107

5. TAX EXPENDITURES

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

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

expenditures are created for a variety of reasons: to

encourage certain activities, to improve fairness, to ease

compliance with and administration of the tax system,

and to reduce certain tax-induced distortions. The Congressional Budget Act of 1974 (Public Law 93–344) requires that a list of tax expenditures be included in

the budget.

The largest tax expenditures tend to be associated

with the individual income tax. For example, sizeable

tax preferences are provided for pension contributions

and earnings, employer contributions for medical insurance, mortgage interest payments on owner-occupied

homes, capital gains, and payments of State and local

individual income and property taxes. Tax expenditures

under the corporate income tax tend to be related to

the rate of cost recovery for various investments; as

is discussed below, the extent to which these provisions

are classified as tax expenditures varies according to

the conceptual baseline used. Charitable contributions

and credits for State taxes on bequests are the largest

tax expenditures under the unified transfer (i.e., estate

and gift) tax.

Because of potential interactions among provisions,

this chapter does not present a grand total for the

revenue loss estimated from tax expenditures. Moreover, past tax changes entailing broad elimination of

tax expenditures were generally accompanied by

changes in tax rates or other basic provisions, so that

the net effects on Federal revenues were considerably

(if not totally) offset. Nevertheless, in aggregate, tax

expenditures have revenue impacts of hundreds of billions of dollars, and are some of the most important

ways in which the Federal Government affects economic

decisions and social welfare.

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

They are estimated for fiscal years 1999–2005 using

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

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

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

in a section at the end of the chapter.

The section 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. Tax expenditures are also discussed

in Section V of the Budget, which considers the Federal

Government’s spending, regulatory, and tax policies

across functional areas.

TAX EXPENDITURES IN THE INCOME TAX

Tax Expenditure Estimates

The Treasury Department prepared all tax expenditure estimates presented here based upon tax law enacted as of December 31, 1999. Expired or repealed

provisions are not listed if their revenue effects result

only from taxpayer activity occurring before fiscal year

1999. Due to the time required to estimate the large

number of tax expenditures, the estimates are based

on mid-session economic assumptions; exceptions are

the earned income tax credit and child credit provisions,

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

The total revenue loss estimates for tax expenditures

for fiscal years 1999–2005 are displayed according to

the budget’s functional categories in Table 5–1. Descriptions of the specific tax expenditure provisions follow

the tables of estimates and discussion of general features of the tax expenditure concept.

As in prior years, two baseline concepts—the normal

tax baseline and the reference tax law baseline—are

used to identify tax expenditures. For the most part,

the two concepts coincide. However, items treated as

tax expenditures under the normal tax baseline, but

not the reference tax law baseline, are indicated by

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

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

discussed in detail following the tables.

Table 5–2 reports the respective portions of the total

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

under the individual and corporate headings does not

imply that these categories of filers benefit from the

special tax provisions in proportion to the respective

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

the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures could be stock-
108 ANALYTICAL PERSPECTIVES

holders, employees, customers, or others, depending on

economic forces.

Table 5–3 ranks the major tax expenditures by fiscal

year 2001 revenue loss. This table merges several individual entries provided in Table 5–1; for example, Table

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

Table 5–1.

Interpreting Tax Expenditure Estimates

The revenue loss estimates shown for individual tax

expenditures in Tables 5–1, 5–2, and 5–3 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 formerly subsidized activity or of other tax preferences or Government programs. For example, if deductibility of mortgage interest were limited, some taxpayers would hold

smaller mortgages, with a concomitantly smaller effect

on the budget than if no such limits were in force.

Tax expenditures are interdependent even without

incentive effects. Repeal of a tax expenditure provision

can increase or decrease the revenue losses associated

with other provisions. For example, even if behavior

does not change, repeal of an itemized deduction could

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

brackets. Alternatively, repeal of an itemized deduction

could lower the revenue loss from other deductions if

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

repealed simultaneously, the increase in tax liability

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

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

in Table 5–2 and do not reflect any possible interactions

between the individual and corporate income tax receipts. For this reason, the estimates in Table 5–1 (as

well as those in Table 5–5, which are also based on

summing individual and corporate estimates) should be

regarded as approximations.

