, 2000.

83. Work opportunity tax credit.—Employers can

claim a tax credit for qualified wages paid to individuals who begin work after September 30, 1996 and

before July 1, 1999 and who are certified as members

of various targeted groups. The Tax and Trade Relief

Extension Act of 1998 extended the expiration date

from July 1, 1998 to July 1, 1999. For employees hired

before October 1, 1997, the amount of the credit that

can be claimed is 35 percent of the first $6,000 paid

during the first year of employment. For employees

hired after September 30, 1997, the credit is 25 percent

for employment of less than 400 hours and 40 percent

for employment of 400 hours or more. Employers must

reduce their deduction for wages paid by the amount

of the credit claimed.

84. 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

after December 31, 1997 and before July 1, 1999. The

Tax and Trade Relief Extension Act of 1998 extended

the expiration date from May 1, 1999 to July 1, 1999.

85. Employer-provided child care.—Employer-provided child care is excluded from an employee’s gross

income even though the employer’s costs for the child

care are a deductible business expense.

86. Adoption credit and exclusion.—Taxpayers can

receive a nonrefundable tax credit for qualified adoption

expenses. The maximum credit is $5,000 per child

($6,000 for special needs adoptions, except foreign adoptions). The credit is phased-out ratably for taxpayers

with modified AGI between $75,000 and $115,000. Unused credits may be carried forward. In lieu of the

tax credit, taxpayers may exclude qualified adoption

expenses from income, subject to the same maximum

amounts and phase-out as the credit. The non-special

needs adoption assistance and foreign special needs assistance expire on December 31, 2001.

87. 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.

88. 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 divorced or separated
132 ANALYTICAL PERSPECTIVES

parents who have custody of children, and by single

parents. Expenditures up to a maximum $2,400 for one

dependent and $4,800 for two or more dependents are

eligible for the credit. The credit is equal to 30 percent

of qualified expenditures for taxpayers with incomes

of $10,000 or less. The credit is reduced to a minimum

of 20 percent by one percentage point for each $2,000

of income between $10,000 and $28,000.

89. 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.

90. Expensing costs of removing architectural

barriers.—Taxpayers can expense (up to $15,000 annually) the cost of removing architectural barriers to the

handicapped rather than depreciate the cost over the

useful life of the asset.

91. 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.

92. 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.

93. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income.

Health

94. 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.

95. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums.

Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 45 percent in 1998, 60 percent in

1999 through 2001, 70 percent in 2002, and 100 percent

in 2003 and thereafter.

96. Workers’ compensation insurance premiums.—Workers’ compensation insurance premiums

are paid by employers and deducted as a business expense, but the premiums are not included in employee

gross income.

97. Medical savings accounts.—Some employees

may deduct annual contributions to a medical savings

account (MSA); employer contributions to MSAs (except

those made through cafeteria plans) for qualified employees are also excluded from income. An employee

may contribute to an MSA in a given year only if the

employer does not contribute to the MSA in that year.

MSAs are only available to self-employed individuals

or employees covered under an employer-sponsored high

deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the

deductible under the high deductible plan for family

coverage (65 percent for individual coverage). Earnings

from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No

new MSAs may be established after December 31, 2000.

98. 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.

99. Hospital construction bonds.—Interest earned

on state and local government debt issued to finance

hospital construction is excluded from income subject

to tax.

100. 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.

101. 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.

102. Blue Cross and Blue Shield.—Blue Cross and

Blue Shield health insurance providers in existence on

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that

substantially reduce (or even eliminate) their tax liabilities.

Income Security

103. 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.

104. Workers’ compensation benefits.—Workers—

compensation provides payments to disabled workers.

These benefits, although income to the recipients, are

not subject to the income tax.

Treasury reviewed the Federal income tax exemption

for workers’ compensation wage replacement benefits

as one of its pilot analyses of tax expenditures. Workers’ compensation programs, with the principal exception of the program covering Federal employees, are
5. TAX EXPENDITURES 133

State programs that do not have to conform to any

national criteria. While the legislative history does not

explain the goal of the tax exemption, the exemption

has the effect of reducing taxes on families with unexpected losses of earnings from work-related injuries or

death. Because the tax exemption may have been considered in setting the levels of benefits mandated by

State laws, the net benefit of the tax exemption to

recipients is uncertain.

105. 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.

106. 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.

107. Military disability pensions.—Most of the

military pension income received by current disabled

retired veterans is excluded from their income subject

to tax.

