285

18. TAX EXPENDITURES 

The Congressional Budget Act of 1974 (Public Law 

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

included in the budget. Tax expenditures are defined 

in the law as ‘‘revenue losses attributable to provisions 

of the Federal tax laws which allow a special exclusion, 

exemption, or deduction from gross income or which 

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

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

as alternatives to other policy instruments, such as 

spending or regulatory programs. Identification and 

measurement of tax expenditures depends importantly 

on the baseline tax system against which the actual 

tax system is compared. 

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

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

contributions for medical insurance, capital gains, and 

payments of State and local individual income and 

property taxes. Reported tax expenditures under the 

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

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

Each tax expenditure estimate in this chapter was 

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

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

interactions among provisions. For that reason, this 

chapter does not present a grand total for the estimated 

tax expenditures. Moreover, past tax changes entailing 

broad elimination of tax expenditures were generally 

accompanied by changes in tax rates or other basic 

provisions, so that the net effects on Federal revenues 

were considerably (if not totally) offset. 

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

2003–2009 using three methods of accounting: revenue 

effects, outlay equivalent, and present value. The 

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

deferrals of tax payments into the future. 

The section of the chapter on performance measures 

and economic effects presents information related to 

assessment of the effect of tax expenditures on the 

achievement of program performance goals. This section 

is a complement to the Government-wide performance 

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

The 2004 Budget included a thorough review of important ambiguities in the tax expenditure concept. In 

particular, this review focused on defining tax expenditures relative to a comprehensive income tax baseline, 

defining tax expenditures relative to a broad-based consumption tax baseline, and defining negative tax expenditures, i.e., provisions of current law that overtax certain items or activities. This review has been 

updated and is presented in the Appendix. 

TAX EXPENDITURES IN THE INCOME TAX 

Tax Expenditure Estimates 

All tax expenditure estimates presented here are 

based upon current tax law enacted as of December 

31, 2003. Expired or repealed provisions are not listed 

if their revenue effects result only from taxpayer activity occurring before fiscal year 2003. Due to the time 

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

assumptions; exceptions are the earned income tax 

credit and child credit provisions, which involve outlay 

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

The total revenue effects for tax expenditures for fiscal years 2003–2009 are displayed according to the 

budget’s functional categories in Table 18–1. Descriptions of the specific tax expenditure provisions follow 

the tables of estimates and the discussion of general 

features of the tax expenditure concept. 

As in prior years, two baseline concepts—the normal 

tax baseline and the reference tax law baseline—are 

used to identify tax expenditures. These baseline concepts are thoroughly discussed in Special Analysis G 

of the 1985 Budget, where the former is referred to 

as the pre-1983 method, and the latter the post-1982 

method. For the most part, the two concepts coincide. 

However, items treated as tax expenditures under the 

normal tax baseline, but not the reference tax law baseline, are indicated by the designation ‘‘normal tax method’’ in the tables. The revenue effects for these items 

are zero using the reference tax rules. The alternative 

baseline concepts are discussed in detail following the 

tables. 

Table 18–2 reports the respective portions of the total 

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

not imply that these categories of filers benefit from 

the special tax provisions in proportion to the respective 

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

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

capital, depending on economic forces. 

Table 18–3 ranks the major tax expenditures by the 

size of their FY 2005–2009 revenue effect. 

Interpreting Tax Expenditure Estimates 

The estimates shown for individual tax expenditures 

in Tables 18–1, 18–2, and 18–3 do not necessarily equal 

the increase in Federal revenues (or the change in the 

budget balance) that would result from repealing these 

special provisions, for the following reasons: 

Eliminating a tax expenditure may have incentive 

effects that alter economic behavior. These incentives 

can affect the resulting magnitudes of the activity or 

of other tax provisions or Government programs. For 

example, if capital gains were taxed at ordinary rates, 

capital gain realizations would be expected to decline, 

potentially resulting in a decline in tax receipts. Such 

behavioral effects are not reflected in the estimates. 

Tax expenditures are interdependent even without 

incentive effects. Repeal of a tax expenditure provision 

can increase or decrease the tax revenues associated 

with other provisions. For example, even if behavior 

does not change, repeal of an itemized deduction could 

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

brackets. Alternatively, repeal of an itemized deduction 

could lower the revenue cost from other deductions if 

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

repealed simultaneously, the increase in tax liability 

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

estimates reported in Table 18–1 are the totals of individual and corporate income tax revenue effects reported in Table 18–2 and do not reflect any possible 

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

Table 18–1 (as well as those in Table 18–5, which are 

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

Present-Value Estimates 

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

Table 18–4. Cash-based estimates reflect the difference 

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

from prior years. Although such estimates are useful 

as a measure of cash flows into the Government, they 

do not accurately reflect the true economic cost of these 

provisions. For example, for a provision where activity 

levels have changed, so that incoming tax receipts from 

past deferrals are greater than deferred receipts from 

new activity, the cash-basis tax expenditure estimate 

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

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

deferral provision, a cash-based estimate can overstate 

the real effect on receipts to the Government because 

the newly deferred taxes will ultimately be received. 

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

Discounted present-value estimates of revenue effects 

are presented in Table 18–4 for certain provisions that 

involve tax deferrals or other long-term revenue effects. 

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

The present-value estimates represent the revenue 

effects, net of future tax payments, that follow from 

activities undertaken during calendar year 2003 which 

cause the deferrals or other long-term revenue effects. 

For instance, a pension contribution in 2003 would 

cause a deferral of tax payments on wages in 2003 

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

the 2003 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.
18. TAX EXPENDITURES 287

Table 18–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 

(in millions of dollars) 

Total from corporations and individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ........................................................... 2,210 2,240 2,260 2,290 2,310 2,330 2,350 11,540

International Affairs 

2 Exclusion of income earned abroad by U.S. citizens ............................................................................... 2,620 2,680 2,750 2,810 2,940 3,100 3,270 14,870

3 Exclusion of certain allowances for Federal employees abroad .............................................................. 770 800 840 880 920 960 1,010 4,610

4 Extraterritorial income exclusion ................................................................................................................ 5,150 5,510 5,890 6,290 6,730 7,200 7,700 33,810

5 Inventory property sales source rules exception ....................................................................................... 1,540 1,620 1,700 1,790 1,880 1,980 2,080 9,430

6 Deferral of income from controlled foreign corporations (normal tax method) ........................................ 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010

7 Deferred taxes for financial firms on certain income earned overseas ................................................... 2,050 2,130 2,190 2,260 960 .............. .............. 5,410

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) ..................................... –1,980 –2,350 4,500 8,290 7,110 6,360 5,570 31,830

9 Credit for increasing research activities ..................................................................................................... 4,960 4,400 2,550 1,090 460 150 60 4,310

Energy 

10 Expensing of exploration and development costs, fuels ........................................................................... 210 270 170 80 70 60 40 420

11 Excess of percentage over cost depletion, fuels ...................................................................................... 640 620 580 590 610 610 610 3,000

12 Alternative fuel production credit ................................................................................................................ 1,280 890 890 890 890 350 .............. 3,020

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

14 Capital gains treatment of royalties on coal .............................................................................................. 100 110 120 120 130 130 140 640

15 Exclusion of interest on energy facility bonds ........................................................................................... 90 100 110 110 120 130 130 600

16 Enhanced oil recovery credit ...................................................................................................................... 400 400 410 420 430 440 450 2,150

17 New technology credit ................................................................................................................................ 280 350 370 370 370 370 370 1,850

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

19 Tax credit and deduction for clean-fuel burning vehicles ......................................................................... 70 60 10 –20 –70 –60 –70 –210

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

Natural Resources and Environment 

21 Expensing of exploration and development costs, nonfuel minerals ....................................................... 10 10 10 10 10 10 10 50

22 Excess of percentage over cost depletion, nonfuel minerals ................................................................... 250 250 260 260 270 280 280 1,350

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ................................ 450 490 530 570 590 630 650 2,970

24 Capital gains treatment of certain timber income ..................................................................................... 100 110 120 120 130 130 140 640

25 Expensing of multiperiod timber growing costs ......................................................................................... 340 340 350 370 380 400 410 1,910

26 Tax incentives for preservation of historic structures ............................................................................... 270 290 300 320 330 340 370 1,660

Agriculture 

27 Expensing of certain capital outlays .......................................................................................................... 120 130 130 130 140 150 160 710

28 Expensing of certain multiperiod production costs .................................................................................... 90 90 90 100 100 100 100 490

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

30 Capital gains treatment of certain income ................................................................................................. 1,050 1,100 1,160 1,220 1,280 1,350 1,420 6,430

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

32 Deferral of gain on sale of farm refiners ................................................................................................... 10 10 10 10 20 20 20 80

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ......................................................................................................... 1,300 1,360 1,430 1,500 1,570 1,650 1,730 7,880

34 Excess bad debt reserves of financial institutions ................................................................................ 40 30 20 20 10 .............. .............. 50

35 Exclusion of interest on life insurance savings ..................................................................................... 18,900 20,500 22,130 24,010 26,050 28,260 30,660 131,110

36 Special alternative tax on small property and casualty insurance companies .................................... 120 120 130 130 140 140 140 680

37 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................ 190 210 220 240 250 260 280 1,250

38 Small life insurance company deduction ............................................................................................... 90 90 90 90 90 90 90 450

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ..................................................... 910 990 1,080 1,150 1,200 1,280 1,320 6,030

40 Exclusion of interest on rental housing bonds ...................................................................................... 280 310 350 370 380 400 410 1,910

41 Deductibility of mortgage interest on owner-occupied homes .............................................................. 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910

42 Deductibility of State and local property tax on owner-occupied homes ............................................ 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

43 Deferral of income from post 1987 installment sales ........................................................................... 1,080 1,100 1,120 1,140 1,160 1,190 1,200 5,810

44 Capital gains exclusion on home sales ................................................................................................. 20,260 20,860 21,490 22,140 22,800 23,480 24,190 114,100

45 Exception from passive loss rules for $25,000 of rental loss .............................................................. 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120

46 Credit for low-income housing investments .......................................................................................... 6,210 6,550 6,860 7,180 7,470 7,830 8,210 37,550

47 Accelerated depreciation on rental housing (normal tax method) ....................................................... 1,220 620 –170 –1,110 –2,330 –3,560 –4,900 –12,070

Commerce: 

48 Cancellation of indebtedness ................................................................................................................. 20 30 30 30 40 40 40 180

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

50 Capital gains (except agriculture, timber, iron ore, and coal) 2 ............................................................ 25,730 27,300 30,190 32,930 36,410 48,930 29,210 177,670

51 Capital gains exclusion of small corporation stock ............................................................................... 130 160 210 250 300 350 390 1,500

52 Step-up basis of capital gains at death ................................................................................................ 14,880 16,280 18,240 20,240 22,240 24,190 26,010 110,920

53 Carryover basis of capital gains on gifts .............................................................................................. 590 390 450 540 550 580 620 2,740

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

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................... –2,290 –3,190 –4,060 –4,690 –6,810 –10,170 –14,430 –40,160
288 ANALYTICAL PERSPECTIVES 

Table 18–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued

(in millions of dollars) 

Total from corporations and individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09

56 Accelerated depreciation of machinery and equipment (normal tax method) ..................................... 48,520 46,800 –10,920 –37,940 –31,040 –28,770 –27,590 –136,260

57 Expensing of certain small investments (normal tax method) ............................................................. 1,030 1,590 4,850 1,650 –490 –30 130 6,110

58 Amortization of start-up costs (normal tax method) ............................................................................. 110 120 130 150 160 160 160 760

59 Graduated corporation income tax rate (normal tax method) .............................................................. 3,030 3,090 3,910 4,650 4,800 4,890 5,040 23,290

60 Exclusion of interest on small issue bonds .......................................................................................... 390 430 470 490 520 550 570 2,600

Transportation 

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

62 Exclusion of reimbursed employee parking expenses .............................................................................. 2,130 2,240 2,360 2,490 2,610 2,740 2,880 13,080

63 Exclusion for employer-provided transit passes ........................................................................................ 320 380 450 520 590 660 730 2,950

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 ........................................................................ 770 840 910 970 1,020 1,080 1,110 5,090

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

67 Empowerment zones, Enterprise communities, and Renewal communities ............................................ 1,070 1,080 1,120 1,210 1,320 1,470 1,730 6,850

68 New markets tax credit .............................................................................................................................. 190 290 430 610 830 870 790 3,530

69 Expensing of environmental remediation costs ......................................................................................... 80 20 –10 –10 –10 –10 –10 –50

Education, Training, Employment, and Social Services 

Education: 

70 Exclusion of scholarship and fellowship income (normal tax method) ................................................ 1,260 1,260 1,340 1,400 1,410 1,420 1,420 6,990

71 HOPE tax credit ..................................................................................................................................... 3,290 3,420 3,510 3,290 3,330 3,320 3,310 16,760

72 Lifetime Learning tax credit ................................................................................................................... 1,910 2,250 2,180 2,120 2,320 2,320 2,300 11,240

73 Education Individual Retirement Accounts ............................................................................................ 70 110 140 190 240 300 370 1,240

74 Deductibility of student-loan interest ...................................................................................................... 730 760 780 800 820 830 840 4,070

75 Deduction for higher education expenses ............................................................................................. 1,730 1,810 2,580 2,610 .............. .............. .............. 5,190

76 State prepaid tuition plans ..................................................................................................................... 50 150 320 430 510 590 660 2,510

77 Exclusion of interest on student-loan bonds ......................................................................................... 260 280 310 320 340 360 380 1,710

78 Exclusion of interest on bonds for private nonprofit educational facilities ........................................... 780 850 930 990 1,030 1,100 1,130 5,180

79 Credit for holders of zone academy bonds .......................................................................................... 80 90 110 130 130 140 140 650

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

81 Parental personal exemption for students age 19 or over ................................................................... 3,140 3,130 2,550 2,000 1,760 1,580 1,430 9,320

82 Deductibility of charitable contributions (education) .............................................................................. 3,670 3,390 3,660 4,000 4,230 4,510 4,830 21,230

83 Exclusion of employer-provided educational assistance ....................................................................... 500 530 560 590 620 660 690 3,120

84 Special deduction for teacher expenses ............................................................................................... 140 140 .............. .............. .............. .............. .............. ...............

Training, employment, and social services: 

85 Work opportunity tax credit .................................................................................................................... 430 370 170 70 30 .............. .............. 270

86 Welfare-to-work tax credit ...................................................................................................................... 60 60 40 30 20 .............. .............. 90

87 Employer provided child care exclusion ................................................................................................ 590 620 770 870 920 960 1,010 4,530

88 Employer-provided child care credit ...................................................................................................... 90 130 140 150 160 170 180 800

89 Assistance for adopted foster children .................................................................................................. 250 290 330 380 430 480 540 2,160

90 Adoption credit and exclusion ................................................................................................................ 220 450 500 540 560 570 580 2,750

91 Exclusion of employee meals and lodging (other than military) .......................................................... 780 810 850 890 930 970 1,000 4,640

92 Child credit 3 ........................................................................................................................................... 37,970 24,340 29,860 24,810 24,680 24,480 25,430 129,260

93 Credit for child and dependent care expenses ..................................................................................... 2,720 2,950 2,690 2,210 2,030 1,900 1,780 10,610

94 Credit for disabled access expenditures ............................................................................................... 50 50 60 60 60 60 60 300

95 Deductibility of charitable contributions, other than education and health .......................................... 30,020 27,370 29,670 32,550 34,500 36,790 39,410 172,920

96 Exclusion of certain foster care payments ............................................................................................ 430 430 440 450 460 470 570 2,390

97 Exclusion of parsonage allowances ...................................................................................................... 380 400 420 450 480 510 540 2,400

Health 

98 Exclusion of employer contributions for medical insurance premiums and medical care ....................... 101,920 106,720 112,990 120,940 129,820 139,620 150,300 653,670

99 Deductibility of self-employed medical insurance premiums ..................................................................... 2,550 3,740 3,780 4,090 4,370 4,750 5,150 22,140

100 Medical Savings Accounts/Health Savings Accounts ................................................................................ –30 –140 –570 –960 –1,380 –1,920 –2,180 –7,010

101 Deductibility of medical expenses .............................................................................................................. 6,240 6,880 7,900 8,480 9,180 10,200 10,990 46,750

102 Exclusion of interest on hospital construction bonds ................................................................................ 1,620 1,780 1,930 2,060 2,160 2,290 2,360 10,800

103 Deductibility of charitable contributions (health) ........................................................................................ 3,390 3,090 3,350 3,670 3,890 4,150 4,450 19,510

104 Tax credit for orphan drug research .......................................................................................................... 160 180 200 220 250 280 310 1,260

105 Special Blue Cross/Blue Shield deduction ................................................................................................ 350 320 310 280 310 260 290 1,450

106 Tax credit for health insurance purchased by certain displaced and retired individuals 4 ...................... .............. 50 60 60 70 70 80 340

Income Security 

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

108 Exclusion of workers’ compensation benefits ............................................................................................ 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710

109 Exclusion of public assistance benefits (normal tax method) ................................................................... 400 410 430 450 470 490 510 2,350

110 Exclusion of special benefits for disabled coal miners ............................................................................. 60 60 50 50 50 40 40 230

111 Exclusion of military disability pensions 100 110 110 110 110 120 120 570

Net exclusion of pension contributions and earnings:.

112 Employer plans ....................................................................................................................................... 59,480 59,380 61,740 66,340 62,650 58,360 60,440 309,530
18. TAX EXPENDITURES 289

Table 18–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued

(in millions of dollars) 

Total from corporations and individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09

113 401(k) plans ............................................................................................................................................ 51,560 56,740 58,910 61,340 65,750 71,080 75,440 332,520

114 Individual Retirement Accounts ............................................................................................................. 20,060 19,810 20,090 20,610 20,150 19,710 19,490 100,050

115 Low and moderate income savers credit .............................................................................................. 880 960 1,100 1,210 730 .............. .............. 3,040

116 Keogh plans ............................................................................................................................................ 6,020 8,730 9,260 9,860 10,530 11,480 12,500 53,630

Exclusion of other employee benefits: 

117 Premiums on group term life insurance ................................................................................................ 1,800 1,830 1,860 1,890 1,920 1,950 1,990 9,610

118 Premiums on accident and disability insurance .................................................................................... 230 240 250 260 270 280 290 1,350

119 Small business retirement plan credit ........................................................................................................ 40 80 100 130 140 150 150 670

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

121 Special ESOP rules .................................................................................................................................... 1,780 1,920 2,060 2,220 2,400 2,580 2,780 12,040

122 Additional deduction for the blind .............................................................................................................. 40 30 40 40 40 40 40 200

123 Additional deduction for the elderly ........................................................................................................... 1,840 1,710 1,800 1,900 1,960 1,920 1,940 9,520

124 Tax credit for the elderly and disabled ...................................................................................................... 20 10 10 10 10 10 10 50

125 Deductibility of casualty losses .................................................................................................................. 500 690 670 680 640 600 630 3,220

126 Earned income tax credit 5 ......................................................................................................................... 5,099 4,884 5,006 5,477 5,515 5,603 5,780 27,381

Social Security 

Exclusion of social security benefits: 

127 Social Security benefits for retired workers .......................................................................................... 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420

128 Social Security benefits for disabled ..................................................................................................... 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420

129 Social Security benefits for dependents and survivors ........................................................................ 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730

Veterans Benefits and Services 

130 Exclusion of veterans death benefits and disability compensation .......................................................... 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560

131 Exclusion of veterans pensions ................................................................................................................. 100 100 100 110 110 110 120 550

132 Exclusion of GI bill benefits ....................................................................................................................... 110 120 130 130 160 170 170 760

133 Exclusion of interest on veterans housing bonds ..................................................................................... 40 50 50 50 60 60 60 280

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose State and local bonds ............................................................... 25,480 25,980 26,370 26,440 26,150 26,940 27,750 133,650

135 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .................... 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

136 Tax credit for corporations receiving income from doing business in U.S. possessions ........................ 1,200 1,150 1,100 800 .............. .............. .............. 1,900

Interest 

137 Deferral of interest on U.S. savings bonds ............................................................................................... 30 40 40 40 40 40 50 210

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied homes ............................................................................................ 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

Nonbusiness State and local taxes other than on owner-occupied homes ........................................ 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

Exclusion of interest on State and local bonds for: 

Public purposes ...................................................................................................................................... 25,480 25,980 26,370 26,440 26,150 26,940 27,750 133,650

Energy facilities ...................................................................................................................................... 90 100 110 110 120 130 130 600

Water, sewage, and hazardous waste disposal facilities ..................................................................... 450 490 530 570 590 630 650 2,970

Small-issues ............................................................................................................................................ 390 430 470 490 520 550 570 2,600

Owner-occupied mortgage subsidies ..................................................................................................... 910 990 1,080 1,150 1,200 1,280 1,320 6,030

Rental housing ........................................................................................................................................ 280 310 350 370 380 400 410 1,910

Airports, docks, and similar facilities ..................................................................................................... 770 840 910 970 1,020 1,080 1,110 5,090

Student loans .......................................................................................................................................... 260 280 310 320 340 360 380 1,710

Private nonprofit educational facilities ................................................................................................... 780 850 930 990 1,030 1,100 1,130 5,180

Hospital construction .............................................................................................................................. 1,620 1,780 1,930 2,060 2,160 2,290 2,360 10,800

Veterans’ housing ................................................................................................................................... 40 50 50 50 60 60 60 280

Credit for holders of zone academy bonds ............................................................................................... 80 90 110 130 130 140 140 650

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: 2003 $1,100; 2004 $1,260; 2005 $1,370; 2006 

$1,430; 2007 $1,470; 2008 $1,510; and 2009 $1,550. 2 If corporate equity were to be included, the revenue loss estimates would be $48,540 in 2003, $51,510 in 2004, $56,970 in 2005, $62,140 in 2006, $68,690 in 2007, $92,320 in 2008, and $55,110 in 

2009. Similarly, if the reduced tax rate on dividends were to be included, the revenue loss estimates would be $1,810 in 2003, $16,720 in 2004, $13,280 in 2005, $13,880 in 2006, $14,480 in 2007, 

$15,970 in 2008, and $8,540 in 2009. 3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2003 $6,435; 2004 $7,447; 2005 $11,486; 2006 

$8,440; 2007 $8,237; 2008 $7,956; and 2009 $7,909 4 In addition to the receipts shown outlays of $60 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected. 5 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2003 $31,961; 2004 $33,551; 2005 

$34,148; 2006 $34,488; 2007 $34,338; 2008 $34,359; and 2009 $35,161. 