Revenues raised by changes to tax expenditures are

sensitive to timing effects and effective dates. Changes

in some provisions could yield their full potential revenue gains relatively quickly, whereas changes to other

provisions would only gradually yield their full revenue

potential, especially if certain deductions or exemptions

were grandfathered.

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

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

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

from prior years. 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 cost to the Government because the newly

deferred taxes will ultimately be received. Presentvalue estimates, which are a useful supplement to the

cash-basis estimates for provisions involving deferrals,

are discussed below.

Repeal on major tax provisions may have some impact on overall levels of income and rates of economic

growth and, thus, on the budget economic assumptions.

In practice, however, most changes in particular provisions are unlikely to have significant macroeconomic

effects.

Present-Value Estimates

Discounted present-value estimates of revenue losses

are presented in Table 5–4 for provisions that involve

tax deferrals or other long-term revenue effects. These

estimates complement the cash-based tax expenditure

estimates presented in the other tables.

The present-value estimates represent the revenue

losses, net of future tax payments, that follow from

activities undertaken during calendar year 1999 which

cause the deferrals or other long-term revenue effects.

For instance, a pension contribution in 1999 would

cause a deferral of tax payments on wages in 1999

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

the 1999 pension contribution and accrued earnings

would be paid out and taxes would be due; these receipts are included in the present-value estimate. In

general, this conceptual approach is similar to the one

used for reporting the budgetary effects of credit programs, where direct loans and guarantees in a given

year affect future cash flows.
5. TAX EXPENDITURES 109

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1999 2000 2001 2002 2003 2004 2005 2001–2005

National Defense

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,120 2,140 2,160 2,180 2,200 2,220 2,240 11,000

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 2,330 2,550 2,790 3,040 3,285 3,545 3,825 16,485

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 635 665 695 725 760 795 830 3,805

4 Exclusion of income of foreign sales corporations ................................................................................ 3,640 3,890 4,160 4,460 4,770 5,100 5,460 23,950

5 Inventory property sales source rules exception ................................................................................... 1,050 1,100 1,150 1,250 1,350 1,450 1,550 6,750

6 Deferral of income from controlled foreign corporations (normal tax method) .................................... 5,800 6,200 6,600 7,000 7,450 7,900 8,400 37,350

7 Deferred taxes for financial firms on certain income earned overseas ................................................ 960 1,190 1,290 540 0 0 0 1,830

General science, space, and technology:

8 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,890 1,865 1,885 1,965 2,090 2,245 2,410 10,595

9 Credit for increasing research activities ................................................................................................. 1,705 1,010 3,360 3,710 2,970 2,605 1,505 14,150

Energy:

10 Expensing of exploration and development costs, fuels ....................................................................... –80 –15 –30 –10 15 15 15 5

11 Excess of percentage over cost depletion, fuels .................................................................................. 265 275 280 280 285 290 290 1,425

12 Alternative fuel production credit ............................................................................................................ 1,025 960 905 845 125 125 125 2,125

13 Exception from passive loss limitation for working interests in oil and gas properties ....................... 30 25 25 25 25 25 25 125

14 Capital gains treatment of royalties on coal .......................................................................................... 65 65 70 70 75 80 85 380

15 Exclusion of interest on energy facility bonds ....................................................................................... 115 115 115 120 120 120 120 595

16 Enhanced oil recovery credit .................................................................................................................. 225 260 295 340 390 450 515 1,990

17 New technology credit ............................................................................................................................ 50 60 80 90 90 90 85 435

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

19 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 85 90 105 100 80 55 20 360

20 Exclusion from income of conservation subsidies provided by public utilities ..................................... 85 80 80 80 85 85 85 415

Natural resources and environment:

21 Expensing of exploration and development costs, nonfuel minerals .................................................... 15 15 20 20 20 20 20 100

22 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 225 230 245 250 265 275 285 1,320

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 460 460 470 475 480 480 490 2,395

24 Capital gains treatment of certain timber income ................................................................................. 65 65 70 70 75 80 85 380

25 Expensing of multiperiod timber growing costs ..................................................................................... 495 500 530 565 590 605 630 2,920

26 Investment credit and seven-year amortization for reforestation expenditures .................................... 10 10 10 15 15 15 15 70

27 Tax incentives for preservation of historic structures ............................................................................ 210 220 240 250 265 280 295 1,330

Agriculture:

28 Expensing of certain capital outlays ...................................................................................................... 70 70 75 75 80 85 90 405

29 Expensing of certain multiperiod production costs ................................................................................ 85 85 90 95 105 110 110 510

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

31 Capital gains treatment of certain income ............................................................................................. 635 665 695 725 760 795 830 3,805

32 Income averaging for farmers ................................................................................................................ 75 75 80 80 80 85 85 410

33 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 15 15 15 65

Commerce and housing:

Financial institutions and insurance:

34 Exemption of credit union income ..................................................................................................... 1,470 1,550 1,650 1,765 1,890 2,020 2,155 9,480

35 Excess bad debt reserves of financial institutions ............................................................................ 60 65 55 45 35 20 5 160

36 Exclusion of interest on life insurance savings ................................................................................. 13,920 14,985 16,130 17,365 18,870 20,130 21,680 94,175

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

38 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 220 225 235 240 250 255 265 1,245

39 Small life insurance company deduction ........................................................................................... 100 100 100 100 100 105 105 510

Housing:

40 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 905 915 920 930 940 950 955 4,695

41 Exclusion of interest on rental housing bonds .................................................................................. 155 155 160 160 160 160 160 800

42 Deductibility of mortgage interest on owner-occupied homes .......................................................... 56,920 58,815 60,925 63,240 65,955 68,965 72,160 331,245

43 Deductibility of State and local property tax on owner-occupied homes ......................................... 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

44 Deferral of income from post-1987 installment sales ....................................................................... 995 1,015 1,035 1,055 1,075 1,095 1,115 5,375

45 Capital gains exclusion on home sales ............................................................................................. 18,000 18,540 19,095 19,670 20,260 20,870 21,495 101,390

46 Exception from passive loss rules for $25,000 of rental loss .......................................................... 5,315 5,035 4,790 4,555 4,330 4,100 3,885 21,660

47 Credit for low-income housing investments ....................................................................................... 2,820 3,055 3,195 3,300 3,405 3,485 3,540 16,925

48 Accelerated depreciation on rental housing (normal tax method) .................................................... 3,710 3,985 4,225 4,500 4,765 4,975 5,145 23,610

Commerce:

49 Cancellation of indebtedness ............................................................................................................. 40 25 15 15 20 20 25 95

50 Exceptions from imputed interest rules ............................................................................................. 160 160 160 165 165 165 165 820

51 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 39,405 40,575 41,780 43,025 44,300 45,615 46,965 221,685

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

53 Step-up basis of capital gains at death ............................................................................................ 25,800 27,090 28,240 29,370 30,545 31,765 33,035 152,955

54 Carryover basis of capital gains on gifts ........................................................................................... 175 185 195 205 210 220 230 1,060

55 Ordinary income treatment of loss from small business corporation stock sale ............................. 35 35 40 40 40 40 40 200
110 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1999 2000 2001 2002 2003 2004 2005 2001–2005

56 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 1,660 710 –435 –755 –1,115 –1,695 –2,145 –6,145

57 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 26,445 27,740 32,830 33,345 34,265 36,390 37,330 174,160

58 Expensing of certain small investments (normal tax method) .......................................................... 1,465 1,590 1,925 1,965 1,920 1,895 1,905 9,610

59 Amortization of start-up costs (normal tax method) .......................................................................... 200 205 205 215 215 220 225 1,080

60 Graduated corporation income tax rate (normal tax method) .......................................................... 6,360 6,300 6,275 6,460 6,490 6,710 6,815 32,750

61 Exclusion of interest on small issue bonds ....................................................................................... 310 315 315 320 320 325 330 1,610

Transportation:

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

63 Exclusion of reimbursed employee parking expenses .......................................................................... 1,725 1,805 1,895 1,995 2,100 2,210 2,330 10,530

64 Exclusion for employer-provided transit passes .................................................................................... 130 150 170 190 215 235 260 1,070

Community and regional development:

65 Investment credit for rehabilitation of structures (other than historic) .................................................. 25 25 30 30 30 30 30 150

66 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 730 735 740 750 755 765 770 3,780

67 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 65 65 65 70 325

68 Empowerment zones and enterprise communities ................................................................................ 330 445 500 465 330 300 260 1,855

69 Expensing of environmental remediation costs ..................................................................................... 115 150 175 60 –30 –35 –30 140