108. 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.

109. 401(k) plans and Individual Retirement Accounts.—Individual taxpayers can take advantage of

several different tax-preferenced retirement plans: deductible IRAs, non-deductible IRAs, Roth IRAs, and

401(k) plans (and 401(k)-type plans like 403(b) plans

and the government’s Thrift Savings Plan).

In 1998, an employee could exclude up to $10,000

(indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k). Employees can annually contribute to a deductible IRA up to $2,000 (or

100 percent of compensation, if less) or $4,000 on a

joint return with only one working spouse if: (a) neither

the individual nor spouse is an active participant in

an employer-provided retirement plan, or (b) their AGI

is below $40,000 ($25,000 for singles). The IRA deduction is phased out for taxpayers with AGI between

$50,000 and $60,000 ($30,000 and $40,000 for singles).

The phase-out range increases annually until it reaches

$80,000 to $100,000 in 2007 ($50,000 to $60,000 for

singles). Taxpayers whose AGI is above the start of

the IRA phase-out range or who are active participants

in an employer-provided retirement plan can contribute

to a non-deductible IRA. The tax on the investment

income earned by 401(k) plans, non-deductible IRAs,

and deductible IRAs is deferred until the money is

withdrawn.

An employed taxpayer can make a non-deductible

contribution of up to $2,000 (a non-employed spouse

can also contribute up to $2,000 if a joint return is

filed) to a Roth IRA. Investment income of a Roth IRA

is not taxed when earned. Withdrawals from a Roth

IRA are tax free if (1) the Roth IRA was opened at

least 5 years before the withdrawal, and (2) the taxpayer either (a) is at least 59–1⁄2, (b) dies, (c) is disabled, or (d) purchases a first-time house. The maximum contribution to a Roth IRA is phased out for taxpayers with AGI between $150,000 and $160,000

($95,000 and $110,000 for singles). Total annual contributions to a taxpayer’s deductible, non-deductible,

and Roth IRAs cannot exceed $2,000 ($4,000 for joints).

110. Keogh plans.—Self-employed individuals can

make deductible contributions to their own retirement

(Keogh) plans equal to 25 percent of their income, up

to a maximum of $30,000 per year. In addition, the

tax on the investment income earned by Keogh plans

is deferred until the money is withdrawn.

111. 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.

112. 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.

113. Employer-provided supplementary unemployment benefits.—Employer-provided supplementary unemployment benefits are excluded from an

employee’s gross income even though the employer’s

costs for the benefits are a deductible business expense.

114. 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.

115. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,000

standard deduction if single, or $800 if married.

116. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,000 standard deduction if single, or $800 if

married.

117. 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
134 ANALYTICAL PERSPECTIVES

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.

118. 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.

119. Earned income tax credit (EITC).—The EITC

may be claimed by low income workers. For a family

with one qualifying child, the credit is 34 percent of

the first $6,680 of earned income in 1998. The credit

is 40 percent of the first $9,390 of income for a family

with two or more qualifying children. When the taxpayer’s income exceeds $12,260, the credit is phased

out at the rate of 15.98 percent (21.06 percent if two

or more qualifying children are present). It is completely phased out at $26,473 of modified adjusted gross

income ($30,095 if two or more qualifying children are

present).

The credit may also be claimed by workers who do

not have children living with them. Qualifying workers

must be at least age 25 and may not be claimed as

a dependent on another taxpayer’s return. The credit

is not available to workers age 65 or older. In 1997,

the credit is 7.65 percent of the first $4,460 of earned

income. When the taxpayer’s income exceeds $5,570,

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

It is completely phased out at $10,030 of modified adjusted gross income.

For workers with or without children, the income

level at which the credit’s phase-outs begin and the

maximum amounts of income on which the credit can

be taken are adjusted for inflation. Earned income tax

credits in excess of tax liabilities owed through the

individual income tax system are refundable to individuals. This portion of the credit is shown as an outlay,

while the amount that offsets tax liabilities is shown

as a tax expenditure.