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

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

Table 18–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES 

(in millions of dollars) 

Corporations Individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09 2003 2004 2005 2006 2007 2008 2009 2005–09

National Defense 

1 Exclusion of benefits and allowances to 

armed forces personnel ........................ ............ ............ ............ ................ ................ ................ ................ .................. 2,210 2,240 2,260 2,290 2,310 2,330 2,350 11,540

International Affairs 

2 Exclusion of income earned abroad by 

U.S. citizens .......................................... ............ ............ ............ ................ ................ ................ ................ .................. 2,620 2,680 2,750 2,810 2,940 3,100 3,270 14,870

3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ............ ................ ................ ................ ................ .................. 770 800 840 880 920 960 1,010 4,610

4 Extraterritorial income exclusion ............... 5,150 5,510 5,890 6,290 6,730 7,200 7,700 33,810 ................ ................ ................ ................ ................ ................ ................ ..................

5 Inventory property sales source rules exception ................................................... 1,540 1,620 1,700 1,790 1,880 1,980 2,080 9,430 ................ ................ ................ ................ ................ ................ ................ ..................

6 Deferral of income from controlled foreign 

corporations (normal tax method) ........ 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010 ................ ................ ................ ................ ................ ................ ................ ..................

7 Deferred taxes for financial firms on certain income earned overseas ............... 2,050 2,130 2,190 2,260 960 ................ ................ 5,410 ................ ................ ................ ................ ................ ................ ................ ..................

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... –1,940 –2,300 4,400 8,130 6,970 6,240 5,460 31,200 –40 –50 100 160 140 120 110 630

9 Credit for increasing research activities ... 4,910 4,360 2,530 1,090 460 150 60 4,290 50 40 20 ................ ................ ................ ................ 20

Energy 

10 Expensing of exploration and development costs, fuels ................................... 180 240 150 70 60 50 30 360 30 30 20 10 10 10 10 60

11 Excess of percentage over cost depletion, 

fuels ....................................................... 530 510 480 490 510 510 510 2,500 110 110 100 100 100 100 100 500

12 Alternative fuel production credit .............. 1,230 850 850 850 850 340 ................ 2,890 50 40 40 40 40 10 ................ 130

13 Exception from passive loss limitation for 

working interests in oil and gas properties ...................................................... ............ ............ ............ ................ ................ ................ ................ .................. 20 20 20 20 20 20 20 100

14 Capital gains treatment of royalties on 

coal ........................................................ ............ ............ ............ ................ ................ ................ ................ .................. 100 110 120 120 130 130 140 640

15 Exclusion of interest on energy facility 

bonds ..................................................... 20 20 20 20 20 20 20 100 70 80 90 90 100 110 110 500

16 Enhanced oil recovery credit .................... 360 360 370 380 390 400 410 1,950 40 40 40 40 40 40 40 200

17 New technology credit ............................... 280 350 370 370 370 370 370 1,850 ................ ................ ................ ................ ................ ................ ................ ..................

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

19 Tax credit and deduction for clean-fuel 

burning vehicles .................................... 50 40 10 –20 –60 –50 –60 –180 20 20 ................ ................ –10 –10 –10 –30

20 Exclusion from income of conservation 

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

Natural Resources and Environment 

21 Expensing of exploration and development costs, nonfuel minerals ................ 10 10 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ..................

22 Excess of percentage over cost depletion, 

nonfuel minerals .................................... 230 230 240 240 250 260 260 1,250 20 20 20 20 20 20 20 100

23 Exclusion of interest on bonds for water, 

sewage, and hazardous waste facilities 100 100 100 110 110 110 120 550 350 390 430 460 480 520 530 2,420

24 Capital gains treatment of certain timber 

income ................................................... ............ ............ ............ ................ ................ ................ ................ .................. 100 110 120 120 130 130 140 640

25 Expensing of multiperiod timber growing 

costs ...................................................... 230 230 240 250 260 280 290 1,320 110 110 110 120 120 120 120 590

26 Tax incentives for preservation of historic 

structures ............................................... 210 230 240 250 260 270 290 1,310 60 60 60 70 70 70 80 350

Agriculture 

27 Expensing of certain capital outlays ......... 20 20 20 20 20 30 30 120 100 110 110 110 120 120 130 590

28 Expensing of certain multiperiod production costs ............................................... 20 20 20 20 20 20 20 100 70 70 70 80 80 80 80 390

29 Treatment of loans forgiven for solvent 

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

30 Capital gains treatment of certain income ............ ............ ............ ................ ................ ................ ................ .................. 1,050 1,100 1,160 1,220 1,280 1,350 1,420 6,430

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

32 Deferral of gain on sale of farm refiners 10 10 10 10 20 20 20 80 ................ ................ ................ ................ ................ ................ ................ ..................

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ........ 1,300 1,360 1,430 1,500 1,570 1,650 1,730 7,880 ................ ................ ................ ................ ................ ................ ................ ..................

34 Excess bad debt reserves of financial 

institutions ......................................... 40 30 20 20 10 ................ ................ 50 ................ ................ ................ ................ ................ ................ ................ ..................

35 Exclusion of interest on life insurance 

savings .............................................. 2,090 2,250 2,410 2,590 2,780 2,980 3,200 13,960 16,810 18,250 19,720 21,420 23,270 25,280 27,460 117,150

36 Special alternative tax on small property and casualty insurance companies .................................................... 120 120 130 130 140 140 140 680 ................ ................ ................ ................ ................ ................ ................ ..................

37 Tax exemption of certain insurance 

companies owned by tax-exempt organizations ........................................ 190 210 220 240 250 260 280 1,250 ................ ................ ................ ................ ................ ................ ................ ..................

38 Small life insurance company deduction ..................................................... 90 90 90 90 90 90 90 450 ................ ................ ................ ................ ................ ................ ................ ..................

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 200 200 210 220 220 230 240 1,120 710 790 870 930 980 1,050 1,080 4,910

40 Exclusion of interest on rental housing 

bonds ................................................. 60 60 70 70 70 70 70 350 220 250 280 300 310 330 340 1,560

41 Deductibility of mortgage interest on 

owner-occupied homes ..................... ............ ............ ............ ................ ................ ................ ................ .................. 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910
18. TAX EXPENDITURES 291

Table 18–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(in millions of dollars) 

Corporations Individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09 2003 2004 2005 2006 2007 2008 2009 2005–09

42 Deductibility of State and local property 

tax on owner-occupied homes ......... ............ ............ ............ ................ ................ ................ ................ .................. 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

43 Deferral of income from post 1987 installment sales .................................. 280 290 290 300 300 310 310 1,510 800 810 830 840 860 880 890 4,300

44 Capital gains exclusion on home sales ............ ............ ............ ................ ................ ................ ................ .................. 20,260 20,860 21,490 22,140 22,800 23,480 24,190 114,100

45 Exception from passive loss rules for 

$25,000 of rental loss ....................... ............ ............ ............ ................ ................ ................ ................ .................. 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120

46 Credit for low-income housing investments ................................................. 3,450 3,640 3,810 3,990 4,150 4,350 4,560 20,860 2,760 2,910 3,050 3,190 3,320 3,480 3,650 16,690

47 Accelerated depreciation on rental 

housing (normal tax method) ........... 50 –10 –50 –110 –180 –260 –340 –940 1,170 630 –120 –1,000 –2,150 –3,300 –4,560 –11,130

Commerce: 

48 Cancellation of indebtedness ................ ............ ............ ............ ................ ................ ................ ................ .................. 20 30 30 30 40 40 40 180

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

50 Capital gains (except agriculture, timber, iron ore, and coal) 2 .................. ............ ............ ............ ................ ................ ................ ................ .................. 25,730 27,300 30,190 32,930 36,410 48,930 29,210 177,670

51 Capital gains exclusion of small corporation stock ................................... ............ ............ ............ ................ ................ ................ ................ .................. 130 160 210 250 300 350 390 1,500

52 Step-up basis of capital gains at death ............ ............ ............ ................ ................ ................ ................ .................. 14,880 16,280 18,240 20,240 22,240 24,190 26,010 110,920

53 Carryover basis of capital gains on 

gifts .................................................... ............ ............ ............ ................ ................ ................ ................ .................. 590 390 450 540 550 580 620 2,740

54 Ordinary income treatment of loss from 

small business corporation stock 

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

55 Accelerated depreciation of buildings 

other than rental housing (normal 

tax method) ....................................... –2,190 –2,920 –3,740 –4,250 –6,060 –9,050 –12,360 –35,460 –100 –270 –320 –440 –750 –1,120 –2,070 –4,700

56 Accelerated depreciation of machinery 

and equipment (normal tax method) 40,600 38,830 –8,720 –32,980 –26,580 –23,990 –22,400 –114,670 7,920 7,970 –2,200 –4,960 –4,460 –4,780 –5,190 –21,590

57 Expensing of certain small investments 

(normal tax method) ......................... 420 710 1,790 680 –390 –140 –30 1,910 610 880 3,060 970 –100 110 160 4,200

58 Amortization of start-up costs (normal 

tax method) ....................................... 100 110 120 130 140 140 140 670 10 10 10 20 20 20 20 90

59 Graduated corporation income tax rate 

(normal tax method) ......................... 3,030 3,090 3,910 4,650 4,800 4,890 5,040 23,290 ................ ................ ................ ................ ................ ................ ................ ..................

60 Exclusion of interest on small issue 

bonds ................................................. 80 90 90 90 100 100 100 480 310 340 380 400 420 450 470 2,120

Transportation 

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

62 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ............ ................ ................ ................ ................ .................. 2,130 2,240 2,360 2,490 2,610 2,740 2,880 13,080

63 Exclusion for employer-provided transit 

passes ................................................... ............ ............ ............ ................ ................ ................ ................ .................. 320 380 450 520 590 660 730 2,950

Community and Regional Development 

64 Investment credit for rehabilitation of 

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

65 Exclusion of interest for airport, dock, and 

similar bonds ......................................... 170 170 180 180 190 190 200 940 600 670 730 790 830 890 910 4,150

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

67 Empowerment zones, Enterprise communities, and Renewal communities ......... 280 280 290 310 330 370 420 1,720 790 800 830 900 990 1,100 1,310 5,130

68 New markets tax credit ............................. 50 70 110 150 210 220 200 890 140 220 320 460 620 650 590 2,640

69 Expensing of environmental remediation 

costs ...................................................... 70 20 –10 –10 –10 –10 –10 –50 10 ................ ................ ................ ................ ................ ................ ..................

Education, Training, Employment, and 

Social Services 

Education: 

70 Exclusion of scholarship and fellowship 

income (normal tax method) ............ ............ ............ ............ ................ ................ ................ ................ .................. 1,260 1,260 1,340 1,400 1,410 1,420 1,420 6,990

71 HOPE tax credit .................................... ............ ............ ............ ................ ................ ................ ................ .................. 3,290 3,420 3,510 3,290 3,330 3,320 3,310 16,760

72 Lifetime Learning tax credit .................. ............ ............ ............ ................ ................ ................ ................ .................. 1,910 2,250 2,180 2,120 2,320 2,320 2,300 11,240

73 Education Individual Retirement Accounts ................................................ ............ ............ ............ ................ ................ ................ ................ .................. 70 110 140 190 240 300 370 1,240

74 Deductibility of student-loan interest .... ............ ............ ............ ................ ................ ................ ................ .................. 730 760 780 800 820 830 840 4,070

75 Deduction for higher education expenses ............................................... ............ ............ ............ ................ ................ ................ ................ .................. 1,730 1,810 2,580 2,610 ................ ................ ................ 5,190

76 State prepaid tuition plans .................... ............ ............ ............ ................ ................ ................ ................ .................. 50 150 320 430 510 590 660 2,510

77 Exclusion of interest on student-loan 

bonds ................................................. 60 60 60 60 60 60 70 310 200 220 250 260 280 300 310 1,400

78 Exclusion of interest on bonds for private nonprofit educational facilities .. 170 170 180 190 190 200 200 960 610 680 750 800 840 900 930 4,220

79 Credit for holders of zone academy 

bonds ................................................. 80 90 110 130 130 140 140 650 ................ ................ ................ ................ ................ ................ ................ ..................

80 Exclusion of interest on savings bonds 

redeemed to finance educational expenses ............................................... ............ ............ ............ ................ ................ ................ ................ .................. 10 10 10 10 20 20 20 80

81 Parental personal exemption for students age 19 or over ....................... ............ ............ ............ ................ ................ ................ ................ .................. 3,140 3,130 2,550 2,000 1,760 1,580 1,430 9,320

82 Deductibility of charitable contributions 

(education) ........................................ 490 510 540 560 590 620 660 2,970 3,180 2,880 3,120 3,440 3,640 3,890 4,170 18,260

83 Exclusion of employer-provided educational assistance ........................... ............ ............ ............ ................ ................ ................ ................ .................. 500 530 560 590 620 660 690 3,120

84 Special deduction for teacher expenses ............................................... ............ ............ ............ ................ ................ ................ ................ .................. 140 140 ................ ................ ................ ................ ................ ..................
292 ANALYTICAL PERSPECTIVES 

Table 18–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(in millions of dollars) 

Corporations Individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09 2003 2004 2005 2006 2007 2008 2009 2005–09

Training, employment, and social services: 

85 Work opportunity tax credit ................... 370 310 140 60 20 ................ ................ 220 60 60 30 10 10 ................ ................ 50

86 Welfare-to-work tax credit ..................... 50 50 30 20 10 ................ ................ 60 10 10 10 10 10 ................ ................ 30

87 Employer provided child care exclusion ............ ............ ............ ................ ................ ................ ................ .................. 590 620 770 870 920 960 1,010 4,530

88 Employer-provided child care credit ..... ............ ............ ............ ................ ................ ................ ................ .................. 90 130 140 150 160 170 180 800

89 Assistance for adopted foster children ............ ............ ............ ................ ................ ................ ................ .................. 250 290 330 380 430 480 540 2,160

90 Adoption credit and exclusion .............. ............ ............ ............ ................ ................ ................ ................ .................. 220 450 500 540 560 570 580 2,750

91 Exclusion of employee meals and 

lodging (other than military) ............. ............ ............ ............ ................ ................ ................ ................ .................. 780 810 850 890 930 970 1,000 4,640

92 Child credit 3 .......................................... ............ ............ ............ ................ ................ ................ ................ .................. 37,970 24,340 29,860 24,810 24,680 24,480 25,430 129,260

93 Credit for child and dependent care 

expenses ........................................... ............ ............ ............ ................ ................ ................ ................ .................. 2,720 2,950 2,690 2,210 2,030 1,900 1,780 10,610

94 Credit for disabled access expenditures .................................................. 10 10 20 20 20 20 20 100 40 40 40 40 40 40 40 200

95 Deductibility of charitable contributions, 

other than education and health ...... 1,110 1,170 1,230 1,290 1,360 1,430 1,500 6,810 28,910 26,200 28,440 31,260 33,140 35,360 37,910 166,110

96 Exclusion of certain foster care payments ................................................. ............ ............ ............ ................ ................ ................ ................ .................. 430 430 440 450 460 470 570 2,390

97 Exclusion of parsonage allowances ..... ............ ............ ............ ................ ................ ................ ................ .................. 380 400 420 450 480 510 540 2,400

Health 

98 Exclusion of employer contributions for 

medical insurance premiums and medical care ................................................. ............ ............ ............ ................ ................ ................ ................ .................. 101,920 106,720 112,990 120,940 129,820 139,620 150,300 653,670

99 Deductibility of self-employed medical insurance premiums ................................. ............ ............ ............ ................ ................ ................ ................ .................. 2,550 3,740 3,780 4,090 4,370 4,750 5,150 22,140

100 Medical Savings Accounts/Health Savings 

Accounts ................................................ ............ ............ ............ ................ ................ ................ ................ .................. –30 –140 –570 –960 –1,380 –1,920 –2,180 –7,010

101 Deductibility of medical expenses ............. ............ ............ ............ ................ ................ ................ ................ .................. 6,240 6,880 7,900 8,480 9,180 10,200 10,990 46,750

102 Exclusion of interest on hospital construction bonds .............................................. 350 360 370 390 400 410 420 1,990 1,270 1,420 1,560 1,670 1,760 1,880 1,940 8,810

103 Deductibility of charitable contributions 

(health) ................................................... 140 150 160 160 170 180 190 860 3,250 2,940 3,190 3,510 3,720 3,970 4,260 18,650

104 Tax credit for orphan drug research ........ 160 180 200 220 250 280 310 1,260 ................ ................ ................ ................ ................ ................ ................ ..................

105 Special Blue Cross/Blue Shield deduction 350 320 310 280 310 260 290 1,450 ................ ................ ................ ................ ................ ................ ................ ..................

106 Tax credit for health insurance purchased 

by certain displaced and retired individuals 4 ...................................................... ............ ............ ............ ................ ................ ................ ................ .................. ................ 50 60 60 70 70 80 340

Income Security 

107 Exclusion of railroad retirement system 

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

108 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ............ ................ ................ ................ ................ .................. 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710

109 Exclusion of public assistance benefits 

(normal tax method) .............................. ............ ............ ............ ................ ................ ................ ................ .................. 400 410 430 450 470 490 510 2,350

110 Exclusion of special benefits for disabled 

coal miners ............................................ ............ ............ ............ ................ ................ ................ ................ .................. 60 60 50 50 50 40 40 230

111 Exclusion of military disability pensions ... ............ ............ ............ ................ ................ ................ ................ .................. 100 110 110 110 110 120 120 570

Net exclusion of pension contributions 

and earnings: 

112 Employer plans ..................................... ............ ............ ............ ................ ................ ................ ................ .................. 59,480 59,380 61,740 66,340 62,650 58,360 60,440 309,530

113 401(k) plans .......................................... ............ ............ ............ ................ ................ ................ ................ .................. 51,560 56,740 58,910 61,340 65,750 71080 75440 332,520

114 Individual Retirement Accounts ............ ............ ............ ............ ................ ................ ................ ................ .................. 20,060 19,810 20,090 20,610 20,150 19,710 19,490 100,050

115 Low and moderate income savers 

credit .................................................. ............ ............ ............ ................ ................ ................ ................ .................. 880 960 1,100 1,210 730 ................ ................ 3,040

116 Keogh plans .......................................... ............ ............ ............ ................ ................ ................ ................ .................. 6,020 8,730 9,260 9,860 10,530 11,480 12,500 53,630

Exclusion of other employee benefits: 

117 Premiums on group term life insurance 1,800 1,830 1,860 1,890 1,920 1,950 1,990 9,610 ................ ................ ................ ................ ................ ................ ................ ..................

118 Premiums on accident and disability insurance .............................................. ............ ............ ............ ................ ................ ................ ................ .................. 230 240 250 260 270 280 290 1,350

119 Small business retirement plan credit ...... 20 40 50 70 70 80 80 350 20 40 50 60 70 70 70 320

120 Income of trusts to finance supplementary 

unemployment benefits ......................... ............ ............ ............ ................ ................ ................ ................ .................. 30 30 30 30 30 30 30 ..................

121 Special ESOP rules ................................... 1460 1570 1690 1820 1970 2120 2280 9,880 320 350 370 400 430 460 500 2,160

122 Additional deduction for the blind ............. ............ ............ ............ ................ ................ ................ ................ .................. 40 30 40 40 40 40 40 200

123 Additional deduction for the elderly .......... ............ ............ ............ ................ ................ ................ ................ .................. 1,840 1,710 1,800 1,900 1,960 1,920 1,940 9,520

124 Tax credit for the elderly and disabled .... ............ ............ ............ ................ ................ ................ ................ .................. 20 10 10 10 10 10 10 50

125 Deductibility of casualty losses ................. ............ ............ ............ ................ ................ ................ ................ .................. 500 690 670 680 640 600 630 3,220

126 Earned income tax credit 5 ........................ ............ ............ ............ ................ ................ ................ ................ .................. 5,099 4,884 5,006 5,477 5,515 5,603 5,780 27,381

Social Security 

Exclusion of social security benefits: 

127 Social Security benefits for retired 

workers .............................................. ............ ............ ............ ................ ................ ................ ................ .................. 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420

128 Social Security benefits for disabled .... ............ ............ ............ ................ ................ ................ ................ .................. 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420

129 Social Security benefits for dependents 

and survivors .................................... ............ ............ ............ ................ ................ ................ ................ .................. 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730

Veterans Benefits and Services 

130 Exclusion of veterans death benefits and 

disability compensation ......................... ............ ............ ............ ................ ................ ................ ................ .................. 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560

131 Exclusion of veterans pensions ................ ............ ............ ............ ................ ................ ................ ................ .................. 100 100 100 110 110 110 120 550

132 Exclusion of GI bill benefits ...................... ............ ............ ............ ................ ................ ................ ................ .................. 110 120 130 130 160 170 170 760

133 Exclusion of interest on veterans housing 

bonds ..................................................... 10 10 10 10 10 10 10 50 30 40 40 40 50 50 50 230
18. TAX EXPENDITURES 293

Table 18–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued

(in millions of dollars) 

Corporations Individuals 

2003 2004 2005 2006 2007 2008 2009 2005–09 2003 2004 2005 2006 2007 2008 2009 2005–09

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose 

State and local bonds ........................... 5,710 5,880 6,060 6,240 6,420 6,620 6,820 32,160 19,770 20,100 20,310 20,200 19,730 20,320 20,930 101,490

135 Deductibility of nonbusiness State and 

local taxes other than on owner-occupied homes ............................................ ............ ............ ............ ................ ................ ................ ................ .................. 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

136 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 1,200 1,150 1,100 800 ................ ................ ................ 1,900 ................ ................ ................ ................ ................ ................ ................ ..................

Interest 

137 Deferral of interest on U.S. savings 

bonds ..................................................... ............ ............ ............ ................ ................ ................ ................ .................. 30 40 40 40 40 40 50 210

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied 

homes ................................................ ............ ............ ............ ................ ................ ................ ................ .................. 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

Nonbusiness State and local taxes 

other than on owner-occupied 

homes ................................................ ............ ............ ............ ................ ................ ................ ................ .................. 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

Exclusion of interest on State and local 

bonds for: 

Public purposes ..................................... 5,710 5,880 6,060 6,240 6,420 6,620 6,820 32,160 19,770 20,100 20,310 20,200 19,730 20,320 20,930 101,490

Energy facilities ..................................... 20 20 20 20 20 20 20 100 70 80 90 90 100 110 110 500

Water, sewage, and hazardous waste 

disposal facilities ............................... 100 100 100 110 110 110 120 550 350 390 430 460 480 520 530 2,420

Small-issues .......................................... 80 90 90 90 100 100 100 480 310 340 380 400 420 450 470 2,120

Owner-occupied mortgage subsidies ... 200 200 210 220 220 230 240 1,120 710 790 870 930 980 1,050 1,080 4,910

Rental housing ...................................... 60 60 70 70 70 70 70 350 220 250 280 300 310 330 340 1,560

Airports, docks, and similar facilities .... 170 170 180 180 190 190 200 940 600 670 730 790 830 890 910 4,150

Student loans ........................................ 60 60 60 60 60 60 70 310 200 220 250 260 280 300 310 1,400

Private nonprofit educational facilities .. 170 170 180 190 190 200 200 960 610 680 750 800 840 900 930 4,220

Hospital construction ............................. 350 360 370 390 400 410 420 1,990 1,270 1,420 1,560 1,670 1,760 1,880 1,940 8,810

Veterans’ housing ................................. 10 10 10 10 10 10 10 50 30 40 40 40 50 50 50 230

Credit for holders of zone academy 

bonds ..................................................... 80 90 110 130 130 140 140 650 ................ ................ ................ ................ ................ ................ ................ ..................