Education, training, employment, and social services:

Education:

70 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,085 1,110 1,120 1,130 1,140 1,150 1,165 5,705

71 HOPE tax credit .................................................................................................................................. 4,595 4,925 5,125 5,145 4,745 4,615 5,335 24,965

72 Lifetime Learning tax credit ................................................................................................................ 2,170 2,375 2,420 2,465 4,405 4,430 4,630 18,350

73 Education Individual Retirement Accounts ........................................................................................ 0 10 25 40 60 80 105 310

74 Deductibility of student-loan interest .................................................................................................. 240 265 310 350 375 395 430 1,860

75 Deferral for State prepaid tuition plans ............................................................................................. 120 175 225 275 320 350 385 1,555

76 Exclusion of interest on student-loan bonds ..................................................................................... 245 250 255 255 255 260 260 1,285

77 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 590 595 600 600 610 615 620 3,045

78 Credit for holders of zone academy bonds ....................................................................................... 5 10 20 35 50 65 70 240

79 Exclusion of interest on savings bonds redeemed to finance educational expenses ..................... 10 15 15 15 15 20 20 85

80 Parental personal exemption for students age 19 or over ............................................................... 915 965 1,015 1,055 1,105 1,155 1,185 5,515

81 Child credit 2 ........................................................................................................................................ 19,435 19,575 19,480 18,970 18,155 17,535 16,855 90,995

82 Deductibility of charitable contributions (education) .......................................................................... 2,525 2,650 2,765 2,910 3,035 3,140 3,300 15,150

83 Exclusion of employer-provided educational assistance ................................................................... 220 235 250 175 0 0 0 425

Training, employment, and social services:

84 Work opportunity tax credit ................................................................................................................ 270 455 465 350 215 95 35 1,160

85 Welfare-to-work tax credit .................................................................................................................. 35 60 80 80 60 25 10 255

86 Exclusion of employer-provided child care ........................................................................................ 645 670 700 725 765 805 850 3,845

87 Adoption assistance ............................................................................................................................ 125 140 140 125 40 15 10 330

88 Exclusion of employee meals and lodging (other than military) ...................................................... 650 680 710 740 775 810 845 3,880

89 Credit for child and dependent care expenses ................................................................................. 2,420 2,390 2,360 2,330 2,305 2,275 2,250 11,520

90 Credit for disabled access expenditures ........................................................................................... 50 50 55 55 55 60 60 285

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

92 Deductibility of charitable contributions, other than education and health ....................................... 19,220 20,015 20,860 21,780 22,750 23,765 24,895 114,050

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

94 Exclusion of parsonage allowances ................................................................................................... 320 340 365 390 415 445 475 2,090

Health:

95 Exclusion of employer contributions for medical insurance premiums and medical care ................... 69,610 75,095 80,570 86,175 90,655 95,960 102,725 456,085

96 Self-employed medical insurance premiums ......................................................................................... 935 1,250 1,380 1,545 2,070 2,905 3,210 11,110

97 Workers’ compensation insurance premiums ........................................................................................ 4,420 4,585 4,555 4,935 5,120 5,315 5,515 25,440

98 Medical Savings Accounts ...................................................................................................................... 20 30 30 30 30 30 25 145

99 Deductibility of medical expenses .......................................................................................................... 3,695 3,910 4,160 4,440 4,720 5,005 5,305 23,630

100 Exclusion of interest on hospital construction bonds ............................................................................ 1,210 1,225 1,235 1,250 1,265 1,275 1,290 6,315

101 Deductibility of charitable contributions (health) .................................................................................... 2,675 2,800 2,930 3,080 3,210 3,315 3,490 16,025

102 Tax credit for orphan drug research ...................................................................................................... 70 80 90 100 115 130 140 575

103 Special Blue Cross/Blue Shield deduction ............................................................................................. 245 315 200 135 180 245 315 1,075

Income security:

104 Exclusion of railroad retirement system benefits ................................................................................... 395 405 410 415 420 430 430 2,105

105 Exclusion of workers’ compensation benefits ........................................................................................ 5,185 5,330 5,785 6,040 6,310 6,575 6,865 31,575

106 Exclusion of public assistance benefits (normal tax method) ............................................................... 345 360 375 390 405 420 435 2,025