Social Security

120. Social Security benefits for retired workers.—Social security benefits that exceed the beneficiary’s contributions out of taxed income are deferred

employee compensation and the deferral of tax on that

compensation is a tax expenditure. These additional

retirement benefits are paid for partly by employers’

contributions that were not included in employees’ taxable compensation. Portions (reaching as much as 85

percent) of recipients’ social security and tier 1 railroad

retirement benefits are included in the income tax base,

however, if the recipient’s provisional income exceeds

certain base amounts. Provisional income is equal to

adjusted gross income plus foreign or U.S. possession

income and tax-exempt interest, and one half of social

security and tier 1 railroad retirement benefits. The

tax expenditure is limited to the portion of the benefits

received by taxpayers who are below the base amounts

at which 85 percent of the benefits are taxable.

121. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund,

for disability and for dependents and survivors, are excluded from the beneficiaries’ gross incomes.

122. Social Security benefits for dependents and

survivors.—Benefit payments from the Social Security

Trust Fund for dependents and survivors are excluded

from the beneficiaries’ gross income.

Veterans Benefits and Services

123. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded

from taxable income.

124. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income.

125. G.I. Bill benefits.—G.I. Bill benefits paid by

the Veterans Administration are excluded from gross

income.

126. 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

127. 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) is tax-exempt.

128. 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.

129. Business income earned in U.S. possessions.—U.S. corporations receiving income from investments or businesses located in a U.S. possession (e.g.,

Puerto Rico) can claim a credit against U.S. tax, which

effectively excludes some of this income from tax. The

credit expires December 31, 2005.

Interest

130. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until

the bonds are redeemed.
5. TAX EXPENDITURES 135

11 An additional tax, at a flat rate of 55 percent, is imposed on lifetime, generationskipping transfers in excess of $1 million. It is considered a generation-skipping transfer

whenever the transferee is at least two generations younger than the transferor, as it

would be in the case of transfers to grandchildren or great-grandchildren. The liability

of this tax is on the recipients of the transfer.

TAX EXPENDITURES IN THE UNIFIED TRANSFER TAX

Exceptions to the general terms of the Federal unified

transfer tax favor particular transferees or dispositions

of transferors, similar to Federal direct expenditure or

loan programs. The transfer tax provisions identified

as tax expenditures satisfy the reference law criteria

for inclusion in the tax expenditure budget that were

described above. There is no generally accepted normal

tax baseline for transfer taxes.

Unified Transfer Tax Reference Rules

The reference tax rules for the unified transfer tax

from which departures represent tax expenditures include:

• Definition of the taxpaying unit. The payment of

the tax is the liability of the transferor whether

the transfer of cash or property was made by gift

or bequest.

• Definition of the tax base. The base for the tax

is the transferor’s cumulative, taxable lifetime

gifts made plus the net estate at death. Gifts in

the tax base are all annual transfers in excess

of $10,000 to any donee except the donor’s spouse.

Excluded are, however, payments on behalf of

family members’ educational and medical expenses, as well as the cost of ceremonial gatherings and celebrations that are not in honor of

the donor.

• Property valuation. In general, property is valued

at its fair market value at the time it is transferred. This is not necessarily the case in the valuation of property for transfer tax purposes. Executors of estates are provided the option to value

assets at the time of the testator’s death or up

to six months later.

• Tax rate schedule. A single graduated tax rate

schedule applies to all taxable transfers. This is

reflected in the name of the ‘‘unified transfer tax’’

that has replaced the former separate gift and

estate taxes. The tax rates vary from 18 percent

on the first $10,000 of aggregate taxable transfers,

to 55 percent on amounts exceeding $3 million.

A lifetime credit is provided against the tax in

determining the final amount of transfer taxes

that are due and payable. For decedents dying

in 1998, this credit allows each taxpayer to make

a $625,000 tax-free transfer of assets that otherwise would be liable to the unified transfer tax.

This figure is scheduled to increase in steps to

$1 million in 2005.11

• Time when tax is due and payable. Donors are

required to pay the tax annually as gifts are

made. The generation-skipping transfer tax is payable by the donees whenever they accede to the

gift. The net estate tax liability is due and payable

within nine months after the decedent’s death.

The Internal Revenue Service may grant an extension of up to 10 years for a reasonable cause.

Interest is charged on the unpaid tax liability at

a rate equal to the cost of Federal short-term borrowing, plus three percentage points.

Tax Expenditures by Function

The estimates of tax expenditures in the Federal unified transfer tax for fiscal years 1998–2004 are displayed by functional category in table 5–6. Outlay

equivalent estimates are similar to revenue loss estimates for transfer tax expenditures and, therefore, are

not shown separately. A description of the provisions

follows.