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: 2003 $1,100; 2004 $1,260; 2005 $1,370; 2006 $1,430; 

2007 $1,470; 2008 $1,510; and 2009 $1,550. 2 If corporate equity were to be included, the revenue loss estimates would be $48,540 in 2003, $51,510 in 2004, $56,970 in 2005, $62,140 in 2006, $68,690 in 2007, $92,320 in 2008, and $55,110 in 

2009. Similarly, if the reduced tax rate on dividends were to be included, the revenue loss estimates would be $1,810 in 2003, $16,720 in 2004, $13,280 in 2005, $13,880 in 2006, $14,480 in 2007, $15,970 

in 2008, and $8,540 in 2009. 3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2003 $6,435; 2004 $7,447; 2005 $11,486; 2006 $8,440; 

2007 $8,237; 2008 $7,956; and 2009 $7,909 4 In addition to the receipts shown outlays of $60 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected. 5 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2003 $31,961; 2004 $33,551; 2005 $34,148; 

2006 $34,488; 2007 $34,338; 2008 $34,359; and 2009 $35,161. 

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

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

Table 18–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2005–2009 PROJECTED REVENUE EFFECT 

(in millions of dollars) 

Provision 2005 2005–2009

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 112,990 653,670

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 69,740 393,910

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 58,910 332,520

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 61,740 309,530

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 46,180 190,290

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 30,190 177,670

Deductibility of charitable contributions, other than education and health ......................................................................... 29,670 172,920

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,370 133,650

Exclusion of interest on life insurance savings ................................................................................................................... 22,130 131,110

Child credit ............................................................................................................................................................................ 29,860 129,260

Capital gains exclusion on home sales ............................................................................................................................... 21,490 114,100

Step-up basis of capital gains at death .............................................................................................................................. 18,240 110,920

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 20,090 100,050

Social Security benefits for retired workers ......................................................................................................................... 19,040 98,420

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 19,410 76,850

Net exclusion of pension contributions and earnings: Keough Plans ................................................................................ 9,260 53,630

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 8,400 48,010

Deductibility of medical expenses ........................................................................................................................................ 7,900 46,750

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,850 38,710

Credit for low-income housing investments ......................................................................................................................... 6,860 37,550

Extraterritorial income exclusion .......................................................................................................................................... 5,890 33,810

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 4,500 31,830

Earned income tax credit ..................................................................................................................................................... 5,006 27,381

Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,910 23,290

Deductibility of self-employed medical insurance premiums .............................................................................................. 3,780 22,140

Social Security benefits for dependents and survivors ....................................................................................................... 4,310 20,730

Deductibility of charitable contributions (education) ............................................................................................................ 3,660 21,230

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,600 20,560

Social Security benefits for disabled ................................................................................................................................... 3,720 20,420

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,390 20,120

Deductibility of charitable contributions (health) .................................................................................................................. 3,350 19,510

HOPE tax credit ................................................................................................................................................................... 3,510 16,760

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,750 14,870

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,360 13,080

Special ESOP rules .............................................................................................................................................................. 2,060 12,040

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,260 11,540

Lifetime Learning tax credit .................................................................................................................................................. 2,180 11,240

Exclusion of interest on hospital construction bonds .......................................................................................................... 1,930 10,800

Credit for child and dependent care expenses ................................................................................................................... 2,690 10,610

Premiums on group term life insurance .............................................................................................................................. 1,860 9,610

Additional deduction for the elderly ..................................................................................................................................... 1,800 9,520

Inventory property sales source rules exception ................................................................................................................. 1,700 9,430

Parental personal exemption for students age 19 or over ................................................................................................. 2,550 9,320

Exemption of credit union income ....................................................................................................................................... 1,430 7,880

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,340 6,990

Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,120 6,850

Capital gains treatment of certain income ........................................................................................................................... 1,160 6,430

Expensing of certain small investments (normal tax method) ............................................................................................ 4,850 6,110

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 1,080 6,030

Deferral of income from post 1987 installment sales ......................................................................................................... 1,120 5,810

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 2,190 5,410

Deduction for higher education expenses ........................................................................................................................... 2,580 5,190

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 930 5,180

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 910 5,090

Exclusion of employee meals and lodging (other than military) ........................................................................................ 850 4,640

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 840 4,610

Employer provided child care exclusion .............................................................................................................................. 770 4,530

Credit for increasing research activities .............................................................................................................................. 2,550 4,310

Deductibility of student-loan interest .................................................................................................................................... 780 4,070

New markets tax credit ........................................................................................................................................................ 430 3,530

Deductibility of casualty losses ............................................................................................................................................ 670 3,220

Exclusion of employer-provided educational assistance ..................................................................................................... 560 3,120

Low and moderate income savers credit ............................................................................................................................ 1,100 3,040

Alternative fuel production credit ......................................................................................................................................... 890 3,020

Excess of percentage over cost depletion, fuels ................................................................................................................ 580 3,000

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 530 2,970

Exclusion for employer-provided transit passes .................................................................................................................. 450 2,950

Adoption credit and exclusion .............................................................................................................................................. 500 2,750

Carryover basis of capital gains on gifts ............................................................................................................................. 450 2,740
18. TAX EXPENDITURES 295

Table 18–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2005–2009 PROJECTED REVENUE EFFECT—

Continued

(in millions of dollars) 

Provision 2005 2005–2009

Exclusion of interest on small issue bonds ......................................................................................................................... 470 2,600

State prepaid tuition plans ................................................................................................................................................... 320 2,510

Exclusion of parsonage allowances ..................................................................................................................................... 420 2,400

Exclusion of certain foster care payments .......................................................................................................................... 440 2,390

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 430 2,350

Assistance for adopted foster children ................................................................................................................................ 330 2,160

Enhanced oil recovery credit ............................................................................................................................................... 410 2,150

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

Expensing of multiperiod timber growing costs ................................................................................................................... 350 1,910

Exclusion of interest on rental housing bonds .................................................................................................................... 350 1,910

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 1,100 1,900

New technology credit .......................................................................................................................................................... 370 1,850

Exclusion of interest on student-loan bonds ....................................................................................................................... 310 1,710

Tax incentives for preservation of historic structures ......................................................................................................... 300 1,660

Capital gains exclusion of small corporation stock ............................................................................................................. 210 1,500

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 310 1,450

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. 260 1,350

Premiums on accident and disability insurance .................................................................................................................. 250 1,350

Tax credit for orphan drug research .................................................................................................................................... 200 1,260

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 220 1,250

Education Individual Retirement Accounts .......................................................................................................................... 140 1,240

Employer-provided child care credit .................................................................................................................................... 140 800

Exclusion of GI bill benefits ................................................................................................................................................. 130 760

Amortization of start-up costs (normal tax method) ............................................................................................................ 130 760

Expensing of certain capital outlays .................................................................................................................................... 130 710

Special alternative tax on small property and casualty insurance companies .................................................................. 130 680

Small business retirement plan credit ................................................................................................................................. 100 670

Credit for holders of zone academy bonds ......................................................................................................................... 110 650

Capital gains treatment of royalties on coal ....................................................................................................................... 120 640

Capital gains treatment of certain timber income ............................................................................................................... 120 640

Exclusion of interest on energy facility bonds .................................................................................................................... 110 600

Exclusion of military disability pensions .............................................................................................................................. 110 570

Exclusion of veterans pensions ........................................................................................................................................... 100 550

Expensing of certain multiperiod production costs .............................................................................................................. 90 490

Small life insurance company deduction ............................................................................................................................. 90 450

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

Expensing of exploration and development costs, fuels .................................................................................................... 170 420

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

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

Tax credit for health insurance purchased by certain displaced and retired individuals .................................................. 60 340

Credit for disabled access expenditures ............................................................................................................................. 60 300

Exclusion of interest on veterans housing bonds ............................................................................................................... 50 280

Work opportunity tax credit .................................................................................................................................................. 170 270

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

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

Exclusion of special benefits for disabled coal miners ....................................................................................................... 50 230

Deferral of interest on U.S. savings bonds ......................................................................................................................... 40 210

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

Cancellation of indebtedness ............................................................................................................................................... 30 180

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

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

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

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

Welfare-to-work tax credit .................................................................................................................................................... 40 90

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

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 80

Expensing of exploration and development costs, nonfuel minerals ................................................................................. 10 50

Tax credit for the elderly and disabled ............................................................................................................................... 10 50

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

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

Expensing of environmental remediation costs ................................................................................................................... –10 –50

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 10 –210

Medical Savings Accounts ................................................................................................................................................... –570 –7,010

Accelerated depreciation on rental housing (normal tax method) ...................................................................................... –170 –12,070

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... –4,060 –40,160

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... –10,920 –136,260
296 ANALYTICAL PERSPECTIVES 

Table 18–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN 

CALENDAR YEAR 2003

(in millions of dollars) 

Provision 

Present 

Value of 

Revenue 

Loss 

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 7,630

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 2,080

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 2,000

4 Expensing of exploration and development costs—fuels .................................................................................... 120

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

6 Expensing of certain multiperiod production costs—agriculture .......................................................................... 170

7 Expensing of certain capital outlays—agriculture ................................................................................................ 200

8 Deferral of income on life insurance and annuity contracts ................................................................................ 25,060

9 Expensing of certain small investments (normal tax method) ............................................................................ 690

10 Amortization of start-up costs (normal tax method) ............................................................................................. 70

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

12 Credit for holders of zone academy bonds ......................................................................................................... 110

13 Credit for low-income housing investments ......................................................................................................... 3,470

14 Deferral for state prepaid tuition plans ................................................................................................................. 1,510

15 Exclusion of pension contributions—employer plans ........................................................................................... 102,470

16 Exclusion of 401(k) contributions .......................................................................................................................... 81,610

17 Exclusion of IRA contributions and earnings ....................................................................................................... 11,030

18 Exclusion of contributions and earnings for Keogh plans ................................................................................... 9,530

19 Exclusion of interest on public-purpose bonds .................................................................................................... 19,440

20 Exclusion of interest on non-public purpose bonds ............................................................................................. 6,120

21 Deferral of interest on U.S. savings bonds .......................................................................................................... 440

Outlay Equivalents 

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

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

The outlay-equivalent measure allows the cost of a tax 

expenditure to be compared with a direct Federal outlay 

on a more even footing. Outlay equivalents are reported 

in Table 18–5.

Table 18–5. OUTLAY EQUVALENT ESTIMATES FOR TAX EXPENDITURES 

(in millions of dollars) 

2003 2004 2005 2006 2007 2008 2009 2005–09

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ........................................................... 2,570 2,600 2,620 2,650 2,680 2,710 2,740 13,400

International Affairs 

2 Exclusion of income earned abroad by U.S. citizens ............................................................................... 3,470 3,530 3,640 3,700 3,880 4,100 4,320 19,640

3 Exclusion of certain allowances for Federal employees abroad .............................................................. 980 1,030 1,070 1,120 1,180 1,230 1,290 5,890

4 Extraterritorial income exclusion ................................................................................................................ 7,920 8,480 9,060 9,680 10,350 11,080 11,850 52,020

5 Inventory property sales source rules exception ....................................................................................... 2,370 2,490 2,620 2,750 2,890 3,050 3,200 14,510

6 Deferral of income from controlled foreign corporations (normal tax method) ........................................ 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010

7 Deferred taxes for financial firms on certain income earned overseas ................................................... 2,050 2,130 2,190 2,260 960 .............. .............. 5,410

General Science, Space, and Technology 

8 Expensing of research and experimentation expenditures (normal tax method) ..................................... –1,980 –2,350 4,500 8,290 7,110 6,360 5,570 31,830

9 Credit for increasing research activities ..................................................................................................... 7,620 6,760 3,930 1,680 700 230 90 6,630

Energy 

10 Expensing of exploration and development costs, fuels ........................................................................... 230 290 190 80 70 70 50 460

11 Excess of percentage over cost depletion, fuels ...................................................................................... 910 780 760 810 820 810 820 4,020

12 Alternative fuel production credit ................................................................................................................ 1,720 1,190 1,190 1,190 1,190 470 .............. 4,040

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

14 Capital gains treatment of royalties on coal .............................................................................................. 140 150 150 160 170 180 190 850

15 Exclusion of interest on energy facility bonds ........................................................................................... 130 150 160 160 170 190 190 870

16 Enhanced oil recovery credit ...................................................................................................................... 620 630 650 660 680 700 720 3,410

17 New technology credit ................................................................................................................................ 380 470 490 490 490 500 500 2,470

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

19 Tax credit and deduction for clean-fuel burning vehicles ......................................................................... 90 80 20 –30 –90 –90 –100 –290

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

Natural Resources and Environment 

21 Expensing of exploration and development costs, nonfuel minerals ....................................................... 10 10 10 10 10 10 10 50

22 Excess of percentage over cost depletion, nonfuel minerals ................................................................... 320 330 330 360 370 370 390 1,820

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ................................ 650 700 760 820 850 900 940 4,270
18. TAX EXPENDITURES 297

Table 18–5. OUTLAY EQUVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(in millions of dollars) 

2003 2004 2005 2006 2007 2008 2009 2005–09

24 Capital gains treatment of certain timber income ..................................................................................... 140 150 150 160 170 180 190 850

25 Expensing of multiperiod timber growing costs ......................................................................................... 450 450 460 470 490 520 530 2,470

26 Tax incentives for preservation of historic structures ............................................................................... 270 290 300 320 330 340 370 1,660

Agriculture 

27 Expensing of certain capital outlays .......................................................................................................... 150 160 160 160 170 180 190 860

28 Expensing of certain multiperiod production costs .................................................................................... 110 110 110 110 110 120 110 560

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

30 Capital gains treatment of certain income ................................................................................................. 1,400 1,470 1,550 1,630 1,710 1,800 1,890 8,580

31 Income averaging for farmers .................................................................................................................... 90 90 90 100 100 100 110 500

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

Commerce and Housing 

Financial institutions and insurance: 

33 Exemption of credit union income ......................................................................................................... 1,650 1,730 1,820 1,910 2,000 2,100 2,210 10,040

34 Excess bad debt reserves of financial institutions ................................................................................ 50 38 25 25 13 .............. .............. 63

35 Exclusion of interest on life insurance savings ..................................................................................... 22,000 23,840 25,730 27,920 30,290 32,860 35,650 152,450

36 Special alternative tax on small property and casualty insurance companies .................................... 170 170 180 180 200 200 200 960

37 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................ 270 300 310 340 350 370 390 1,760

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

Housing: 

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ..................................................... 1,310 1,420 1,550 1,660 1,730 1,840 1,890 8,670

40 Exclusion of interest on rental housing bonds ...................................................................................... 400 440 510 530 550 580 590 2,760

41 Deductibility of mortgage interest on owner-occupied homes .............................................................. 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910

42 Deductibility of State and local property tax on owner-occupied homes ............................................ 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

43 Deferral of income from post 1987 installment sales ........................................................................... 1,060 1,080 1,100 1,120 1,140 1,170 1,190 5,720

44 Capital gains exclusion on home sales ................................................................................................. 26,570 27,367 28,188 29,034 29,905 30,802 31,726 149,655

45 Exception from passive loss rules for $25,000 of rental loss .............................................................. 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120

46 Credit for low-income housing investments .......................................................................................... 4,670 4,920 5,160 5,390 5,620 5,880 6,170 28,220

47 Accelerated depreciation on rental housing (normal tax method) ....................................................... 1,220 620 –170 –1,110 –2,330 –3,560 –4,900 –12,070

Commerce: 

48 Cancellation of indebtedness ................................................................................................................. 20 30 30 30 40 40 40 180

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

50 Capital gains (except agriculture, timber, iron ore, and coal) .............................................................. 34,310 36,400 40,260 43,910 48,540 65,240 38,950 236,900

51 Capital gains exclusion of small corporation stock ............................................................................... 170 220 270 340 400 460 530 2,000

52 Step-up basis of capital gains at death ................................................................................................ 19,840 21,710 24,320 26,990 29,650 32,260 34,680 147,900

53 Carryover basis of capital gains on gifts .............................................................................................. 590 390 450 540 550 580 620 2,740

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

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................... –2,290 –3,190 –4,060 –4,690 –6,810 –10,170 –14,430 –40,160

56 Accelerated depreciation of machinery and equipment (normal tax method) ..................................... 48,520 46,800 –10,920 –37,940 –31,040 –28,770 –27,590 –136,260

57 Expensing of certain small investments (normal tax method) ............................................................. 1,030 1,590 4,850 1,650 –490 –30 130 6,110

58 Amortization of start-up costs (normal tax method) ............................................................................. 110 120 130 150 160 160 160 760

59 Graduated corporation income tax rate (normal tax method) .............................................................. 4,670 4,760 6,020 7,150 7,390 7,520 7,760 35,840

60 Exclusion of interest on small issue bonds .......................................................................................... 560 610 670 700 750 790 820 3,730

Transportation 

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

62 Exclusion of reimbursed employee parking expenses .............................................................................. 2,750 2,900 3,050 3,210 3,370 3,540 3,710 16,880

63 Exclusion for employer-provided transit passes ........................................................................................ 400 480 560 650 740 820 910 3,680

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 ........................................................................ 1,110 1,210 1,310 1,390 1,460 1,550 1,600 7,310

66 Exemption of certain mutuals’ and cooperatives’ income ......................................................................... 70 80 80 80 80 80 90 410

67 Empowerment zones, Enterprise communities, and Renewal communities ............................................ 1,070 1,080 1,120 1,210 1,320 1,470 1,730 6,850

68 New markets tax credit .............................................................................................................................. 190 290 430 610 830 870 790 3,530

69 Expensing of environmental remediation costs ......................................................................................... 110 40 –20 –10 –10 –10 –10 –60

Education, Training, Employment, and Social Services 

Education: 

70 Exclusion of scholarship and fellowship income (normal tax method) ................................................ 1,390 1,380 1,480 1,540 1,550 1,560 1,560 7,690

71 HOPE tax credit ..................................................................................................................................... 4,210 4,390 4,500 4,210 4,270 4,250 4,250 21,480

72 Lifetime Learning tax credit ................................................................................................................... 2,440 2,890 2,800 2,720 2,970 2,970 2,950 14,410

73 Education Individual Retirement Accounts ............................................................................................ 90 130 180 240 310 390 470 1,590

74 Deductibility of student-loan interest ...................................................................................................... 870 900 930 960 980 990 990 4,850

75 Deduction for higher education expenses ............................................................................................. 2,210 2,320 3,310 3,340 .............. .............. .............. 6,650

76 State prepaid tuition plans ..................................................................................................................... 50 150 320 430 510 590 660 2,510

77 Exclusion of interest on student-loan bonds ......................................................................................... 370 400 440 460 490 510 550 2,450

78 Exclusion of interest on bonds for private nonprofit educational facilities ........................................... 1,120 1,220 1,340 1,420 1,480 1,580 1,630 7,450

79 Credit for holders of zone academy bonds .......................................................................................... 110 130 160 180 190 200 200 930

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

81 Parental personal exemption for students age 19 or over ................................................................... 3,480 3,470 2,820 2,220 1,950 1,750 1,580 10,320
298 ANALYTICAL PERSPECTIVES 

Table 18–5. OUTLAY EQUVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(in millions of dollars) 

2003 2004 2005 2006 2007 2008 2009 2005–09

82 Deductibility of charitable contributions (education) .............................................................................. 3,670 3,390 3,660 4,000 4,230 4,510 4,830 21,230

83 Exclusion of employer-provided educational assistance ....................................................................... 620 660 690 730 770 810 860 3,860

84 Special deduction for teacher expenses ............................................................................................... 180 170 .............. .............. .............. .............. .............. ...............

Training, employment, and social services: 

85 Work opportunity tax credit .................................................................................................................... 430 370 170 70 30 .............. .............. 270

86 Welfare-to-work tax credit ...................................................................................................................... 60 60 40 30 20 .............. .............. 90

87 Employer provided child care exclusion ................................................................................................ 790 830 1,030 1,160 1,230 1,280 1,350 6,050

88 Employer-provided child care credit ...................................................................................................... 120 170 190 200 220 230 240 1,080

89 Assistance for adopted foster children .................................................................................................. 280 330 370 420 480 540 610 2,420

90 Adoption credit and exclusion ................................................................................................................ 280 570 640 690 710 730 750 3,520

91 Exclusion of employee meals and lodging (other than military) .......................................................... 950 990 1,030 1,080 1,130 1,180 1,210 5,630

92 Child credit 2 ........................................................................................................................................... 50,520 25,950 39,010 32,280 31,960 31,450 31,450 166,150

93 Credit for child and dependent care expenses ..................................................................................... 3,630 3,930 3,590 2,950 2,710 2,530 2,370 14,150

94 Credit for disabled access expenditures ............................................................................................... 70 70 70 70 70 80 80 370

95 Deductibility of charitable contributions, other than education and health .......................................... 30,020 27,370 29,670 32,550 34,500 36,790 39,410 172,920

96 Exclusion of certain foster care payments ............................................................................................ 490 500 510 520 530 540 650 2,750

97 Exclusion of parsonage allowances ...................................................................................................... 460 490 520 550 580 620 660 2,930

Health 

98 Exclusion of employer contributions for medical insurance premiums and medical care ....................... 129,010 133,400 141,590 151,940 163,510 176,320 190,300 823,660

99 Deductibility of self-employed medical insurance premiums ..................................................................... 3,170 4,640 4,610 4,990 5,310 5,770 6,250 26,930

100 Medical Savings Accounts/Health Savings Accounts ................................................................................ –40 –180 –730 –1,230 –1,780 –2,460 –2,800 –9,000

101 Deductibility of medical expenses .............................................................................................................. 6,700 7,400 8,540 9,170 9,930 11,060 11,930 50,630

102 Exclusion of interest on hospital construction bonds ................................................................................ 2,330 2,560 2,770 2,960 3,110 3,290 3,390 15,520

103 Deductibility of charitable contributions (health) ........................................................................................ 3,390 3,090 3,350 3,670 3,890 4,150 4,450 19,510

104 Tax credit for orphan drug research .......................................................................................................... 240 270 300 330 370 420 470 1,890

105 Special Blue Cross/Blue Shield deduction ................................................................................................ 440 400 390 350 390 330 360 1,820

106 Tax credit for health insurance purchased by certain displaced and retired individuals 3 ...................... .............. 60 80 80 90 90 100 440

Income Security 

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

108 Exclusion of workers’ compensation benefits ............................................................................................ 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710

109 Exclusion of public assistance benefits (normal tax method) ................................................................... 400 410 430 450 470 490 510 2,350

110 Exclusion of special benefits for disabled coal miners ............................................................................. 60 60 50 50 50 40 40 230

111 Exclusion of military disability pensions ..................................................................................................... 100 110 110 110 110 120 120 570

Net exclusion of pension contributions and earnings: 

112 Employer plans ....................................................................................................................................... 72980 72410 75290 80900 76400 71170 73710 377,470

113 401(k) plans ............................................................................................................................................ 63260 69200 71840 74800 80180 86680 92000 405,500

114 Individual Retirement Accounts ............................................................................................................. 26220 26390 26910 27530 27010 26640 26320 134,410

115 Low and moderate income savers credit .............................................................................................. 880 960 1100 1210 730 .............. .............. 3,040

116 Keogh plans ............................................................................................................................................ 7640 11040 11660 12360 13140 14320 15600 67,080

Exclusion of other employee benefits: 

117 Premiums on group term life insurance ................................................................................................ 2,400 2,440 2,480 2,520 2,560 2,600 2,650 12,810

118 Premiums on accident and disability insurance .................................................................................... 310 320 330 350 360 370 390 1,800

119 Small business retirement plan credit ........................................................................................................ 60 110 140 190 200 210 210 950

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

121 Special ESOP rules .................................................................................................................................... 2,850 3,060 3,280 3,520 3,800 4,080 4,360 19,040

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

123 Additional deduction for the elderly ........................................................................................................... 2,220 2,070 2,180 2,290 2,380 2,330 2,350 11,530

124 Tax credit for the elderly and disabled ...................................................................................................... 30 20 20 20 10 10 10 70

125 Deductibility of casualty losses .................................................................................................................. 550 760 740 750 640 600 630 3,360

126 Earned income tax credit 4 ......................................................................................................................... 5,666 5,427 5,562 6,085 6,127 6,226 6,422 30,422

Social Security 

Exclusion of social security benefits: 

127 Social Security benefits for retired workers .......................................................................................... 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420

128 Social Security benefits for disabled ..................................................................................................... 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420

129 Social Security benefits for dependents and survivors ........................................................................ 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730

Veterans Benefits and Services 

130 Exclusion of veterans death benefits and disability compensation .......................................................... 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560

131 Exclusion of veterans pensions ................................................................................................................. 100 100 100 110 110 110 120 550

132 Exclusion of GI bill benefits ....................................................................................................................... 110 120 130 130 160 170 170 760

133 Exclusion of interest on veterans housing bonds ..................................................................................... 50 70 70 70 80 80 80 380

General Purpose Fiscal Assistance 

134 Exclusion of interest on public purpose State and local bonds ............................................................... 36,550 37,270 37,830 37,920 37,490 38,620 39,770 191,630

135 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .................... 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

136 Tax credit for corporations receiving income from doing business in U.S. possessions ........................ 1,710 1,640 1,570 1,140 .............. .............. .............. 2,710

Interest 

137 Deferral of interest on U.S. savings bonds ............................................................................................... 30 40 40 40 40 40 50 210
18. TAX EXPENDITURES 299

Table 18–5. OUTLAY EQUVALENT ESTIMATES FOR TAX EXPENDITURES—Continued

(in millions of dollars) 

2003 2004 2005 2006 2007 2008 2009 2005–09

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied homes ............................................................................................ 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850

Nonbusiness State and local taxes other than on owner-occupied homes ........................................ 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290

Exclusion of interest on State and local bonds for: 

Public purposes ...................................................................................................................................... 36,550 37,270 37,830 37,920 37,490 38,620 39,770 191,630

Energy facilities ...................................................................................................................................... 130 150 160 160 170 190 190 870

Water, sewage, and hazardous waste disposal facilities ..................................................................... 650 700 760 820 850 900 940 4,270

Small-issues ............................................................................................................................................ 560 610 670 700 750 790 820 3,730

Owner-occupied mortgage subsidies ..................................................................................................... 1,310 1,420 1,550 1,660 1,730 1,840 1,890 8,670

Rental housing ........................................................................................................................................ 400 440 510 530 550 580 590 2,760

Airports, docks, and similar facilities ..................................................................................................... 1,110 1,210 1,310 1,390 1,460 1,550 1,600 7,310

Student loans .......................................................................................................................................... 370 400 440 460 490 510 550 2,450

Private nonprofit educational facilities ................................................................................................... 1,120 1,220 1,340 1,420 1,480 1,580 1,630 7,450

Hospital construction .............................................................................................................................. 2,330 2,560 2,770 2,960 3,110 3,290 3,390 15,520

Veterans’ housing ................................................................................................................................... 50 70 70 70 80 80 80 380

Credit for holders of zone academy bonds ............................................................................................... 110 130 160 180 190 200 200 930

1 In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 

$1,320; 2006 $1,370; 2007 $1,400; and 2008 $1,430. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $980; 2002 $5,060 2003 $5,870; 2004 $5,860; 

2005 $5,700; 2006 $7,630; 2007 $7,630; and 2008 $7,500 3 In addition to the outlay equivalents shown outlays of $60 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 

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

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

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

Tax Expenditure Baselines 

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

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

law. As noted previously, deciding whether provisions 

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

in prior years, most of this year’s tax expenditure estimates are presented using two baselines: the normal 

tax baseline and the reference tax law baseline. An 

exception is provided for the reduction in the tax rate 

on dividends and capital gains on corporate shares by 

the Jobs and Growth Tax Relief Reconciliation Act of 

2003 (JGTRRA), as dicussed below. 

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

sum of consumption and the change in net wealth in 

a given period of time. The normal tax baseline allows 

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

is not limited to a particular structure of tax rates, 

or by a specific definition of the taxpaying unit. 

The reference tax law baseline is also patterned on 

a comprehensive income tax, but it is closer to existing 

law. Tax expenditures under the reference law baseline 

are generally tax expenditures under the normal tax 

baseline, but the reverse is not always true. 

Both the normal and reference tax baselines allow 

several major departures from a pure comprehensive 

income tax. For example: 

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

own produce) is regarded as a tax expenditure. 

Both accrued and imputed income would be taxed 

under a comprehensive income tax. 

• A comprehensive income tax would generally not 

exclude from the tax base amounts for personal 

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

• There generally is a separate corporate income 

tax. 

• Values of assets and debt are not generally adjusted for inflation. A comprehensive income tax 

would adjust the cost basis of capital assets and 

debt for changes in the price level during the time 

the assets or debt are held. Thus, under a comprehensive income tax baseline, the failure to take 

account of inflation in measuring depreciation, 

capital gains, and interest income would be regarded as a negative tax expenditure (i.e., a tax 

penalty), and failure to take account of inflation 

in measuring interest costs would be regarded as 

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

Although the reference law and normal tax baselines 

are generally similar, areas of difference include:

Tax rates. The separate schedules applying to the 

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

below the maximum statutory rate do not give 

rise to a tax expenditure. The normal tax baseline 

is similar, except that, by convention, it specifies 

the current maximum rate as the baseline for the 

corporate income tax. The lower tax rates applied 

to the first $10 million of corporate income are 

thus regarded as a tax expenditure. Again by convention, the alternative minimum tax is treated 
300 ANALYTICAL PERSPECTIVES 

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

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

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

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

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

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

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

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

may be limited under the alternative minimum tax. 

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

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

as part of the baseline rate structure under both 

the reference and normal tax methods. 

Income subject to the tax. Income subject to tax 

is defined as gross income less the costs of earning 

that income. The Federal income tax defines gross 

income to include: (1) consideration received in 

the exchange of goods and services, including labor 

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

of gross or net income earned and/or reported by 

another entity (such as a partnership). Under the 

reference tax rules, therefore, gross income does 

not include gifts—defined as receipts of money or 

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

thought of as gifts from the Government.1 The 

normal tax baseline also excludes gifts between 

individuals from gross income. Under the normal 

tax baseline, however, all cash transfer payments 

from the Government to private individuals are 

counted in gross income, and exemptions of such 

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

deductible in determining taxable income under 

both the reference and normal tax baselines.2

Capital recovery. Under the reference tax law 

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

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

The latter represents a change in the calculation 

of the tax expenditure under normal law first 

made in the 2004 Budget. The Appendix provides 

further details on the new methodology and how 

it differs from the prior methodology. 

Treatment of foreign income. Both the normal and 

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

income taxes that would otherwise be due), which 

prevents double taxation of income earned abroad. 

Under the normal tax method, however, controlled 

foreign corporations (CFCs) are not regarded as 

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

under this method. In contrast, except for tax 

haven activities, the reference law baseline follows 

current law in treating CFCs as separate taxable 

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

until distributed to U.S. taxpayers. Under this 

baseline, deferral of tax on CFC income is not 

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

income.

In addition to these areas of difference, the Joint 

Committee on Taxation considers a somewhat broader 

set of tax expenditures under its normal tax baseline 

than is considered here. 

Treatment of JGTRRA’s Cut in the Tax Rates 

on Dividends and Capital Gains 

Although not in line with previous reference tax law 

or normal tax law baselines, our tables exclude from 

the list of tax expenditures JGTRRA’s reductions in 

the tax rate on dividends. Reference law used for the 

FY 2005 Budget includes capital gains as tax expenditure, but only to the extent capital gains have not previously been taxed under the corporate income tax. 

Similarly, the lower tax rate on dividends is not included as a tax expenditure under reference law because dividends have generally already been taxed 

under the corporate income tax. This exception was 

made as part of Treasury’s ongoing reevaluation of the 

tax expenditure concept and to consider gradually 

changes in the baseline tax system to conform more 

closely with a comprehensive income tax that excludes 

double tax on corporate income. The same treatment 

is extended to the tax rate differential applied to capital 

gains on corporate shares, including JGTRRA’s increase 

in this differential. 

Performance Measures and the Economic 

Effects of Tax Expenditures 

The Government Performance and Results Act of 

1993 (GPRA) directs Federal agencies to develop annual 

and strategic plans for their programs and activities. 

These plans set out performance objectives to be 

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

to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA3 calls on the 

Executive branch to undertake a series of analyses to 

assess the effect of specific tax expenditures on the 

achievement of agencies’ performance objectives. 

The Executive Branch is continuing to focus on the 

availability of data needed to assess the effects of the 

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

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

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

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

panel sample was drawn from tax returns filed in 2000 

for tax year 1999. The sample will capture the changing 

demographic and economic circumstances of individuals 

and the effects of changes in tax law over an extended 

period of time. Data from the sample will therefore 

permit more extensive, and better, analyses of many 

tax provisions than can be performed using only annual 

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

panel sample will enhance our ability to analyze the 
18. TAX EXPENDITURES 301

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

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

for certain types of consumption deemed meritorious. 

effect of tax expenditures designed to increase savings. 

Other efforts by OMB, Treasury, and other agencies 

to improve data available for the analysis of savings 

tax expenditures will continue over the next several 

years. 

Comparison of tax expenditure, spending, and 

regulatory policies. Tax expenditures by definition 

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

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

Because there is an existing public administrative and 

private compliance structure for the tax system, the 

incremental administrative and compliance costs for a 

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

some tax expenditures actually simplify the tax system, 

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

gains on home sales). Tax expenditures also implicitly 

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

have different economic effects. Finally, a variety of 

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

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

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

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

be flexible and can have very different economic effects. 

Tax expenditures also have limitations. In many 

cases they add to the complexity of the tax system, 

which raises both administrative and compliance costs. 

For example, targeting personal exemptions and credits 

can complicate filing and decisionmaking. The income 

tax system may have little or no contact with persons 

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

information on certain characteristics of individuals 

used in some spending programs, such as wealth. These 

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

Tax expenditures also generally do not enable the same 

degree of agency discretion as an outlay program. For 

example, grant or direct Federal service delivery programs can prioritize activities to be addressed with specific resources in a way that is difficult to emulate 

with tax expenditures. Finally, tax expenditures may 

not receive the same level of scrutiny afforded to other 

programs. 

Outlay programs have advantages where direct Government service provision is particularly warranted—

such as equipping and providing the armed forces or 

administering the system of justice. Outlay programs 

may also be specifically designed to meet the needs 

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

programs may also receive more year-to-year oversight 

and fine tuning, through the legislative and executive 

budget process. In addition, many different types of 

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

governments, the private sector, or individuals in the 

form of grants or contracts—provide flexibility for policy 

design. On the other hand, certain outlay programs—

such as direct Government service provision—may rely 

less directly on economic incentives and private-market 

provision than tax incentives, which may reduce the 

relative efficiency of spending programs for some goals. 

Spending programs also require resources to be raised 

via taxes, user charges, or Government borrowing, 

which can impose further costs by diverting resources 

from their most efficient uses. Finally, spending programs, particularly on the discretionary side, may respond less readily to changing activity levels and economic conditions than tax expenditures. 

Regulations have more direct and immediate effects 

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

private sector. Regulations can also be fine-tuned more 

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

largely upon voluntary compliance, rather than detailed 

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

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

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

this feature can also promote full compliance where 

(as in certain safety-related cases) policymakers believe 

that trade-offs with economic considerations are not of 

paramount importance. Also, regulations generally do 

not directly affect Federal outlays or receipts. Thus, 

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

that goes well beyond the analysis required for outlays 

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

lack of formal analysis. 

Some policy objectives are achieved using multiple 

approaches. For example, minimum wage legislation, 

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

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

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

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

saving for retirement or investing in certain sectors); 

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

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

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

Also, many tax expenditures, including those cited 

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

accelerated depreciation may encourage investment. In 

addition, the economic effects of particular provisions 

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

incomes may have positive or negative effects on tax 

neutrality). 

Performance measurement is generally concerned 

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

expenditures, the principal input is usually the revenue 

effect. Outputs are quantitative or qualitative measures 

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

turn, represent the changes in the economy, society, 

or environment that are the ultimate goals of programs. 

Thus, for a provision that reduces taxes on certain 

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

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

inequity or unintended consequence in the tax code, 

an important performance measure might be how they 

change effective tax rates (the discounted present-value 

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

distortions caused by taxes). Effects on the incomes of 

members of particular groups may be an important 

measure for certain provisions. 

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

groups of tax expenditures. The discussion is intended 

to be illustrative and not all encompassing. However, 

it is premised on the assumption that the data needed 

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

major challenge, and data constraints may limit the 

assessment of the effectiveness of many provisions. In 

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

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

tax preferences for military benefits reflect, among 

other things, the view that benefits such as housing, 

subsistence, and moving expenses are intrinsic aspects 

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

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

associated with foreign earnings is targeted to benefit 

U.S. Government civilian personnel working abroad by 

offsetting the living costs that can be higher than those 

in the United States. These tax expenditures should 

be considered together with direct agency budget costs 

in making programmatic decisions. 

International affairs.—Tax expenditures are also 

aimed at goals such as tax neutrality. These include 

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

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

General science, space and technology; energy; 

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

tax expenditures reduces the cost of investment, both 

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

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

incentives by measuring their effects on the cost of 

capital (the interest rate which investments must yield 

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

of these provisions on the amounts of corresponding 

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

some cases, such as research, there is evidence that 

the investment can provide significant positive 

externalities—that is, economic benefits that are not 

reflected in the market transactions between private 

parties. It could be useful to quantify these externalities 

and compare them with the size of tax expenditures. 

Measures could also indicate the effects on production 

from these investments—such as numbers or values 

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

extent to which the preferences increase production (as 

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

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

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

scientific, and other information (such as the effects 

of increased domestic fuel production on imports from 

various regions, or the effects of various energy sources 

on the environment). 

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

value of owner-occupied housing services is not included 

in a taxpayer’s taxable income. Taxpayers also may 

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

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

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

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

making housing more affordable as well as easing the 

cost of providing community services through these 
18. TAX EXPENDITURES 303

taxes. Provisions intended to promote investment in 

rental housing could be evaluated for their effects on 

making such housing more available and affordable. 

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

Transportation.—Employer-provided parking is a 

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

taxation. The tax expenditure estimates reflect the cost 

of parking that is leased by employers for employees; 

an estimate is not currently available for the value 

of parking owned by employers and provided to their 

employees. The exclusion for employer-provided transit 

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

could be compared with alternative transportation policies. 

Community and regional development.—A series 

of tax expenditures is intended to promote community 

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

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

activity in disadvantaged areas. These provisions can 

be compared with grants and other policies designed 

to spur economic development. 

Education, training, employment, and social 

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

costs of raising children, and to promote a variety of 

charitable activities. The education incentives can be 

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

child credits are intended to adjust the tax system for 

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

compared to other Federal tax and spending policies, 

including related features of the tax system, such as 

personal exemptions (which are not defined as a tax 

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

tax reduction. 

Health.—Individuals also benefit from favorable 

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

and pooling of risks. The effects of insurance coverage 

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

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

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

Income security, Social Security, and veterans 

benefits and services.—Major tax expenditures in the 

income security function benefit retirement savings, 

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

might be evaluated in terms of their effects on boosting 

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

as well as public savings or deficits). Interactions with 

other programs, including Social Security, also may 

merit analysis. As in the case of employer-provided 

health insurance, analysis of employer-provided pension 

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

Other provisions principally affect the incomes of 

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

in contrast, should be evaluated for its effects on labor 

force participation as well as the income it provides 

lower-income workers. 

General purpose fiscal assistance and interest.—

The tax-exemption for public purpose State and local 

bonds reduces the costs of borrowing for a variety of 

purposes (borrowing for non-public purposes is reflected 

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

primarily relates to personal income taxes (property tax 

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

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

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

bonds benefits savers who invest in these instruments. 

The extent of these benefits and any effects on Federal 

borrowing costs could be evaluated. 

The above illustrative discussion, although broad, is 

nevertheless incomplete, omitting important details 

both for the provisions mentioned and the many that 

are not explicitly cited. Developing a framework that 

is sufficiently comprehensive, accurate, and flexible to 

reflect the objectives and effects of the wide range of 

tax expenditures will be a significant challenge. OMB, 

Treasury, and other agencies will work together, as 

appropriate, to address this challenge. As indicated 

above, over the next few years the Executive Branch’s 

focus will be on the availability of the data needed 

to assess the effects of the tax expenditures designed 

to increase savings. 

Descriptions of Income Tax Provisions 

Descriptions of the individual and corporate income 

tax expenditures reported upon in this chapter follow. 

These descriptions relate to current law as of December 

31, 2003, and do not reflect proposals made elsewhere 

in the Budget. 

National Defense 

1. Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, as well as certain 

amounts of pay related to combat service, are excluded 

from income subject to tax. 
304 ANALYTICAL PERSPECTIVES 

5The determination of whether a provision is a tax expenditure is made on the basis 

of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under 

general U.S. income tax principles. For that reason, the tax expenditure estimates include, 

for example, estimates related to the exclusion of extraterritorial income, as well as other 

exclusions, notwithstanding that such exclusions define income under the general rule of 

U.S. income taxation. 

International Affairs 

2. Income earned abroad.— U.S. citizens who lived 

abroad, worked in the private sector, and satisfied a 

foreign residency requirement in 2001 may exclude up 

to $78,000 in foreign earned income from U.S. taxes. 

The exclusion increases to $80,000 in 2002 (and thereafter). In addition, if these taxpayers receive a specific 

allowance for foreign housing from their employers, 

they may also exclude the value of that allowance. If 

they do not receive a specific allowance for housing 

expenses, they may deduct against their U.S. taxes that 

portion of such expenses that exceeds one-sixth the salary of a civil servant at grade GS-14, step 1 ($72,381 

in 2003). 

3. Exclusion of certain allowances for Federal 

employees abroad.—U.S. Federal civilian employees 

and Peace Corps members who work outside the continental United States are allowed to exclude from U.S. 

taxable income certain special allowances they receive 

to compensate them for the relatively high costs associated with living overseas. The allowances supplement 

wage income and cover expenses like rent, education, 

and the cost of travel to and from the United States. 

4. Extraterritorial income exclusion.5—For purposes of calculating U.S. tax liability, a taxpayer may 

exclude from gross income the qualifying foreign trade 

income attributable to foreign trading gross receipts. 

The exclusion generally applies to income from the sale 

or lease of qualifying foreign trade property and certain 

types of services income. The FSC Repeal and 

Extraterritorial Income Exclusion Act of 2000 created 

the extraterritorial income exclusion to replace the foreign sales corporation provisions, which the Act repealed. The exclusion is generally available for transactions entered into after September 30, 2000. 

5. Sales source rule exceptions.—The worldwide 

income of U.S. persons is taxable by the United States 

and a credit for foreign taxes paid is allowed. The 

amount of foreign taxes that can be credited is limited 

to the pre-credit U.S. tax on the foreign source income. 

The sales source rules for inventory property allow U.S. 

exporters to use more foreign tax credits by allowing 

the exporters to attribute a larger portion of their earnings abroad than would be the case if the allocation 

of earnings was based on actual economic activity. 

6. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled 

by U.S. shareholders is not subject to U.S. taxation. 

The income becomes taxable only when the controlling 

U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal 

tax method, the currently attributable foreign source 

pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not 

distributed. Thus, the normal tax method considers the 

amount of controlled foreign corporation income not yet 

distributed to a U.S. shareholder as tax-deferred income. 

7. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. Taxes on 

income earned through December 31, 2006 can be deferred. 

General Science, Space, and Technology 

8. Expensing R&E expenditures.—Research and 

experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue 

for several years. It is often difficult, however, to identify whether a specific R&E project is successful and, 

if successful, what its expected life will be. Under the 

normal tax method, the expensing of R&E expenditures 

is viewed as a tax expenditure. The baseline assumed 

for the normal tax method is that all R&E expenditures 

are successful and have an expected life of five years. 

9. R&E credit.—The research and experimentation 

(R&E) credit is 20 percent of qualified research expenditures in excess of a base amount. The base amount 

is generally determined by multiplying a ‘‘fixed-base 

percentage’’ by the average amount of the company’s 

gross receipts for the prior four years. The taxpayer’s 

fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through 

1988. Taxpayers may also elect an alternative credit 

regime. Under the alternative credit regime the taxpayer is assigned a three-tiered fixed-base percentage 

that is lower than the fixed-base percentage that would 

otherwise apply, and the credit rate is reduced (the 

rates range from 2.65 percent to 3.75 percent). A 20-

percent credit with a separate threshold is provided 

for a taxpayer’s payments to universities for basic research. The credit applies to research conducted before 

July 1, 2004 and extends to research conducted in Puerto Rico and the U.S. possessions. 