Natural Resources and Environment

1. Donations of conservation easements.—Bequests of property and easements (in perpetuity) for

conservation purposes can be excluded from taxable estates. Use of the property and easements must be restricted to at least one of the following purposes: outdoor recreation or scenic enjoyment for the general public; protection of the natural habitats of fish, wildlife,

plants, etc.; and preservation of historic land areas and

structures. Conservation gifts are similarly excluded

from the gift tax. Up to 40 percent of the value of

land subject to certain conservation easements may be

excluded from taxable estates; the maximum amount

of the exclusion is $100,000 in 1998 and increases by

$100,000 in each year through 2002.

Agriculture

2. Special-use valuation of farms.—Up to $750,000

in farmland owned and operated by a decedent and/

or a member of the family may be valued for estate

tax purposes on the basis of its ‘‘continued use’’ as

farmland if: (1) the value of the farmland is at least

25 percent of the gross estate; (2) the entire value of

all farm property is at least 50 percent of the gross

estate; and (3) family heirs to the farm agree to continue to operate the property as a farm for at least

10 years. The $750,000 limit is indexed at 1998 levels,

beginning in 1999.

3. Tax deferral of closely held farms.—The tax

on a decedent’s farm can be deferred for up to 14 years

if the value of the farm is at least 35 percent of the

net estate. For the first 4 years of deferral, no tax

need be paid. During the last 10 years of deferral, the

tax liability must be paid in equal annual installments.

Throughout the 14 year period, interest is charged at

a special, favorable rate. For estates of decedents dying

after December 31, 1997, the applicable interest rates

are lower and the interest is non-deductible.

Commerce and Housing

4. Special-use valuation of closely-held businesses.—The special-use valuation rule available for
136 ANALYTICAL PERSPECTIVES

family farms is also available for nonfarm family businesses. To be eligible for the special-use valuation, the

same three conditions previously described must be

met.

5. Tax deferral of closely-held businesses.—The

tax-deferral rule available for family farms is also available for nonfarm family businesses. To be eligible for

the tax deferral, the value of stock in closely-held corporations must exceed 35 percent of the decedent’s

gross estate, less debt and funeral expenses.

6. Exclusion for family-owned businesses.—Certain family-owned businesses that are bequeathed to

qualified heirs can be excluded from taxable estates.

The exclusion generally cannot exceed $1.3 million less

the value of the unified credit. The exclusion is recaptured if certain conditions are not maintained for 10

years.

Education, Training, Employment, and Social

Services

7. Charitable contributions to educational institutions.—Bequests to educational institutions can be

deducted from taxable estates.

8. Charitable contributions, other than education and health.— Bequests to charitable, religious,

and certain other nonprofit organizations can be deducted from taxable estates.

Health

9. Charitable contributions to health institutions.—Bequests to health institutions can be deducted

from taxable estates.

General Government

10. State and local death taxes.—A credit against

the federal estate tax is allowed for State taxes on

bequests. The amount of this credit is determined by

a rate schedule that reaches a maximum of 16 percent

of the taxable estate in excess of $60,000.

Table 5–6. REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED TRANSFER TAX

(In millions of dollars)

Description 1998 1999 2000 2001 2002 2003 2004 2000–

2004

Natural Resources and Environment:

1 Donations of conservation easements .......................................................... 0 10 25 40 55 75 95 290

Agriculture:

2 Special use valuation of farm real property .................................................. 80 95 110 115 120 125 135 605

3 Tax deferral of closely held farms ................................................................. 0 0 0 5 5 10 10 30

Commerce:

4 Special use valuation of real property used in closely held businesses ..... 5 5 5 5 5 10 10 35

5 Tax deferral of closely held business ........................................................... 15 0 10 20 30 50 65 175

6 Exclusion for family owned businesses ........................................................ 0 490 490 495 525 530 555 2,595

Education, training, employment, and social services:

7 Deduction for charitable contributions (education) ........................................ 1,115 1,195 1,245 1,305 1,395 1,470 1,560 6,975

8 Deduction for charitable contributions (other than education and health) ... 3,295 3,525 3,670 3,850 4,115 4,345 4,605 20,585

Health:

9 Deduction for charitable contributions (health) ............................................. 1,010 1,080 1,125 1,180 1,260 1,330 1,410 6,305

General government:

10 Credit for State death taxes .......................................................................... 4,650 4,970 5,175 5,410 5,670 5,965 6,200 28,420