Energy 

10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of 

unsalvageable materials used in constructing wells) 

may be expensed rather than amortized over the productive life of the property. Integrated oil companies 

may deduct only 70 percent of such costs and must 

amortize the remaining 30 percent over five years. The 

same rule applies to the exploration and development 

costs of surface stripping and the construction of shafts 

and tunnels for other fuel minerals. 

11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed 

to take percentage depletion deductions rather than 

cost depletion on limited quantities of output. Under 

cost depletion, outlays are deducted over the productive 

life of the property based on the fraction of the resource 

extracted. Under percentage depletion, taxpayers de-
18. TAX EXPENDITURES 305

duct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent 

for oil, gas and oil shale; and 10 percent for coal. The 

deduction is limited to 50 percent of net income from 

the property, except for oil and gas where the deduction 

can be 100 percent of net property income. Production 

from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit 

on output and no limitation with respect to qualified 

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

investment. 

12. Alternative fuel production credit.—A nontaxable credit of $3 per oil-equivalent barrel of production (in 1979 dollars) is provided for several forms of 

alternative fuels. The credit is generally available if 

the price of oil stays below $29.50 (in 1979 dollars). 

The credit generally expires on December 31, 2002. 

13. Oil and gas exception to passive loss limitation.—Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations. 

As a result, the working interest-holder, who manages 

on behalf of himself and all other owners the development of wells and incurs all the costs of their operation, 

may aggregate negative taxable income from such interests with his income from all other sources. 

14. Capital gains treatment of royalties on 

coal.—Sales of certain coal under royalty contracts can 

be treated as capital gains rather than ordinary income. 

15. Energy facility bonds.—Interest earned on 

State and local bonds used to finance construction of 

certain energy facilities is tax-exempt. These bonds are 

generally subject to the State private-activity bond annual volume cap. 

16. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for 

tertiary oil recovery on U.S. projects. Qualifying costs 

include tertiary injectant expenses, intangible drilling 

and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property. 

17. New technology credits.—A credit of 10 percent 

is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from 

renewable resources such as wind, biomass, and poultry 

waste facilities. The renewable resources credit applies 

only to electricity produced by a facility placed in service on or before December 31, 2004. 

18. Alcohol fuel credits.—An income tax credit is 

provided for ethanol that is derived from renewable 

sources and used as fuel. The credit equals 53 cents 

per gallon in 2001 and 2002; 52 cents per gallon in 

2003 and 2004; and 51 cents per gallon in 2005, 2006, 

and 2007. To the extent that ethanol is mixed with 

taxable motor fuel to create gasohol, taxpayers may 

claim an exemption of the Federal excise tax rather 

than the income tax credit. In addition, small ethanol 

producers are eligible for a separate 10 cents per gallon 

credit. 

19. Credit and deduction for clean-fuel vehicles 

and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles 

and owners of clean-fuel refueling property may deduct 

part of their expenditures. The credit and deduction 

are phased out from 2004 through 2007,. 

20. Exclusion of utility conservation subsidies.—

Non-business customers can exclude from gross income 

subsidies received from public utilities for expenditures 

on energy conservation measures. 

Natural Resources and Environment 

21. Exploration and development costs.—Certain 

capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than 

depreciated over the life of the asset. 

22. Percentage depletion.—Most nonfuel mineral 

extractors may use percentage depletion rather than 

cost depletion, with percentage depletion rates ranging 

from 22 percent for sulfur to 5 percent for sand and 

gravel. 

23. Sewage, water, solid and hazardous waste facility 

bonds.—Interest earned on State and local bonds used 

to finance the construction of sewage, water, or hazardous waste facilities is tax-exempt. These bonds are 

generally subject to the State private-activity bond annual volume cap. 

24. Capital gains treatment of certain timber.—

Certain timber sold under a royalty contract can be 

treated as a capital gain rather than ordinary income. 

25. Expensing multiperiod timber growing 

costs.—Most of the production costs of growing timber 

may be expensed rather than capitalized and deducted 

when the timber is sold. In most other industries, these 

costs are capitalized under the uniform capitalization 

rules. 

26. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20-

percent investment credit, but the depreciable basis 

must be reduced by the full amount of the credit taken. 

Agriculture 

27. Expensing certain capital outlays.—Farmers, 

except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for 

feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though 

these expenditures are for inventories held beyond the 

end of the year, or for capital improvements that would 

otherwise be capitalized. 

28. Expensing multiperiod livestock and crop 

production costs.—The production of livestock and 

crops with a production period of less than two years 

is exempt from the uniform cost capitalization rules. 

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale 

with a production period of two years or more may 

elect not to capitalize costs. If they do, they must apply 
306 ANALYTICAL PERSPECTIVES 

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, debtors must include the amount of loan forgiveness as income or reduce their recoverable basis in 

the property to which the loan relates. If the debtor 

elects to reduce basis and the amount of forgiveness 

exceeds the basis in the property, the excess forgiveness 

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

the amount of loan forgiveness reduces carryover losses, 

then unused credits, and then basis; any remainder 

of the forgiven debt is excluded from tax. Farmers with 

forgiven debt are considered insolvent for tax purposes, 

and thus qualify for income tax forgiveness. 

30. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops, 

can be treated as capital gains rather than ordinary 

income. 

31. Income averaging for farmers.—Taxpayers can 

lower their tax liability by averaging, over the prior 

three-year period, their taxable income from farming. 

32. Deferral of gain on sales of farm refiners.—

A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement 

property. 

Commerce and Housing 

This category includes a number of tax expenditure 

provisions that also affect economic activity in other 

functional categories. For example, provisions related 

to investment, such as accelerated depreciation, could 

be classified under the energy, natural resources and 

environment, agriculture, or transportation categories. 

33. Credit union income.—The earnings of credit 

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

34. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings 

banks, and savings and loan associations may deduct 

additions to bad debt reserves in excess of actually 

experienced losses. 

35. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided 

for investment income within qualified life insurance 

and annuity contracts. Investment income earned on 

qualified life insurance contracts held until death is 

permanently exempt from income tax. Investment income distributed prior to the death of the insured is 

tax-deferred, if not tax-exempt. Investment income 

earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits 

from tax deferral without annual contribution or income 

limits generally applicable to other tax-favored retirement income plans.

36. Small property and casualty insurance companies.— Insurance companies that have annual net 

premium incomes of less than $350,000 are exempt 

from tax; those with $350,000 to $2.1 million of net 

premium incomes may elect to pay tax only on the 

income earned by their investment portfolio. 

37. Insurance companies owned by exempt organizations.—Generally, the income generated by life 

and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations 

conducted by such exempt organizations as fraternal 

societies and voluntary employee benefit associations, 

however, are exempt from tax. 

38. Small life insurance company deduction.—

Small life insurance companies (gross assets of less 

than $500 million) can deduct 60 percent of the first 

$3 million of otherwise taxable income. The deduction 

phases out for otherwise taxable income between $3 

million and $15 million. 

39. Mortgage housing bonds.—Interest earned on 

State and local bonds used to finance homes purchased 

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds 

that can be issued to finance these and other private 

activity is limited. The combined volume cap for private 

activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial 

development bonds was $62.50 per capita ($187.5 million minimum) per State in 2001, and $75 per capita 

($225 million minimum) in 2002. The Community Renewal Tax Relief Act of 2000 accelerated the scheduled 

increase in the state volume cap and indexed the cap 

for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax 

credits for a specified percentage of interest on qualified 

mortgages. The total amount of MCCs issued by a State 

cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds. 

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 
18. TAX EXPENDITURES 307

after October 13, 1987, it is limited to no more than 

$1 million. Interest on up to $100,000 of other debt 

secured by a lien on a principal or second residence 

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions 

on personal residences are tax expenditures because 

the value of owner-occupied housing services is not included in a taxpayer’s taxable income. The Appendix 

provides an alternative calculation of the tax expenditure based on the implicit rental income on owner-occupied housing, which is generally viewed as a more accurate measure of the tax expenditure relative to a comprehensive income tax base. 

42. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their 

primary and secondary residences even though they are 

not required to report the value of owner-occupied housing services as gross income. 

43. Installment sales.—Dealers in real and personal 

property (i.e., sellers who regularly hold property for 

sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment. 

Nondealers (i.e., sellers of real property used in their 

business) are required to pay interest on deferred taxes 

attributable to their total installment obligations in excess of $5 million. Only properties with sales prices 

exceeding $150,000 are includable in the total. The payment of a market rate of interest eliminates the benefit 

of the tax deferral. The tax exemption for nondealers 

with total installment obligations of less than $5 million 

is, therefore, a tax expenditure. 

44. Capital gains exclusion on home sales.—A 

homeowner can exclude from tax up to $500,000 

($250,000 for singles) of the capital gains from the sale 

of a principal residence. The exclusion may not be used 

more than once every two years. 

45. Passive loss real estate exemption.—In general, passive losses may not offset income from other 

sources. Losses up to $25,000 attributable to certain 

rental real estate activity, however, are exempt from 

this rule. 

46. Low-income housing credit.—Taxpayers who 

invest in certain low-income housing are eligible for 

a tax credit. The credit rate is set so that the present 

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other 

Federal benefits (such as tax-exempt bond financing), 

or (2) substantially rehabilitated existing housing. The 

credit is allowed in equal amounts over 10 years. State 

agencies determine who receives the credit; States are 

limited in the amount of credit they may authorize 

annually. The Community Renewal Tax Relief Act of 

2000 increased the per-resident limit to $1.50 in 2001 

and to $1.75 in 2002 and indexed the limit for inflation, 

beginning in 2003. The Act also created a $2 million 

minimum annual cap for small States beginning in 

2002; the cap is indexed for inflation, beginning in 

2003. 

47. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of 

the reference law rules, and thus do not give rise to 

tax expenditures under the reference method. Under 

the normal tax method, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

48. Cancellation of indebtedness.—Individuals are 

not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not 

reported as current income, however, the basis of the 

underlying property must be reduced by the amount 

canceled. 

49. Imputed interest rules.—Holders (issuers) of 

debt instruments are generally required to report interest earned (paid) in the period it accrues, not when 

paid. In addition, the amount of interest accrued is 

determined by the actual price paid, not by the stated 

principal and interest stipulated in the instrument. In 

general, any debt associated with the sale of property 

worth less than $250,000 is excepted from the general 

interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but 

is under normal law. Exceptions above $250,000 are 

a tax expenditure under reference law; these exceptions 

include the following: (1) sales of personal residences 

worth more than $250,000, and (2) sales of farms and 

small businesses worth between $250,000 and $1 million. 

50. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held 

for more than 1 year are taxed at a lower rate than 

ordinary income. Under the revised reference law baseline used for the FY 2005 Budget, the lower rate on 

capital gains is considered a tax expenditure under the 

reference law method, but only for capital gains that 

have not been previously taxed under the corporate 

income tax. As discussed above, this treatment excludes 

the double tax on corporate income and is more consistent with a comprehensive income tax base. 

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

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

top capital gains tax rate for assets held for more than 

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

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

are not recognized. 

For assets held for more than 1 year by taxpayers 

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

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

the top capital gains tax rate for assets held by these 

taxpayers for more than 5 years was 8 percent. 

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

previous 10 percent and 8 percent rates to 5 percent 

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

held for more than one year. The lower rates apply 

to assets sold after May 6, 2003 through 2008. 
308 ANALYTICAL PERSPECTIVES 

51. Capital gains exclusion for small business 

stock.—An exclusion of 50 percent is provided for capital gains from qualified small business stock held by 

individuals for more than 5 years. A qualified small 

business is a corporation whose gross assets do not 

exceed $50 million as of the date of issuance of the 

stock. 

52. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are 

not subject to capital gains taxes. The cost basis of 

the appreciated assets is adjusted upward to the market value at the owner’s date of death. After repeal 

of the estate tax for 2010 under the Economic Growth 

and Tax Relief Reconciliation Act (EGTRRA) of 2001, 

the basis for property acquired from a decedent will 

be the lesser of fair market value or the decedent’s 

basis. Certain types of additions to basis will be allowed 

so that assets in most estates that are not currently 

subject to estate tax will not be subject to capital gains 

tax in the hands of the heirs. 

53. Carryover basis of capital gains on gifts.—

When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the 

transferred property was first acquired) carries-over to 

the donee. The carryover of the donor’s basis allows 

a continued deferral of unrealized capital gains. Even 

though the estate tax is repealed for 2010 under 

EGTRRA, the gift tax is retained with a lifetime exemption of $1 million. 

54. Ordinary income treatment of losses from 

sale of small business corporate stock shares.—

Up to $100,000 in losses from the sale of small business 

corporate stock (capitalization less than $1 million) may 

be treated as ordinary losses. Such losses would, thus, 

not be subject to the $3,000 annual capital loss writeoff limit. 

55. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus 

do not give rise to tax expenditures under reference 

law. Under normal law, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

56. Accelerated depreciation of machinery and 

equipment.—The tax depreciation allowance provisions 

are part of the reference law rules, and thus do not 

give rise to tax expenditures under reference law. 

Under the normal tax baseline, this tax depreciation 

allowance is measured relative to economic depreciation. This calculation is described in more detail in 

the Appendix. 

57. Expensing of certain small investments.—In 

2002, qualifying investments in tangible property up 

to $24,000 could be expensed rather than depreciated 

over time. The expensing limit increases to $25,000 

in 2003. To the extent that qualifying investment during the year exceeds $200,000, the amount eligible for 

expensing is decreased. In 2002, the amount expensed 

was completely phased out when qualifying investments 

exceeded $224,000. 

58. Business start-up costs.—When taxpayers enter 

into a new business, certain start-up expenses, such 

as the cost of legal services, are normally incurred. 

Taxpayers may elect to amortize these outlays over 60 

months even though they are similar to other payments 

made for nondepreciable intangible assets that are not 

recoverable until the business is sold. The normal tax 

method treats this amortization as a tax expenditure; 

the reference tax method does not. 

59. Graduated corporation income tax rate 

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000 

of taxable income, 25 percent on the next $25,000, and 

34 percent on the next $9.925 million. Compared with 

a flat 34-percent rate, the lower rates provide an 

$11,750 reduction in tax liability for corporations with 

taxable income of $75,000. This benefit is recaptured 

for corporations with taxable incomes exceeding 

$100,000 by a 5-percent additional tax on corporate 

incomes in excess of $100,000 but less than $335,000. 

The corporate tax rate is 35 percent on income over 

$10 million. Compared with a flat 35-percent tax rate, 

the 34-percent rate provides a $100,000 reduction in 

tax liability for corporations with taxable incomes of 

$10 million. This benefit is recaptured for corporations 

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but 

less than $18.33 million. Because the corporate rate 

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method. 

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower 

rates is considered a tax expenditure under this concept. 

60. Small issue industrial development bonds.—

Interest earned on small issue industrial development 

bonds (IDBs) issued by State and local governments 

to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must 

be depreciated, however, using the straight-line method. 

The annual volume of small issue IDBs is subject to 

the unified volume cap discussed in the mortgage housing bond section above. 

Transportation 

61. Deferral of tax on U.S. shipping companies.—

Certain companies that operate U.S. flag vessels can 

defer income taxes on that portion of their income used 

for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment 

of loans to finance these investments. Once indefinite, 

the deferral has been limited to 25 years since January 

1, 1987. 

62. Exclusion of employee parking expenses.—

Employee parking expenses that are paid for by the 

employer or that are received in lieu of wages are excludable from the income of the employee. Since 2002, 

the maximum amount of the parking exclusion is $185 

(indexed) per month. The tax expenditure estimate does 

not include parking at facilities owned by the employer. 
18. TAX EXPENDITURES 309

63. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in 

lieu of wages to defray an employee’s commuting costs 

are excludable from the employee’s income. Since 2002, 

the maximum amount of the exclusion is $100 (indexed) 

per month. 

Community and Regional Development 

64. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation 

of buildings that are used for business or productive 

activities and that were erected before 1936 for other 

than residential purposes. The taxpayer’s recoverable 

basis must be reduced by the amount of the credit. 

65. Airport, dock, and similar facility bonds.—

Interest earned on State and local bonds issued to finance high-speed rail facilities and government-owned 

airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to 

a volume cap. 

66. Exemption of income of mutuals and cooperatives.—The incomes of mutual and cooperative telephone and electric companies are exempt from tax if 

at least 85 percent of their revenues are derived from 

patron service charges. 

67. Empowerment zones, enterprise communities, 

and renewal communities.—Qualifying businesses in 

designated economically depressed areas can receive tax 

benefits such as an employer wage credit, increased 

expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain 

capital gains incentives. The Job Creation and Worker 

Assistance Act of 2002 expanded the existing provisions 

by adding the ‘‘New York City Liberty Zone.’’ In addition, certain first-time buyers of a principal residence 

in the District of Columbia can receive a tax credit 

on homes purchased on or before December 31, 2003, 

and investors in certain D.C. property can receive a 

capital gains break. The Community Renewal Tax Relief Act of 2000 created the renewal communities tax 

benefits, which begin on January 1, 2002 and expires 

on December 31, 2009. The Act also created additional 

empowerment zones, increased the tax benefits for empowerment zones, and extended the expiration date of 

(1) empowerment zones from December 31, 2004 to December 31, 2009, and (2) the D.C. home-buyer credit 

from December 31, 2001 to December 31, 2003. 

68. New markets tax credit.—Taxpayers who invest 

in a community development entity (CDE) after December 31, 2000 are eligible for a tax credit. The total 

equity investment available for the credit across all 

CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and 

2003, $2.0 billion in 2004 and 2005, and $3.5 billion 

in 2006 and 2007. The amount of the credit equals 

(1) 5 percent in the year of purchase and the following 

2 years, and (2) 6 percent in the following 4 years. 

A CDE is any domestic firm whose primary mission 

is to serve or provide investment capital for low-income 

communities/individuals; a CDE must be accountable 

to residents of low-income communities. The Community Renewal Tax Relief Act of 2000 created the new 

markets tax credit. 

69. Expensing of environmental remediation 

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

costs, rather than capitalize the costs, even though the 

expenses will generally increase the value of the property significantly or appreciably prolong the life of the 

property. The expensing only applies to clean-up costs 

incurred on or before December 31, 2003. The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2001 to December 31, 

2003. The Act also expanded the number of qualified 

sites. 

Education, Training, Employment, and Social 

Services 

70. Scholarship and fellowship income.—Scholarships and fellowships are excluded from taxable income 

to the extent they pay for tuition and course-related 

expenses of the grantee. Similarly, tuition reductions 

for employees of educational institutions and their families are not included in taxable income. From an economic point of view, scholarships and fellowships are 

either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus, 

under the reference law method, this exclusion is not 

a tax expenditure because this method does not include 

either gifts or price reductions in a taxpayer’s gross 

income. The exclusion, however, is considered a tax expenditure under the normal tax method, which includes 

gift-like transfers of Government funds in gross income 

(many scholarships are derived directly or indirectly 

from Government funding). 

71. HOPE tax credit.— The non-refundable HOPE 

tax credit allows a credit for 100 percent of an eligible 

student’s first $1,000 of tuition and fees and 50 percent 

of the next $1,000 of tuition and fees. The credit only 

covers tuition and fees paid during the first two years 

of a student’s post-secondary education. In 2003, the 

credit is phased out ratably for taxpayers with modified 

AGI between $83,000 and $103,000 ($41,000 and 

$51,000 for singles), indexed. 

72. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for 

20 percent of an eligible student’s tuition and fees. For 

tuition and fees paid after December 31, 2002, the maximum credit per return is $2,000. The credit is phased 

out ratably for taxpayers with modified AGI between 

$83,000 and $103,000 ($41,000 and $51,000 for singles) 

(indexed beginning in 2002). The credit applies to both 

undergraduate and graduate students. 

73. Deduction for Higher Education Expenses.—

The maximum annual deduction for qualified higher 

education expenses is $3,000 in 2003 for taxpayers with 

adjusted gross income up to $130,000 on a joint return 

($65,000 for singles). The maximum deduction increases 

to $4,000 in 2004. Taxpayers with adjusted gross income up to $160,000 on a joint return ($80,000 for 
310 ANALYTICAL PERSPECTIVES 

singles) may deduct up to $2,000 beginning in 2004. 

No deduction is allowed for expenses paid after December 31, 2005. 

74. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is 

not taxed when earned, and investment income from 

an education IRA is tax-exempt when withdrawn to 

pay for a student’s tuition and fees. The maximum contribution to an education IRA in 2003 is $200 per beneficiary. The maximum contribution is phased down ratably for taxpayers with modified AGI between $159,000 

and $220,000 ($95,000 and $110,000 for singles). 

EGTRRA increases the maximum contribution to 

$2,000 and the phase-out range for joint filers to 

$190,000 through $220,000 of modified AGI, double the 

range of singles. 

75. Student-loan interest.—Taxpayers may claim 

an above-the-line deduction of up to $2,500 on interest 

paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. In 2003, the maximum deduction 

is phased down ratably for taxpayers with modified 

AGI between $100,000 and $130,000 ($50,000 and 

$65,000 for singles), indexed. 

76. State prepaid tuition plans.—Some States 

have adopted prepaid tuition plans and prepaid room 

and board plans, which allow persons to pay in advance 

for college expenses for designated beneficiaries. In 

2001 taxes on the earnings from these plans are paid 

by the beneficiaries and are deferred until tuition is 

actually paid. Beginning in 2002, investment income 

is not taxed when earned, and is tax-exempt when 

withdrawn to pay for qualified expenses. These changes 

were the result of EGTRRA. 

77. Student-loan bonds.—Interest earned on State 

and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds 

that each State may issue annually is limited. 

78. Bonds for private nonprofit educational institutions.—Interest earned on State and local Government bonds issued to finance the construction of facilities used by private nonprofit educational institutions 

is not taxed. 

79. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds 

receive a non-refundable tax credit (at a rate set by 

the Treasury Department) rather than interest. The 

credit is included in gross income. Proceeds from zone 

academy bonds may only be used to renovate, but not 

construct, qualifying schools and for certain other 

school purposes. The total amount of zone academy 

bonds that may be issued is limited to $1.6 billion—

$400 million in each year from 1998 to 2003. 

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

earned on U.S. savings bonds issued after December 

31, 1989 is tax-exempt if the bonds are transferred 

to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers 

with AGI between $87,750 and $117.750 ($58,500 and 

$73,500 for singles) in 2003. 

81. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent 

children age 19 or over who (1) receive parental support 

payments of $1,000 or more per year, (2) are full-time 

students, and (3) do not claim a personal exemption 

on their own tax returns. 

82. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to 

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the assets’ current value without being taxed on 

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent 

of adjusted gross income; a corporation’s total charitable 

contributions generally may not exceed 10 percent of 

pre-tax income. 

83. Employer-provided educational assistance.—

Employer-provided educational assistance is excluded 

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. EGTRRA permanently extended this exclusion and extended the exclusion to also include graduate education (beginning in 2002). 

84. Special deduction for teacher expenses.—Educators in both public and private elementary and secondary schools, who work at least 900 hours during 

a school year as a teacher, instructor, counselor, principal or aide, may subtract up to $250 of qualified expenses when figuring their adjusted gross income (AGI). 

85. Work opportunity tax credit.—Employers can 

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2004 

and who are certified as members of various targeted 

groups. The amount of the credit that can be claimed 

is 25 percent for employment of less than 400 hours 

and 40 percent for employment of 400 hours or more. 

The maximum credit per employee is $2,400 and can 

only be claimed on the first year of wages an individual 

earns from an employer. Employers must reduce their 

deduction for wages paid by the amount of the credit 

claimed. 

86. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible 

wages paid to qualified long-term family assistance recipients during the first two years of employment. The 

credit is 35 percent of the first $10,000 of wages in 

the first year of employment and 50 percent of the 

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The 

credit applies to wages paid to employees who are hired 

on or before December 31, 2004. 

87. Employer-provided child care exclusion.—

Employer-provided child care is excluded from an employee’s gross income even though the employer’s costs 

for the child care are a deductible business expense. 

88. Employer-provided child care credit.—Employers can deduct expenses for supporting child care 

or child care resource and referral services. EGTRRA 
18. TAX EXPENDITURES 311

provides a tax credit to employers for qualified expenses 

beginning in 2002. The credit is equal to 25 percent 

of qualified expenses for employee child care and 10 

percent of qualified expenses for child care resource 

and referral services. Employer deductions for such expenses are reduced by the amount of the credit. The 

maximum total credit is limited to $150,000 per taxable 

year. 

89. Assistance for adopted foster children.—Taxpayers who adopt eligible children from the public foster care system can receive monthly payments for the 

children’s significant and varied needs and a reimbursement of up to $2,000 for nonrecurring adoption expenses. These payments are excluded from gross income. 

90. Adoption credit and exclusion.—Taxpayers can 

receive a nonrefundable tax credit for qualified adoption 

expenses. The maximum credit is $10,160 per child for 

2003. The credit is phased-out ratably for taxpayers 

with modified AGI between $152,390 and $192,390 in 

2003. The credit amounts and the phase-out thresholds 

are indexed for inflation beginning in 2003. Unused 

credits may be carried forward and used during the 

five subsequent years. Taxpayers may also exclude 

qualified adoption expenses from income, subject to the 

same maximum amounts and phase-out as the credit. 

The same expenses cannot qualify for tax benefits 

under both programs; however, a taxpayer may use 

the benefits of the exclusion and the tax credit for different expenses. Stepchild adoptions are not eligible for 

either benefit. 

91. 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. 

92. Child credit.—Taxpayers with children under 

age 17 can qualify for a $1,000 refundable per child 

credit. The maximum credit is equal to $700 in 2005, 

$800 in 2009, and $1,000 in 2010, and declines to $500 

in 2011 and later years. The credit is phased out for 

taxpayers at the rate of $50 per $1,000 of modified 

AGI above $110,000 ($75,000 for singles). 

93. Child and dependent care expenses.—Married 

couples with child and dependent care expenses may 

claim a tax credit when one spouse works full time 

and the other works at least part time or goes to school. 

The credit may also be claimed by single parents and 

by divorced or separated parents who have custody of 

children. Expenditures up to a maximum $3,000 for 

one dependent and $6,000 for two or more dependents 

are eligible for the credit. The credit is equal to 35 

percent of qualified expenditures for taxpayers with incomes of $15,000. The credit is reduced to a minimum 

of 20 percent by one percentage point for each $2,000 

of income in excess of $15,000. 

94. 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. 

95. 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. 

96. 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. 

97. 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 

98. 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. 

99. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums. 

Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 2001, 70 percent in 

2002, and 100 percent in 2003 and thereafter. 

100. Medical and health savings accounts.—Some 

employees may deduct annual contributions to a medical savings account (MSA); employer contributions to 

MSAs (except those made through cafeteria plans) for 

qualified employees are also excluded from income. An 

employee may contribute to an MSA in a given year 

only if the employer does not contribute to the MSA 

in that year. MSAs are only available to self-employed 

individuals or employees covered under an employersponsored high deductible health plan of a small employer. The maximum annual MSA contribution is 75 

percent of the deductible under the high deductible plan 

for family coverage (65 percent for individual coverage). 

Earnings from MSAs are excluded from taxable income. 

Distributions from an MSA for medical expenses are 

not taxable. The number of taxpayers who may benefit 

annually from MSAs is generally limited to 750,000. 

No new MSAs may be established after December 31, 

2003. The Medicare Prescription Drug, Improvemnet, 

and Modernization Act of 2003 introduced health savings accounts (HSA) which provides a tax-favored savings for health care expenses. The definition of a high-
312 ANALYTICAL PERSPECTIVES 

deductible health plan is less restrictive for HSAs than 

for MSAs. 

101. Medical care expenses.—Personal expenditures for medical care (including the costs of prescription drugs) exceeding 7.5 percent of the taxpayer’s adjusted gross income are deductible. 

102. Hospital construction bonds.—Interest earned 

on State and local government debt issued to finance 

hospital construction is excluded from income subject 

to tax. 

103. Charitable contributions to health institutions.—Individuals and corporations may deduct contributions to nonprofit health institutions. Tax expenditures resulting from the deductibility of contributions 

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

104. Orphan drugs.—Drug firms can claim a tax 

credit of 50 percent of the costs for clinical testing required by the Food and Drug Administration for drugs 

that treat rare physical conditions or rare diseases. 

105. Blue Cross and Blue Shield.—Blue Cross and 

Blue Shield health insurance providers in existence on 

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that 

substantially reduce (or even eliminate) their tax liabilities. 

106. Tax credit for health insurance purchased 

by certain displaced and retired individuals.—The 

Trade Act of 2002 provided a refundable tax credit of 

65 percent for the purchase of health insurance 

covergae by individuals eligible for Trade Adjustment 

Assitance and certain PBGC pension recipients. 

Income Security 

107. Railroad retirement benefits.—Railroad retirement benefits are not generally subject to the income tax unless the recipient’s gross income reaches 

a certain threshold. The threshold is discussed more 

fully under the Social Security function. 

108. Workers’ compensation benefits.—Workers 

compensation provides payments to disabled workers. 

These benefits, although income to the recipients, are 

not subject to the income tax. 

109. Public assistance benefits.—Public assistance 

benefits are excluded from tax. The normal tax method 

considers cash transfers from the Government as taxable and, thus, treats the exclusion for public assistance 

benefits as a tax expenditure. 

110. Special benefits for disabled coal miners.—

Disability payments to former coal miners out of the 

Black Lung Trust Fund, although income to the recipient, are not subject to the income tax. 

111. Military disability pensions.—Most of the 

military pension income received by current disabled 

retired veterans is excluded from their income subject 

to tax. 

112. Employer-provided pension contributions 

and earnings.—Certain employer contributions to pension plans are excluded from an employee’s gross income even though the employer can deduct the contributions. In addition, the tax on the investment income earned by the pension plans is deferred until the 

money is withdrawn. 

113. 401(k) plans.—Individual taxpayers can make 

tax-preferred contributions to certain types of employerprovided 401(k) plans (and 401(k)-type plans like 403(b) 

plans and the Federal government’s Thrift Savings 

Plan). In 2001, an employee could exclude up to $12,000 

of wages from AGI under a qualified arrangement with 

an employer’s 401(k) plan. This increases to $13,000 

in 2004, $14,000 in 2005 and $15,000 in 2006 (indexed 

thereafter). The tax on the investment income earned 

by 401(k)-type plans is deferred until withdrawn. 

Employees are allowed to make after-tax contributions to 401(k) and 401(k)-type plans. These contributions are not excluded from AGI, but the investment 

income of such after-tax contributions is not taxed when 

earned or withdrawn. 

114. Individual Retirement Accounts.—Individual 

taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs, 

non-deductible IRAs, and Roth IRAs. The annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. 

The IRA contribution limit to $3,000 in 2003, $4,000 

in 2005, and $5,000 in 2008 (indexed thereafter) and 

allows taxpayers over age 50 to make additional ‘‘catchup’’ contributions of $1,000 (by 2006). 

Taxpayers whose AGI is below $70,000 ($50,000 for 

non-joint filers) in 2003 can claim a deduction for IRA 

contributions. The IRA deduction is phased out for taxpayers with AGI between $60,000 and $70,000 ($40,000 

and $50,000 for non-joint). The phase-out range increases annually until it reaches $80,000 to $100,000 

in 2007 ($50,000 to $60,000 in 2005 for non-joint filers). 

Taxpayers whose AGI is above the phase-out range can 

also claim a deduction for their IRA contributions depending on whether they (or their spouse) are an active 

participant in an employer-provided retirement plan. 

The tax on the investment income earned by 401(k) 

plans, non-deductible IRAs, and deductible IRAs is deferred until the money is withdrawn. 

Taxpayers with incomes below $160,000 ($110,000 for 

nonjoint filers) can make contributions to Roth IRAs. 

The maximum contribution to a Roth IRA is phased 

out for taxpayers with AGI between $150,000 and 

$160,000 ($95,000 and $110,000 for singles). Investment 

income of a Roth IRA is not taxed when earned nor 

when withdrawn. Withdrawals from a Roth IRA are 

penalty free if: (1) the Roth IRA was opened at least 

5 years before the withdrawal, and (2) the taxpayer 

either (a) is at least 591 2, (b) dies, (c) is disabled, or 

(d) purchases a first-time house. 

Taxpayers can contribute to a non-deductible IRA regardless of their income and whether they are an active 

participant in an employer-provided retirement plan. 

The tax on investment income earned by non-deductible 

IRAs is deferred until the money is withdrawn. 
18. TAX EXPENDITURES 313

115. Low and moderate income savers’ credit.—

EGTRRA provides an additional incentive for lowerincome taxpayers to save through a nonrefundable credit of up to 50 percent on IRA contributions. This credit 

is in addition to any deduction or exclusion. The credit 

is completely phased out by $50,000 for joint filers and 

$25,000 for single filers. This temporary credit is in 

effect from 2002 through 2006. 

116. Keogh plans.—Self-employed individuals can 

make deductible contributions to their own retirement 

(Keogh) plans equal to 25 percent of their income, up 

to a maximum of $40,000 in 2001. Total plan contributions are limited to 25 percent of a firm’s total wages. 

The tax on the investment income earned by Keogh 

plans is deferred until withdrawn. 

117. Employer-provided life insurance benefits.—

Employer-provided life insurance benefits are excluded 

from an employee’s gross income even though the employer’s costs for the insurance are a deductible business expense. 

118. Small business retirement plan credit.—

EGTRRA provides businesses with 100 or fewer employees a credit for 50 percent of the qualified startup costs 

associated with a new qualified retirement plan. The 

credit is limited to $500 annually and may only be 

claimed for expenses incurred during the first three 

years from the start of the qualified plan. Qualified 

startup expenses include expenses related to the establishment and administration of the plan, and the retirement-related education of employees. The credit applies 

to costs incurred beginning in 2002. 

119. Employer-provided accident and disability 

benefits.—Employer-provided accident and disability 

benefits are excluded from an employee’s gross income 

even though the employer’s costs for the benefits are 

a deductible business expense. 

120. Employer-provided supplementary unemployment benefits.—Employers may establish trusts 

to pay supplemental unemployment benefits to employees separated from employment. Interest payments to 

such trusts are exempt from taxation. 

121. Employer Stock Ownership Plan (ESOP) 

provisions.—ESOPs are a special type of tax-exempt 

employee benefit plan. Employer-paid contributions (the 

value of stock issued to the ESOP) are deductible by 

the employer as part of employee compensation costs. 

They are not included in the employees’ gross income 

for tax purposes, however, until they are paid out as 

benefits. The following special income tax provisions 

for ESOPs are intended to increase ownership of corporations by their employees: (1) annual employer contributions are subject to less restrictive limitations; (2) 

ESOPs may borrow to purchase employer stock, guaranteed by their agreement with the employer that the 

debt will be serviced by his payment (deductible by 

him) of a portion of wages (excludable by the employees) to service the loan; (3) employees who sell appreciated company stock to the ESOP may defer any taxes 

due until they withdraw benefits; and (4) dividends 

paid to ESOP-held stock are deductible by the employer. 

122. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,150 

standard deduction if single, or $950 if married in 2003. 

123. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,150 standard deduction if single, or $950 if 

married in 2003. 

124. Tax credit for the elderly and disabled.—

Individuals who are 65 years of age or older, or who 

are permanently disabled, can take a tax credit equal 

to 15 percent of the sum of their earned and retirement 

income. Income is limited to no more than $5,000 for 

single individuals or married couples filing a joint return where only one spouse is 65 years of age or older, 

and up to $7,500 for joint returns where both spouses 

are 65 years of age or older. These limits are reduced 

by one-half of the taxpayer’s adjusted gross income over 

$7,500 for single individuals and $10,000 for married 

couples filing a joint return. 

125. Casualty losses.—Neither the purchase of property nor insurance premiums to protect its value are 

deductible as costs of earning income; therefore, reimbursement for insured loss of such property is not reportable as a part of gross income. Taxpayers, however, 

may deduct uninsured casualty and theft losses of more 

than $100 each, but only to the extent that total losses 

during the year exceed 10 percent of AGI. 

126. Earned income tax credit (EITC).—The EITC 

may be claimed by low income workers. For a family 

with one qualifying child, the credit is 34 percent of 

the first $7,490 of earned income in 2003. The credit 

is 40 percent of the first $10,510 of income for a family 

with two or more qualifying children. The credit is 

phased out beginning when the taxpayer’s income exceeds $13,730 at the rate of 15.98 percent (21.06 percent if two or more qualifying children are present). 

It is completely phased out when the taxpayer’s modified adjusted gross income reaches $29,666 ($33,692 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 2003, 

the credit is 7.65 percent of the first $4,990 of earned 

income. When the taxpayer’s income exceeds $6,240, 

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

It is completely phased out at $11,230 of modified adjusted gross income. 

For workers with or without children, the income 

levels at which the credit begins to phase-out and the 

maximum amounts of income on which the credit can 

be taken are adjusted for inflation. For married taxpayers filing a joint return, The base amount for the 

phase-out increases by $2,000 in 2005 through 2007, 

and $3,000 in 2008 (indexed thereafter). 

Earned income tax credits in excess of tax liabilities 

owed through the individual income tax system are re-
314 ANALYTICAL PERSPECTIVES 

fundable to individuals. This portion of the credit is 

shown as an outlay, while the amount that offsets tax 

liabilities is shown as a tax expenditure. 

Social Security 

127. Social Security benefits for retired workers.—The non-taxation of Social Security benefits that 

exceed the beneficiary’s contributions out of taxed income is a tax expenditure. These additional retirement 

benefits are paid for partly by employers’ contributions 

that were not included in employees’ taxable compensation. Portions (reaching as much as 85 percent) of recipients’ Social Security and Tier 1 Railroad Retirement 

benefits are included in the income tax base, however, 

if the recipient’s provisional income exceeds certain 

base amounts. Provisional income is equal to adjusted 

gross income plus foreign or U.S. possession income 

and tax-exempt interest, and one half of Social Security 

and tier 1 railroad retirement benefits. The tax expenditure is limited to the portion of the benefits received 

by taxpayers who are below the base amounts at which 

85 percent of the benefits are taxable. 

128. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund 

for disability are partially excluded from a beneficiary’s 

gross incomes. 

129. Social Security benefits for dependents and 

survivors.—Benefit payments from the Social Security 

Trust Fund for dependents and survivors are partially 

excluded from a beneficiary’s gross income. 

Veterans Benefits and Services 

130. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded 

from taxable income. 

131. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income. 

132. G.I. Bill benefits.—G.I. Bill benefits paid by 

the Veterans Administration are excluded from gross 

income. 

133. Tax-exempt mortgage bonds for veterans.—

Interest earned on general obligation bonds issued by 

State and local governments to finance housing for veterans is excluded from taxable income. The issuance 

of such bonds is limited, however, to five pre-existing 

State programs and to amounts based upon previous 

volume levels for the period January 1, 1979 to June 

22, 1984. Furthermore, future issues are limited to veterans who served on active duty before 1977. 

General Government 

134. Public purpose State and local bonds.—Interest earned on State and local government bonds 

issued to finance public-purpose construction (e.g., 

schools, roads, sewers), equipment acquisition, and 

other public purposes is tax-exempt. Interest on bonds 

issued by Indian tribal governments for essential governmental purposes is also tax-exempt. 

135. Deductibility of certain nonbusiness State 

and local taxes.—Taxpayers may deduct State and 

local income taxes and property taxes even though 

these taxes primarily pay for services that, if purchased 

directly by taxpayers, would not be deductible. 

136. Business income earned in U.S. possessions.—U.S. corporations operating in a U.S. possession 

(e.g., Puerto Rico) can claim a credit against some or 

all of their U.S. tax liability on possession business 

income. The credit expires December 31, 2005. 

Interest 

137. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until 

the bonds are redeemed. 

Appendix: 

TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION 

This appendix provides an initial presentation of the 

Treasury Department review of the tax expenditure 

budget, which was first prepared for the 2004 Budget. 

The review focuses on three issues: (1) using comprehensive income as a baseline tax system, (2) using 

a consumption tax as a baseline tax system, and (3) 

defining negative tax expenditures (provisions that 

cause taxpayers to pay too much tax). 

The first section of this appendix compares major 

tax expenditures in the current budget to those implied 

by a comprehensive income baseline. This comparison 

includes a discussion of negative tax expenditures. The 

second section compares the major tax expenditures in 

the current budget to those implied by a consumption 

tax baseline, and also discusses negative tax expenditures. The final section addresses concerns that have 

been raised over the measurement of some current tax 

expenditures by describing a new estimate of the tax 

expenditure caused by accelerated depreciation and alternative estimates of the tax expenditures resulting 

from the tax exemption of the return earned on owneroccupied housing and preferential treatment of capital 

gains. The final section also provides an estimate of 

the negative tax expenditure caused by the double tax 

on corporate profits. 
18. TAX EXPENDITURES 315

6See, e.g., David F. Bradford, Untangling the Income Tax (Cambridge, MA: Harvard 

University Press, 1986), pp. 15–31, and Richard Goode, ‘‘The Economic Definition of Income’’ 

in Joseph Pechman, ed., Comprehensive Income Taxation (Washington, D.C.: The Brookings 

Institution, 1977), pp. 1–29. 

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON 

COMPREHENSIVE INCOME 

As discussed in the main body of the tax expenditure 

chapter, official tax expenditures are measured relative 

to normal law or reference law baselines that deviate 

from a uniform tax on a comprehensive concept of income. Consequently, tax expenditures identified in the 

budget can differ from those that would be identified 

if a comprehensive income tax were chosen as the baseline tax system. This appendix addresses this issue by 

comparing major tax expenditures listed in the current 

tax expenditure budget with those implied by a comprehensive income baseline. Most large tax expenditures would continue to be tax expenditures were the 

baseline taken to be comprehensive income, although 

some would be much smaller. A comprehensive income 

baseline would also result in a number of additional 

tax provisions being counted as tax expenditures. 

Current budgetary practice excludes from the list of 

official tax expenditures those provisions that over-tax 

certain items of income. This exclusion conforms to the 

view that tax expenditures are substitutes for direct 

Government spending programs. However, this treatment gives a one-sided picture of how current law deviates from the baseline tax system. Relative to comprehensive income, a number of current tax provisions 

would be negative tax expenditures. Some of these also 

might be negative tax expenditures under the reference 

law or normal law baselines, expanded to admit negative tax expenditures.

Treatment of Major Tax Expenditures from the Current 

Budget under a Comprehensive Income Tax Baseline

Comprehensive income, also called Haig-Simons income, is the real, inflation adjusted, accretion to one’s 

economic power arising between two points in time, 

e.g., the beginning and ending of the year. It includes 

all accretions to wealth, whether or not realized, whether or not related to a market transaction, and whether 

a return to capital or labor. Inflation adjusted capital 

gains (and losses) would be included in comprehensive 

income as they accrue. Business, investment, and casualty losses, including losses caused by depreciation, 

would be deducted. Implicit returns, such as those accruing to homeowners, also would be included in comprehensive income. A comprehensive income tax baseline would tax all sources of income once. Thus, it 

would not include a separate tax on corporate income 

that leads to the double taxation of corporate income. 

While comprehensive income can be defined on the 

sources side of the consumer’s balance sheet, it sometimes is instructive to use the identity between the 

sources of wealth and the uses of wealth to redefine 

it as the sum of consumption during the period plus 

the change in net worth between the beginning and 

the end of the period. 

Comprehensive income is widely held to be the idealized base for an income tax even though it is not a 

perfectly defined concept.6 It suffers from conceptual 

ambiguities, some of which are discussed below, as well 

as practical problems in measurement and tax administration, e.g., how to implement a practicable deduction 

for economic depreciation or include in income the return earned on consumer durable goods, including housing, automobiles, and major appliances. 

Furthermore, comprehensive income does not necessarily represent an ideal tax base; efficiency or equity 

might be improved by deviating from comprehensive 

income as a tax base, e.g., by reducing the tax on capital income in order to further spur economic growth 

or by subsidizing certain types of activities in order 

to correct for market failures or to improve the aftertax distribution of income. In addition, some elements 

of comprehensive income would be difficult or impossible to include in a tax system that is administrable. 

Classifying items under a comprehensive income 

baseline is difficult, in part because of the ambiguity 

of the baseline. It also is difficult because of interactions between tax provisions (or their absence). These 

interactions mean that it may not always be appropriate to consider each item in isolation. Nonetheless, 

Appendix Table 1 attempts such a classification for 

each of the thirty largest tax expenditures from the 

Budget. 

We classify fourteen of the thirty items as tax expenditures under a comprehensive tax base (those in 

panel A). Most of these give preferential tax treatment 

to the return on certain types of savings or investment. 

They are a result of the explicitly hybrid nature of 

the existing tax system, and arise out of policy decisions 

that reflect discomfort with the high tax rate on capital 

income that would otherwise arise under the current 

structure of the income tax. Even these relatively clear 

cut items, however, can raise ambiguities particularly 

in light of the absence of integration of the corporate 

and individual tax systems. Consider, for example, the 

tax expenditures related to retirement savings. Considered alone, these items clearly would be tax expenditures under a comprehensive income tax baseline. However, much of the income earned in these accounts is 

subject to the corporate income tax, and would not be 

taxed again under a comprehensive income tax. If account is taken simultaneously of the corporate income 

tax and the individual income tax, then much of what 

is measured in these tax expenditures might not be 

considered preferential tax treatment under a comprehensive income tax baseline. But, if the corporate 

level income tax is separately itemized as a surcharge, 

or a negative tax expenditure, then the preferential 

treatments of retirement saving would remain tax expenditures. 
316 ANALYTICAL PERSPECTIVES 

7Suppose a taxpayer buys a one year term unemployment insurance policy at the beginning of the year. At that time he exchanges one asset, cash, for another, the insurance 

policy, so there is no change in net worth. But, at the end of the year, the policy expires 

and so is worthless, hence the taxpayer has a reduction in net worth equal to the premium. 

If the policy pays off during the year (i.e., the taxpayer has a work related injury), then 

the taxpayer would include the proceeds in income because they represent an increase 

in his net worth. 8 As a practical matter, this may be impossible to do. Valuing claims subject to future 

contingencies is very difficult, as discussed in Bradford, Untangling the Income Tax, pp. 

23–24. 

9This includes the tax expenditure for benefits paid to workers, that for benefits paid 

to survivors and dependents, and that for benefits paid to dependents. 10The current budget does not include as a tax expenditure the absence of income taxation 

on the employer’s contributions (payroll taxes) to Social Security retirement at the time 

these contributions are made. 11Private pensions allow the employee to defer tax on all inside build-up. They also 

allow the employee to defer tax on contributions made by the employer, but not on contributions made directly by the employee. Applying these tax rules to Social Security would 

require the employee to include in his taxable income benefits paid out of inside buildup and out of the employer’s contributions, but would allow the employee to exclude from 

his taxable income benefits paid out of his own contributions. 

The exclusion of worker’s compensation benefits also 

would be a tax expenditure under comprehensive income principles. Under comprehensive income tax principles, if the worker were to buy the insurance himself, 

he would be able to deduct the premium (since it represents a reduction in net worth) but should include 

in income the benefit when paid (since it represents 

an increase in net worth).7 If the employer pays the 

premium, the proper treatment would allow the employer a deduction and allow the employee to disregard 

the premium, but he would take the proceeds, if any, 

into income. Current law allows the employer to deduct 

the premium and excludes both the premium and the 

benefits from the employee’s tax base. 

Panel B deals with items that probably are tax expenditures, but that raise some issues. The step-up of 

basis at death lowers the income tax on capital gains 

for those who inherit assets below what it would be 

otherwise. From that perspective it would be a tax expenditure under a comprehensive income baseline. 

Nonetheless, there are ambiguities. Under a comprehensive income baseline, all real inflation adjusted 

gains would be taxed as accrued, so there would be 

no deferred unrealized gains on assets held at death. 

The lack of full taxation of Social Security benefits 

also is listed in panel B. Consider first Social Security 

retirement benefits. To the extent that Social Security 

is viewed as a pension, a comprehensive income tax 

would include in income all contributions to Social Security retirement funds (payroll taxes) and tax accretions to value as they arise (inside build-up).8 Benefits 

paid out of prior contributions and the inside buildup, however, would not be included in the tax base 

because the fall in the value of the individual’s Social 

Security account would be offset by an increase in cash. 

In contrast, to the extent that Social Security is viewed 

as a transfer program, all contributions should be deductible from the income tax base and all benefits received should be included in the income tax base. 

A similar analysis applies to Social Security benefits 

paid to dependents and survivors. If these benefits represent transfers from the Government, then they should 

be included in the tax base. If the taxpaying unit consists of the worker plus dependents and survivors, then 

to the extent that Social Security benefits represent 

payments from a pension, the annual pension earnings 

should be taxed in the same way that earnings accruing 

to retirees are taxed. However, benefits paid to dependents and survivors might be viewed as a gift or transfer 

from the decedent, in which case the dependents and 

survivors should pay tax on the full amount of the 

benefit received. (In this case the decedent or his estate 

should pay tax on the pension income as well, to the 

extent that the gift represents consumption rather than 

a reduction in net worth). 

In addition, dependent and survivors benefits might 

be viewed in part as providing life insurance. In that 

case, the annual premiums paid each year, or the portion of Social Security taxes attributable to the premiums, should be deducted from income, since they 

represent a decline in net worth, while benefits should 

be included in income. Alternatively, taxing premiums 

and excluding benefits also would represent appropriate 

income tax policy. 

In contrast to any of these treatments, current law 

excludes one-half of contributions (employer-paid payroll taxes) from the base of the income tax, makes no 

attempt to tax accretions, and subjects some, but not 

all, benefits to taxation. The difference between current 

law’s treatment of Social Security benefits and their 

treatment under a comprehensive income tax would 

qualify as a tax expenditure, but such a tax expenditure 

differs in concept from that included in the official 

budget. 

The tax expenditures in the official budget9 reflect 

exemptions for lower income beneficiaries from the tax 

on 85 percent of Social Security benefits.10 Historically, 

payroll taxes paid by the employee represented no more 

than 15 percent of the expected value of the retirement 

benefits received by a lower-earnings Social Security 

beneficiary. The 85 percent inclusion rate is therefore 

intended to tax the remaining amount of the retirement 

benefit payment arising from the payroll tax contributions made by employers and the implicit return on 

the employee and employer contributions. Thus, the tax 

expenditure conceived and measured in the current 

budget is not intended to capture the deviation from 

comprehensive income baseline, which would additionally account for the deferral of tax on these components 

(less an inflation adjustment attributable to the employee’s payroll tax contributions). Rather, it is intended 

to approximate the taxation of private pensions with 

employee contributions made from after-tax income,11

on the assumption that Social Security is comparable 

to such pensions. Hence, the official tax expenditure 

understates the tax advantage accorded Social Security 

retirement benefits relative to a comprehensive income 

baseline. 

To the extent that the benefits paid to dependents 

and survivors should be taxed as private pensions, the 

same conclusion applies: the official tax expenditure 

understates the tax advantage. 

To the extent that the personal and dependent care 

exemptions and the standard deduction properly remove from taxable income all expenditures that do not 
18. TAX EXPENDITURES 317

12See, for example, Goode, The Economic Definition of Income, pp. 16–17, and Bradford, 

Untangling the Income Tax, pp. 19–21, and pp.30–31. 13The item also includes gifts of appreciated property, at least part of which represents 

a tax expenditure relative to an ideal income tax, even if one assumes that charitable 

donations are not consumption. 14 If recipients tend to be in lower tax brackets, then the tax expenditure is smaller 

than when measured at the donor’s tax rates. 

15Fiscal Year 2003 Budget of the United States Government, Analytical Perspectives (Washington, D.C.: U.S. Government Printing Office, 2002) p. 127. 16 U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: U.S. Government 

Printing Office, 1977) p. 92. 17 Home mortgage interest and property taxes on owner-occupied housing raise the same 

ambiguity. Classifying them as probably not tax expenditures arguably is inconsistent. It 

yield consumption value, then the child care credit and 

the earned income tax credit would be tax expenditures. 

In contrast, a competing perspective views these credits 

as appropriate modifications that account for differing 

taxpaying capacity. Even accepting this competing perspective, however, one might question why these programs come in the form of credits rather than deductions. 

The next category (panel C) includes items whose 

treatment is less certain. The proper treatment of some 

of these items under a comprehensive income tax is 

ambiguous, while others perhaps serve as proxies for 

what would be a tax expenditure under a comprehensive income base.12 Consider, for example, the items 

relating to charitable contributions. Under existing law, 

charitable contributions are deductible, and this deduction is considered on its face a tax expenditure in the 

current budget.13

The treatment of charitable donations, however, is 

ambiguous under a comprehensive income tax. If charitable contributions are a consumption item for the 

giver, then they are properly included in his taxable 

income; a deduction for contributions would then be 

a tax expenditure relative to a comprehensive income 

tax baseline. In contrast, charitable contributions could 

represent a transfer of purchasing power from the giver 

to the receiver. As such, they would represent a reduction in the giver’s net worth, not an item of consumption, and so properly would be deductible, implying that 

current law’s treatment is not a tax expenditure. At 

the same time, the value of the charitable benefits received is income to the recipient. Under current law, 

such income generally is not taxed, and so represents 

a tax expenditure whose size might be approximated 

by the size of the donor’s contribution.14

Medical expenditures may or may not be an element 

of income (or consumption), depending on one’s point 

of view. Some argue that medical expenditures don’t 

represent discretionary spending, and so aren’t consumption. Instead, they are a reduction of net worth 

and should be excluded from the tax base. Others argue 

that there is no way to logically distinguish medical 

care from other consumption items. Moreover, clearly 

there is choice in health care decisions, e.g., whether 

to go to the best doctor, whether to have voluntary 

surgical procedures, and whether to exercise and eat 

nutritiously so as to improve and maintain one’s health 

and minimize medical expenditures. 

The exemption of full taxation of Social Security benefits paid to the disabled also raises some issues. Social 

Security benefits for the disabled most closely resemble 

either Government transfers or insurance. A comprehensive income tax would require the worker to include the benefit fully in his income and would allow 

him to deduct associated Social Security taxes. If 

viewed as insurance, he also could include the premium 

(i.e., tax) and exclude the benefit. The deviation between such treatment and current law’s treatment (described above) would be a tax expenditure under a comprehensive income baseline. 

In contrast, as described above, the official tax expenditure measures the benefit of exemption for low 

income beneficiaries from the tax on 85 percent of Social Security benefits. This measurement does not correspond closely to that required under a comprehensive 

income base. If the payment of the benefit is viewed 

as a transfer and divorced from the treatment of Social 

Security taxes, then the current tax expenditure understates the tax expenditure measured relative to a comprehensive income baseline. If the payment of the benefit is viewed as a transfer but the inability to deduct 

the employee’s share of the Social Security tax is simultaneously considered, then it is less likely that the current tax expenditure overstates the tax expenditure relative to a comprehensive income baseline, and in some 

cases it may generate a negative tax expenditure. Negative tax expenditures arise when the actual tax treatment imposes a higher tax burden than would the baseline tax system, and are discussed in more detail below. 

If the benefit is viewed as insurance and the tax as 

a premium, then the current tax expenditure overstates 

the tax expenditure relative to a comprehensive income 

baseline. Indeed, in the insurance model, the ability 

to exclude from tax only 1 2 of the premium might suggest that 1 2 of the payout should be taxed, so that 

the current tax rules impose a greater tax burden than 

that implied by a comprehensive income tax, i.e., a 

negative tax expenditure. 

The deduction of nonbusiness state and local taxes 

other than on owner-occupied homes also is included 

here. These taxes include both income taxes and property taxes. The stated justification for this tax expenditure is that ‘‘Taxpayers may deduct State and local 

income taxes and property taxes even though these 

taxes primarily pay for services that, if purchased directly by taxpayers, would not be deductible.’’15 The 

idea is that these taxes represent consumption expenditures, and so are elements of income. 

In contrast to the view in the official budget, the 

deduction for State and local taxes might not be a tax 

expenditure if the baseline were comprehensive income. 

Properly measured comprehensive income would include the value of State and local government benefits 

received, but would allow a deduction for State and 

local taxes paid.16 Thus, in this sense the deductibility 

of State and local taxes is consistent with comprehensive income tax principles; it should not be a tax expenditure. However, imputing the value of State and 

local services may be difficult and, as a rough correction, the tax system might disallow the deduction for 

State and local taxes.17 So, if the value of services 
318 ANALYTICAL PERSPECTIVES 

reflects the judgment that no comprehensive tax is likely to tax the value of State and 

local services, while it appears somewhat easier to impute and tax the rental income from 

owner-occupied housing. 18 Under the normal tax method employed by the Joint Committee on Taxation, the 

value of some public assistance benefits provided by State Governments is included as 

a tax expenditure, thereby raising a potential double counting issue. 19 As discussed below, the double tax on corporate profits would be a major negative 

tax expenditure. 20 In contrast, the passive loss rules themselves, which restrict the deduction of losses, 

would be a negative tax expenditure when compared to a comprehensive tax base. 21To the extent that premiums are deductible.

22 Current law offers favorable treatment to some education costs, thereby creating (positive) tax expenditures. Current law allows expensing of that part of the cost of education 

and career training that is related to foregone earnings and this would be a tax expenditure 

under a comprehensive income baseline. In addition, some education has consumption value, 

and under a comprehensive income definition would be taxable to that extent, but is not 

taxable under current law. 

from State and local governments is excluded from the 

tax base, as it generally is under current law, a deduction for taxes might be viewed as a tax expenditure 

relative to a comprehensive income baseline.18

Mortgage interest would be deductible from the base 

of a comprehensive income tax, since comprehensive 

income would include implicit rental income on owneroccupied housing. Similarly, property taxes on owneroccupied housing would be deductible, since they represent a reduction in net worth. One could argue, however, that because current law does not impute rental 

income nor does it impute the value of Government 

services, the home mortgage interest deduction and the 

deduction for property taxes move away from rather 

than towards the outcome observed under a comprehensive income tax base, and so might be considered tax 

expenditures. Alternatively, they might be viewed as 

proxies for the correct tax expenditures. They are, however, extremely crude proxies for the implicit rental 

income earned on owner-occupied housing. The interest 

deduction proxy, for example, understates the extent 

of the tax expenditure associated with ignoring implicit 

rental income to the extent a house is unencumbered 

by a mortgage that approximates the house’s market 

value, and does not include the effects on net income 

of such costs as depreciation, maintenance, and repairs. 

The final category (panel D) includes items that 

would not be tax expenditures under a comprehensive 

income tax base. Most versions of a comprehensive income tax would assign tax liability to individuals. There 

would be no separate corporation income tax. Hence, 

the issue of graduated corporate tax rates would not 

arise.19 A tax based on comprehensive income would 

allow all losses to be deducted. Hence, the exception 

from the passive loss rules would not be a tax expenditure.20

Major Tax Expenditures under a Comprehensive Income 

Tax That Are Excluded from the Current Budget

While most of the major tax expenditures in the current budget also would be tax expenditures under a 

comprehensive income base, there also are tax expenditures relative to a comprehensive income base that are 

not found on the existing tax expenditure list. These 

additional tax expenditures include the imputed return 

from consumer durables and owner-occupied housing, 

the difference between capital gains (and losses) as they 

accrue and capital gains as they are realized, private 

gifts and inheritances received, in-kind benefits from 

such Government programs as food-stamps, Medicaid, 

and public housing, the value of payouts from insurance 

policies,21 and benefits received from private charities. 

Under some ideas of comprehensive income, the value 

of leisure and of household production of goods and 

services also would be included as tax expenditures. 

The personal exemption and standard deduction also 

might be considered tax expenditures, although they 

can be viewed differently, e.g., as elements of the basic 

tax rate schedule. The foreign tax credit also might 

be a tax expenditure, since a deduction for foreign 

taxes, rather than a credit, would seem to measure 

the income of U.S. residents properly. 

Negative Tax Expenditures

Under current budgetary practice, negative tax expenditures, tax provisions that raise rather than lower 

taxes, are excluded from the official tax expenditure 

list. This exclusion conforms with the view that tax 

expenditures are intended to be similar to Government 

spending programs. 

If attention is expanded from a focus on spendinglike programs to include any deviation from the baseline tax system, negative tax expenditures would be 

of interest. Relative to a comprehensive income baseline, there are a number of important negative tax expenditures, some of which also might be viewed as negative tax expenditures under an expanded interpretation of the normal or reference law baseline. Among 

the more important negative tax expenditures is the 

corporation income tax, or more generally the double 

tax on corporate profits, which would be eliminated 

under a comprehensive income tax. The Jobs and 

Growth Tax Relief and Reconciliation Act of 2003 

(JGTRRA) reduced the tax rate on dividends and capital gains to 15 percent, thus reducing the double tax 

compared to prior law. Nonetheless, as discussed later 

in the Appendix, current law still imposes a substantial 

double tax on corporate profits. The passive loss rules, 

restrictions on the deductibility of capital losses, and 

NOL carry-forward requirements each would generate 

a negative tax expenditure, since a comprehensive income tax would allow full deductibility of losses. If 

human capital were considered an asset, then its cost 

(e.g., certain education and training expenses, including 

perhaps the cost of college and professional school) 

should be amortizable, but it is not under current law.22

Some restricted deductions under the individual AMT 

might be negative tax expenditures as might the phaseout of personal exemptions and of itemized deductions. 

The inability to deduct consumer interest also might 
18. TAX EXPENDITURES 319

23See Bradford, Untangling the Income Tax, p. 41. 24 Accelerated depreciation can be described as the equivalent of an interest free loan 

from the Government to the taxpayer. Under federal budget accounting principles, such 

a loan would be treated as an outlay equal to the present value of the foregone interest. 

be a negative tax expenditure, as an interest deduction 

may be required to properly measure income, as seen 

by the equivalence between borrowing and reduced 

lending.23 As discussed above, the current treatment 

of Social Security payments to the disabled also might 

represent a negative tax expenditure, if viewed as payments on an insurance policy. 

Current tax law also fails to index for inflation interest receipts, capital gains, depreciation, and inventories. 

This failure leads to negative tax expenditures because 

comprehensive income would be indexed for inflation. 

Current law, however, also fails to index for inflation 

the deduction for interest payments; this represents a 

(positive) tax expenditure. 

The issue of indexing also highlights that even if 

one wished to focus only on tax policies that are similar 

to spending programs, accounting for some negative tax 

expenditures may be required. For example, the net 

subsidy created by accelerated depreciation is properly 

measured by the difference between depreciation allowances specified under existing tax law and economic 

depreciation, which is indexed for inflation.24

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES RELATIVE 

TO A CONSUMPTION BASE 

This section compares tax expenditures listed in the 

official tax expenditure budget with those implied by 

a comprehensive consumption tax baseline. It first discusses some of the difficulties encountered in trying 

to compare current tax provisions to those that would 

be observed under a comprehensive consumption tax. 

Next, it discusses which of the thirty largest official 

tax expenditures would be tax expenditures under the 

consumption tax baseline, concluding that about onehalf of the top thirty official tax expenditures would 

remain tax expenditures under a consumption tax baseline. Most of those that fall off the list are tax incentives for saving and investment. 

The section next discusses some major differences between current law and a comprehensive consumption 

tax baseline that are excluded from the current list 

of tax expenditures. These differences include the consumption value of owner-occupied housing and other 

consumer durables, benefits from in-kind Government 

transfers, and gifts. It concludes with a discussion of 

negative tax expenditures relative to a consumption tax 

baseline

Ambiguities in Determining Tax Expenditures Relative 

to a Consumption Baseline

A broad-based consumption tax is a combination of 

an income tax plus a deduction for net saving. This 

follows from the definition of comprehensive income as 

consumption plus the change in net worth. It therefore 

seems straightforward to say that current law’s deviations from a consumption base are the sum of (a) 

tax expenditures on an income base associated with 

exemptions and deductions for certain types of income, 

plus (b) overpayments of tax, or negative tax expenditures, to the extent net saving is not deductible from 

the tax base. In reality, however, the situation is more 

complicated. A number of issues arise, some of which 

also are problems in defining a comprehensive income 

tax, but seem more severe, or at least only more obvious, for the consumption tax baseline. 

It is not always clear how to treat certain items 

under a consumption tax. One problem is determining 

whether a particular expenditure is an item of consumption. Spending on medical care and charitable donations are two examples. Another problem relates to 

foreign source income. It is sometimes argued that a 

credit for foreign income taxes is inappropriate against 

the base of a consumption tax. Does that mean that 

the current foreign tax credit is a tax expenditure for 

a consumption tax base? The classification below suggests that medical spending and charitable contributions might be included in the definition of consumption, but also considers an alternative view. It makes 

no judgment about the treatment of foreign taxes, but 

provides a brief discussion of the issues. 

There may be more than one way to treat various 

items under a consumption tax. For example, a consumption tax might ignore borrowing and lending by 

excluding from the borrower’s tax base the proceeds 

from loans, denying the borrower a deduction for payments of interest and principal, and excluding interest 

and principal payments received from the lender’s tax 

base. On the other hand, a consumption tax might include borrowing and lending in the tax base by requiring the borrower to add the proceeds from loans in 

his tax base, allowing the lender to deduct loans from 

his tax base, allowing the borrower to deduct payments 

of principal and interest, and requiring the lender to 

include receipt of principal and interest payments. In 

present value terms, the two approaches are equivalent 

for both the borrower and the lender; in particular both 

allow the tax base to measure consumption and both 

impose a zero effective tax rate on interest income. 

But which approach is taken obviously has different 

implications (at least on an annual flow basis) for the 

treatment of many important items of income and expense, such as the home mortgage interest deduction. 

The classification below suggests that the deduction for 

home mortgage interest could well be a tax expenditure, 

but takes note of alternative views. 

Some exclusions of income are equivalent in many 

respects to consumption tax treatment that immediately deducts the cost of an investment while taxing 

the future cash-flow. For example, exempting invest-
320 ANALYTICAL PERSPECTIVES 

ment income is equivalent to consumption tax treatment as far as the normal rate of return on new investment is concerned. This is because expensing generates 

a tax reduction that offsets in present value terms the 

tax paid on the investment’s future normal returns. 

Expensing gives the income from a marginal investment a zero effective tax rate. However, a yield exemption approach differs from a consumption tax as far 

as the distribution of income and Government revenue 

is concerned. Pure profits in excess of the normal rate 

of return would be taxed under a consumption tax, 

because they are an element of cash-flow, but would 

not be taxed under a yield exemption tax system. 

Should exemption of certain kinds of investment income, and certain investment tax credits, be regarded 

as the equivalent of consumption tax treatment? The 

classification that follows takes a fairly broad view of 

this equivalence and considers many tax provisions that 

reduce or eliminate the tax on capital income to be 

roughly consistent with a broad-based consumption tax. 

Looking at provisions one at a time can be misleading. The hybrid character of the existing tax system 

leads to many provisions that might make good sense 

in the context of a consumption tax, but that generate 

inefficiencies because of the problem of the ‘‘uneven 

playing field’’ when evaluated within the context of the 

existing tax rules. It is not clear how these should 

be classified. For example, many saving incentives are 

targeted to specific tax favored sources of capital income, and so potentially distort economic choices in 

ways that would not occur under a broad-based consumption tax. As another example, under a consumption VAT based on the destination principle, there 

would be a rebate of the VAT on exports and a tax 

on imports. Does this mean that the extraterritorial 

income exclusion (the successor of the Foreign Sales 

Corporation provision) is not a tax expenditure? Resolution comes down to judgments about how broad is broad 

enough to be considered general, or whether it even 

matters at all that a provision is targeted in some 

way. The classification that follows views many savings 

incentives, even if targeted, as roughly consistent with 

a broad based consumption tax. 

Capital gains would not be a part of a comprehensive 

consumption tax base. Proceeds from asset sales and 

sometimes borrowing would be part of the cash-flow 

tax base, but, for transactions between domestic investors at a flat tax rate, would cancel out in the economy 

as a whole. How should existing tax expenditures related to capital gains be classified? The classification 

below generally views available capital gains tax breaks 

as consistent with a broad-based consumption tax because they lower the tax rate on capital income toward 

the zero rate that is consistent with a consumptionbased tax. 

Such considerations suggest that trying to compute 

the current tax’s deviations from ‘‘the’’ base of a consumption tax is impossible because deviations cannot 

be uniquely determined, making it very difficult to do 

a consistent accounting of the differences between the 

current tax base and a consumption tax base. Nonetheless, Appendix Table 2 attempts a classification based 

on the criteria outlined above.

Treatment of Major Tax Expenditures under a Comprehensive Consumption Baseline

As noted above, the major difference between a comprehensive consumption tax and a comprehensive income tax is in the treatment of saving, or in the taxation of capital income. Consequently, many current 

tax expenditures related to preferential taxation of capital income would not be tax expenditures under a consumption tax. However, preferential treatment of items 

of income that is unrelated to moderately broad-based 

saving or investment incentives would remain tax expenditures under a consumption baseline. In addition, 

several official tax expenditures relating to items of 

income and expense are difficult to properly classify, 

while others may serve as proxies for properly measured tax expenditures. 

Appendix Table 2 shows the thirty largest official 

tax expenditures from the Budget classified according 

to whether they would be considered a tax expenditure 

under a consumption tax. One of the thirty items clearly would be a tax expenditure (shown in panel A) under 

a consumption tax, while an additional four (those in 

panel B) probably would be tax expenditures. 

Exclusion of workers’ compensation benefits allows 

an exclusion from income that is unrelated to investment, and so should be included in the base of a comprehensive consumption tax. 

The official tax expenditures for Social Security benefits reflects exceptions for low income taxpayers from 

the general rule that 85 percent of Social Security benefits are included in the recipient’s tax base. The 85 

percent inclusion is intended as a simplified mechanism 

for taxing Social Security benefits as if the Social Security program were a private pension with employee contributions made from after-tax income. Under these tax 

rules, income earned on contributions made by both 

employers and employees benefits from tax deferral, 

but employer contributions also benefit because the employee may exclude them from his taxable income, 

while the employee’s own contributions are included 

in his taxable income. These tax rules give the equivalent of consumption tax treatment, a zero effective tax 

rate on the return, to the extent that the original pension contributions are made by the employer, but give 

less generous treatment to the extent that the original 

contributions are made by the employee. Income earned 

on employee contributions is taxed at a low, but positive, effective tax rate. Based on historical calculations, 

the 85 percent inclusion reflects roughly the outcome 

of applying these tax rules to a lower-income earner 

when one-half of the contributions are from the employer and one-half from the employee. 

The current tax expenditure measures a tax benefit 

relative to a baseline that is somewhere between a com-
18. TAX EXPENDITURES 321

prehensive income tax and a consumption tax. The 

properly measured tax expenditure relative to a consumption tax baseline would include only those Social 

Security benefits that are accorded treatment more favorable than that implied by a consumption tax, which 

would correspond to including 50 percent of Social Security benefits in the recipient’s tax base. 

A similar analysis would apply to exclusion of Social 

Security benefits of dependents and retirees. 

The child credit and the earned income tax credit 

can be viewed as social welfare programs unrelated 

to measuring and taxing consumption. As such, they 

would be tax expenditures relative to a consumption 

baseline. 

The treatment of the items in panels C is less uncertain. Several of these items relate to the costs of medical care or to charitable contributions. As discussed 

in the previous section of the appendix, there is disagreement within the tax policy community over the 

extent to which medical care and charitable giving represent consumption items. While widely held to be consumption, a competing view is that they represent reductions in net worth that should be excluded from 

the tax base because they do not yield direct satisfaction to taxpayer who makes the expenditure. 

There also is the issue of how to tax medical insurance premiums. Under current law, employees do not 

have to include insurance premiums paid for by employers in their income. The self-employed also may exclude 

(via a deduction) medical insurance premiums from 

their taxable income. From some perspectives, these 

premiums should be in the tax base because they appear to represent consumption. Yet an alternative perspective would support excluding the premium from tax 

as long as the consumption tax base included the value 

of any medical services paid for by the insurance policy, 

because the premium equals the expected value of insurance benefits received. But even from this alternative perspective, the official tax expenditure might 

continue to be a tax expenditure under a consumption 

tax baseline because current law excludes the value 

of medical services paid with insurance benefits from 

the employee’s taxable income. 

If medical spending is not consumption, one approach 

to measuring the consumption base would ignore insurance, but allow the consumer to deduct the value of 

all medical services obtained. An alternative approach 

would allow a deduction for the premium but include 

the value of any insurance benefits received, while continuing to allow a deduction for a value of all medical 

services obtained. In either case, the official tax expenditure for the exclusion of employer provided medical 

insurance and expenses would not be a tax expenditure 

relative to a consumption tax baseline. 

Consider next the deductibility of home mortgage interest. A consumption tax seeks to tax the consumption 

value of housing services consumed no matter how the 

house is financed. From this perspective, home mortgage interest should not be deductible. However, what 

governs the proper treatment of interest under a consumption tax is whether financial flows are in or out 

of the consumption tax base. A result equivalent to 

disallowing the interest deduction would require that 

the loan be taken into income and would permit the 

associated interest and principal payments to be deducted. If the loans are taken into income (as they 

would be under some types of consumption taxes), then 

the associated interest and principal payments should 

be deductible, otherwise not. Without specifying how 

financial flows are treated, it is unclear how to treat 

the home mortgage interest deduction. Nonetheless, 

given that loans are not taken into income under current law, and this treatment’s equivalency to disallowing the interest deduction, classifying the deduction of home mortgage interest as a tax expenditure 

might be reasonable. 

Ambiguities arise about the proper treatment of State 

and local taxes under a consumption tax, as they do 

under an income tax. These taxes are not of themselves 

consumption items, but might serve as proxies for the 

value of Government services consumed. 

The extraterritorial income exclusion replaces the 

previous Foreign Sales Corporation program. It provides an exclusion from income for certain exports. To 

the extent that the program is viewed as a component 

of a destination based VAT it might not be a tax expenditure. In addition, to the extent that the exclusion 

is an investment subsidy, it might be consistent with 

consumption tax principles (i.e., a low tax rate on capital income). 

The taxation of Social Security benefits for the disabled also is difficult to classify. As discussed in this 

appendix above, these benefits generally ought to be 

taxed because they represent purchasing power. However, the associated Social Security taxes ought to be 

fully deductible, but they are not. Hence the proper 

treatment is unclear. Moreover, if the insurance model 

is applied, the taxation of Social Security benefits might 

be a negative tax expenditure. 

The credit for low income housing acts to lower the 

tax burden on qualified investment, and so from one 

perspective would not be a tax expenditure under a 

consumption tax baseline. However, in some cases the 

credit is too generous; it can give a negative tax on 

income from qualified investment rather than the zero 

tax called for under consumption tax principles. In addition, the credit is very narrowly targeted. Consequently, it could be considered a tax expenditure relative to a consumption tax baseline. 

The final panel (D) shows items that are not likely 

to be tax expenditures under a consumption base. Most 

of these relate to tax provisions that eliminate or reduce the tax on various types of capital income because 

a zero tax on capital income is consistent with consumption tax principles. But in those cases where a 

tax remains, a negative tax expenditure under the consumption tax is created. 

The graduated corporate income tax rates would not 

be a tax expenditure under a comprehensive consumption baseline. A consumption tax would have no tax 
322 ANALYTICAL PERSPECTIVES 

25See Barbara Fraumeni, ‘‘The Measurement of Depreciation in the U.S. National Income 

and Product Accounts,’’ in Survey of Current Business 77 No. 7 (Washington, D.C.: Department of Commerce, Bureau of Economic Analysis, July, 1997), pp. 7–42, and the National 

Income and Product Accounts of the United States, Table 7.6, ‘‘Chain-type Quantity and 

Price Indexes for Private Fixed Investment by Type,’’ U.S. Department of Commerce, Bureau 

of Economic Analysis. 26The temporary provision allows 30 percent of the cost of a qualifying investment to 

be deducted immediately rather than capitalized and depreciated over time. It is generally 

effective for qualifying investments made after September 10, 2001 and before September 

11, 2004. The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the deduction 

to 50 percent depreciation (up from 30 percent) of the cost new equipment purchased 

after May 5, 2003 and placed into service before January 1, 2005. Qualifying investments 

generally are limited to tangible property with depreciation recovery periods of 20 years 

or less, certain software, and leasehold improvements, but this set of assets corresponds 

closely to machinery and equipment. 

on corporate income or profits, hence the issue of 

whether the rate structure on corporate income provides a special benefit to corporations with low income 

would not arise. 

The exception from the passive loss rules probably 

would not be a tax expenditure because proper measurement of income, and hence of consumption, requires 

full deduction of losses.

Major Tax Expenditures under a Consumption Tax That 

Are Excluded from the Current Budget

Several differences between current law and a consumption tax are left off the official tax expenditure 

list. Additional tax expenditures include the imputed 

consumption value from consumer durables and owneroccupied housing, private gifts and inheritances received, possibly benefits paid by insurance policies, inkind benefits from such Government programs as foodstamps, Medicaid, and public housing, and benefits received from charities. Under some ideas of a comprehensive consumption tax, the value of leisure and 

of household production of goods and services would 

be included as a tax expenditure. 

A consumption tax implemented as a tax on cash 

flows would tax all proceeds from sales of capital assets 

when consumed, rather than just capital gains; because 

of expensing, taxpayers effectively would have a zero 

basis. The proceeds from borrowing would be in the 

base of a consumption tax that also allowed a deduction 

for repayment of principal and interest, but are excluded from the current tax base. The deduction of business interest expense might be a tax expenditure, since 

under some forms of consumption taxation interest is 

neither deducted from the borrower’s tax base nor included in the lender’s tax base. The personal exemption 

and standard deduction also might be considered tax 

expenditures, although they can be viewed differently, 

e.g., as elements of the basic tax rate schedule.

Negative Tax Expenditures

Importantly, current law also deviates from a consumption tax norm in ways that increase, rather than 

decrease, tax liability. These could be called negative 

tax expenditures. The official budget excludes negative 

tax expenditures on the theory that tax expenditures 

are intended to substitute for Government spending 

programs. Yet excluding negative tax expenditures 

would give a very one-sided look at the differences between the existing tax system and a consumption tax. 

A large item on this list would be the inclusion of 

capital income in the current individual income tax 

base, including the income earned on inside-build up 

in Social Security accounts. The revenue from the corporation income tax, or more generally a measure of 

the double tax on corporate profits, also would be a 

negative tax expenditure. Depreciation allowances, even 

if accelerated, would be a negative tax expenditure 

since consumption tax treatment generally would require expensing. Depending on the treatment of loans, 

the borrower’s inability to deduct payments of principal 

and the lender’s inability to deduct loans might be a 

negative tax expenditure. The passive loss rules, restrictions on the deductibility of capital losses, and NOL 

carryforward provisions also would generate negative 

tax expenditures, because the change in net worth requires a deduction for losses. If human capital were 

considered an asset, then its cost (e.g., certain education and training expenses, including perhaps costs 

of college and professional school) should be expensed, 

but it is not under current law. Certain restrictions 

under the individual AMT as well as the phase-out 

of personal exemptions and of itemized deductions also 

might be considered negative tax expenditures. Under 

some views, the current tax treatment of Social Security benefits paid to the disabled would be a negative 

tax expenditure. 

REVISED ESTIMATES OF SELECTED TAX EXPENDITURES

Accelerated Depreciation

Under the reference tax law baseline no tax expenditures arise from accelerated depreciation. In the past, 

official tax expenditure estimates of accelerated depreciation under the normal tax law baseline compared 

tax allowances based on the historic cost of an asset 

with allowances calculated using the straight-line method over relatively long recovery periods. Normal law 

allowances also were determined by the historical cost 

of the asset and so did not adjust for inflation, although 

such an adjustment is required when measuring economic depreciation, the age related fall in the real value 

of the asset. 

Beginning with the 2004 Budget, the tax expenditures for accelerated depreciation under the normal law 

concept have been recalculated using as a baseline depreciation rates and replacement cost indexes from the 

National Income and Product Accounts.25 The revised 

estimates are intended to approximate the degree of 

acceleration provided by current law over a baseline 

determined by real, inflation adjusted, and economic 

depreciation. Current law depreciation allowances for 

machinery and equipment include the benefits of a temporary expensing provision.26 The estimates are shown 

in tables in the body of the main text, e.g., Table 18.1. 
18. TAX EXPENDITURES 323

27 Estimates under the old methodology are no longer shown in the tables. 28 U.S. Department of the Treasury, Report to the Congress on Depreciation Recovery 

Periods and Methods (Washington, D.C.: U.S. Government Printing Office, July, 2000), 

p. 32. 29 National Income and Production Accounts, Table 2.4. 

The revised tax expenditure estimates differ substantially from estimates calculated under the old methodology. In general, the new tax expenditure estimates 

are smaller than the old estimates.27 In part this is 

because the new baseline uses depreciation allowances 

that are faster than those in the old baseline. In addition, the new baseline calculates depreciation on a replacement cost basis rather on the historic cost basis 

previously used; this translates into larger depreciation 

allowances to the extent that asset prices rise over 

time. In many years the new tax expenditures are negative, indicating that current law’s tax depreciation allowances are smaller than those implied by economic 

depreciation. Because these estimates are on a cash 

flow, rather than a present value, basis, the negative 

value does not necessarily indicate that tax depreciation 

is decelerated relative to economic depreciation over the 

life of an investment. Even when tax depreciation is 

accelerated over the life of an investment, negative annual cash flow estimates could obtain in the later years 

of an investment’s economic life. This type of vintage 

effect contributes importantly to the negative tax expenditures calculated for equipment in 2005–2009 because the temporary expensing provision expires at the 

end of 2004. Calculations that compare the present 

value of tax depreciation (without the temporary expensing) with the present value of inflation indexed 

economic depreciation over each investment’s economic 

life show that for many types of assets tax depreciation 

is accelerated, but only slightly, assuming a moderate 

rate of inflation.28

Owner-Occupied Housing

A homeowner receives a flow of housing services 

equal in gross value to the rent that could have been 

earned had the owner chosen to rent the house to others. Comprehensive income would include in its base 

the implicit net rental income earned on investment 

in owner-occupied housing. Current law, however, excludes from its tax base such net rental income. This 

exclusion is a tax expenditure relative to a comprehensive income base. 

In contrast to a comprehensive income baseline, the 

official list of tax expenditures does not include the 

exclusion of implicit rental income on owner-occupied 

housing. Instead, it includes as tax expenditures deductions for home mortgage interest and for property taxes. 

These are poor proxies for the exclusion of implicit net 

rental income. To the extent that a homeowner owns 

his house outright, unencumbered by a mortgage, he 

would have no home mortgage interest deduction, yet 

he still would enjoy the benefits of receiving tax free 

the implicit rental income earned on his house. When 

measuring the net income from an investment in 

owner-occupied housing, mortgage interest and property 

taxes generally would be deductible. The official tax 

expenditures do not allow for depreciation and other 

costs incurred by the homeowner that must be deducted 

in determining his net rental income. 

Appendix Table 3 shows an estimate of the tax expenditure caused by the exclusion of implicit net rental 

income from investment in owner-occupied housing. 

This estimate starts with the NIPA calculated value 

of gross rent on owner-occupied housing, and subtracts 

interest, taxes, economic depreciation, and other costs 

in arriving at an estimate of net-rental income from 

owner-occupied housing.29

The tax expenditure estimate is substantial, growing 

from $24 billion in 2005 to $35 billion in 2009. Nonetheless, it is only about one-third as large as the official 

tax expenditure for the deduction of home mortgage 

interest. In part this discrepancy reflects depreciation 

and other expenses that must be subtracted from gross 

rents in arriving at net rental income. In part, it also 

might reflect homeowners’ ability to borrow against 

their homes to fund other spending, leading to a relatively high debt/equity ratio for housing.

Accrued Capital Gains

Under a comprehensive income baseline, all real 

gains would be taxed as accrued. These gains would 

be taxed as ordinary income rather than at preferential 

rates. There would be no deferred unrealized gains on 

assets held at death, nor gains carried over on gifts, 

or other preferential treatments. Indeed, all of the provisions related to capitals gains listed in the tax expenditure budget would be dropped. Instead, in their 

place the difference between the ordinary tax on real 

gains accrued and the actual tax paid would be calculated. For 1999, for instance, the tax on real accrued 

gains on corporate equity is estimated at $594 billion. 

This compares to an estimated tax on realized gains 

of $62 billion, for forgone revenues of $562 billion. However, this tax expenditure may easily turn into a penalty given the limits on capital losses. For 2000, for 

instance, real accrued losses in corporate equity 

amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion in capital gains taxes. This roughly 

translates into an overpayment of taxes to the tune 

of $464 billion.

Double Tax on Corporate Profits

A comprehensive income tax would tax all sources 

of income once. Taxes would not vary by type or source 

of income. 

In contrast to this benchmark, current law taxes income that shareholders earn on investment in corporate 

stocks at least twice, and at combined rates that generally are higher than those imposed on other sources 

of income. Corporate profits are taxed once at the company level under the corporation income tax. They are 

taxed again at the shareholder level when received as 

a dividend or recognized as a capital gain. Corporate 

profits can be taxed more then twice when they pass 

through multiple corporations before being distributed 

to noncorporate shareholders. Corporate level taxes cas-
324 ANALYTICAL PERSPECTIVES 

cade because corporations are taxed on capital gains 

they realize on the sale of stock shares and on some 

dividend income received. Compared to a comprehensive income tax current law’s double (or more) tax on 

corporate profits is an example of a negative tax expenditure because it subjects income to a larger tax 

burden than implied by a comprehensive income baseline. 

Appendix Table 3 provides an estimate of the negative tax expenditure caused by the multiple levels of 

tax on corporate profits. This negative tax expenditure 

is measured as the shareholder level tax on dividends 

paid and capital gains realized out of earnings that 

have been fully taxed at the corporate level. It also 

includes the corporate tax paid on inter-corporate dividends and on corporate capital gains attributable to 

the sale of stock shares. The estimate includes the reduction in the dividends and capital gains tax rates 

enacted in JGTRRA. 

The negative tax expenditure is large in magnitude; 

it exceeds $33 billion in the years 2005 through in 

2009. It is comparable in size (but opposite in sign) 

to all but the largest official tax expenditures. JGTRRA 

reduced but did not eliminate the double tax on corporate profits. 

Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE INCOME TAX 1

(In millions of dollars) 

Description 2005 Revenue 

Effect 

A. Tax Expenditure Under a Comprehensive Income Tax 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 61,740

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 58,910

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 30,190

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,370

Exclusion of interest on life insurance savings ................................................................................................................... 22,130

Capital gains exclusion on home sales ............................................................................................................................... 21,490

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 20,090

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,260

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 8,400

Credit for low-income housing investments ......................................................................................................................... 6,860

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,850

Extraterritorial income exclusion .......................................................................................................................................... 5,890

Expensing of certain small investments (normal tax method) ............................................................................................ 4,850

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 4,500

B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications 

Child credit ............................................................................................................................................................................ 29,860

Exclusion of Social Security benefits for retired workers ................................................................................................... 19,040

Step-up basis of capital gains at death .............................................................................................................................. 18,240

Earned income tax credit ..................................................................................................................................................... 5,006

Exclusion of Social security benefits of dependents and survivors ................................................................................... 4,310

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 112,990

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 69,740

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .............................................. 46,180

Deductibility of charitable contributions, other than education and health ......................................................................... 29,670

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 19,410

Deductibility of medical expenses ........................................................................................................................................ 7,900

Deductibility of self-employed medical insurance premiums .............................................................................................. 3,780

Social Security benefits for disabled ................................................................................................................................... 3,720

Deductibility of charitable contributions (education) ............................................................................................................ 3,660

D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax 

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,390

Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,910

1 The measurement of certain tax expenditures under a comprehensive income tax baseline may differ from the official budget estimate even when the provision would be a tax expenditure under both baselines.

Source: Table 18–2, Tax Expenditure Budget. 
18. TAX EXPENDITURES 325

Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE CONSUMPTION TAX 1

(In millions of dollars) 

Description 2005 Revenue 

Effect 

A. Tax Expenditure Under a Consumption Base 

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,850

B. Probably a Tax Expenditure Under a Consumption Base, 

Child credit ............................................................................................................................................................................ 29,860

Exclusion of Social Security benefits for retired workers ................................................................................................... 19,040

Earned income tax credit ..................................................................................................................................................... 5,006

Exclusion of Social security benefits of dependents and survivors ................................................................................... 4,310

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 112,990

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 69,740

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 46,180

Deductibility of charitable contributions, other than education and health ......................................................................... 29,670

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 19,410

Deductibility of medical expenses ........................................................................................................................................ 7,900

Credit for low-income housing investments ......................................................................................................................... 6,860

Extraterritorial income exclusion .......................................................................................................................................... 5,890

Deductibility of self-employed medical insurance premiums .............................................................................................. 3,780

Deductibility of charitable contributions (education) ............................................................................................................ 3,660

Social Security benefits for disabled ................................................................................................................................... 3,720

D. Not a Tax Expenditure under a Consumption Base 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 61,740

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 58,910

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 30,190

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,370

Exclusion of interest on life insurance savings ................................................................................................................... 22,130

Capital gains exclusion on home sales ............................................................................................................................... 21,490

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 20,090

Step-up basis of capital gains at death .............................................................................................................................. 18,240

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,260

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 8,400

Expensing of certain small investments (normal tax method) ............................................................................................ 4,850

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 4,500

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,390

Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,910

1 The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even 

when the provision would be a tax expenditure under both baselines.

Source: Table 6–2, Tax Expenditure Budget. 

Appendix Table 3. REVISED TAX EXPENDITURE ESTIMATES 1

(In millions of dollars) 

Provision 

Revenue Loss 

2003 2004 2005 2006 2007 2008 2009

Imputed Rent On Owner-Occupied Housing ..................................... 18,340 20,540 24,100 25,160 28,250 31,400 34,710

Double Tax on corporate profit 2 ....................................................... –24,020 –26,740 –34,940 –33,340 –33,260 –33,660 –34,280

1 Calculations described in the appendix text.

2 This is a negative tax expenditure, a tax provision that overtaxes income relative to the treatment specified by the baseline tax system.