107 Exclusion of special benefits for disabled coal miners ......................................................................... 75 75 70 70 65 60 55 320

108 Exclusion of military disability pensions ................................................................................................. 130 130 135 140 140 145 150 710

Net exclusion of pension contributions and earnings:

109 Employer plans ................................................................................................................................... 83,780 88,830 92,390 97,085 102,575 108,020 113,705 513,775

110 Individual Retirement Accounts .......................................................................................................... 13,350 15,050 15,975 17,030 17,630 18,250 18,750 87,635

111 Keogh plans ........................................................................................................................................ 5,230 5,550 5,895 6,255 6,635 7,040 7,465 33,290

Exclusion of other employee benefits:
5. TAX EXPENDITURES 111

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

(In millions of dollars)

Total revenue loss from corporate and individual Income taxes

1999 2000 2001 2002 2003 2004 2005 2001–2005

112 Premiums on group term life insurance ............................................................................................ 1,700 1,740 1,780 1,820 1,860 1,915 1,970 9,345

13 Premiums on accident and disability insurance ................................................................................ 185 195 205 215 225 235 245 1,125

114 Income of trusts to finance supplementary unemployment benefits .................................................... 0 0 0 5 5 5 5 20

115 Special ESOP rules ................................................................................................................................ 1,130 1,175 1,205 1,250 1,300 1,360 1,425 6,540

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

117 Additional deduction for the elderly ........................................................................................................ 1,785 1,830 1,890 1,955 1,985 2,030 2,110 9,970

118 Tax credit for the elderly and disabled .................................................................................................. 35 35 35 35 35 35 35 175

119 Deductibility of casualty losses .............................................................................................................. 255 265 275 285 295 310 325 1,490

120 Earned income tax credit 3 ..................................................................................................................... 4,825 4,700 4,790 4,985 5,205 5,440 5,740 26,160

Social Security:

Exclusion of social security benefits:

121 Social Security benefits for retired workers ....................................................................................... 17,135 18,010 18,885 19,995 21,230 22,505 16,515 99,130

122 Social Security benefits for disabled ................................................................................................. 2,390 2,595 2,830 3,090 3,375 3,700 3,150 16,145

123 Social Security benefits for dependents and survivors ..................................................................... 3,775 3,900 4,050 4,210 4,385 4,555 3,625 20,825

Veterans benefits and services:

124 Exclusion of veterans death benefits and disability compensation ...................................................... 2,940 3,070 3,200 3,335 3,490 3,655 3,830 17,510

125 Exclusion of veterans pensions .............................................................................................................. 65 70 75 80 85 85 90 415

126 Exclusion of GI bill benefits .................................................................................................................... 75 85 90 90 95 100 105 480

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

General purpose fiscal assistance:

128 Exclusion of interest on public purpose bonds ..................................................................................... 22,750 22,975 23,205 23,440 23,670 23,905 24,145 118,365

129 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ................ 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

130 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 2,515 2,590 2,670 2,600 2,550 2,600 2,650 13,070

Interest:

131 Deferral of interest on U.S. savings bonds ........................................................................................... 1,015 1,065 1,115 1,175 1,235 1,295 1,355 6,175

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

Nonbusiness State and local taxes other than on owner-occupied homes 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 22,750 22,975 23,205 23,440 23,670 23,905 24,145 118,365

Energy facilities ................................................................................................................................... 115 115 115 120 120 120 120 595

Water, sewage, and hazardous waste disposal facilities ................................................................. 460 460 470 475 480 480 490 2,395

Small-issues ........................................................................................................................................ 310 315 315 320 320 325 330 1,610

Owner-occupied mortgage subsidies ................................................................................................. 905 915 920 930 940 950 955 4,695

Rental housing .................................................................................................................................... 155 155 160 160 160 160 160 800

Airports, docks, and similar facilities ................................................................................................. 730 735 740 750 755 765 770 3,780

Student loans ...................................................................................................................................... 245 250 255 255 255 260 260 1,285

Private nonprofit educational facilities ............................................................................................... 590 595 600 600 610 615 620 3,045

Hospital construction .......................................................................................................................... 1,210 1,225 1,235 1,250 1,265 1,275 1,290 6,315

Veterans’ housing ............................................................................................................................... 40 40 40 40 40 40 40 200

Credit for holders of zone academy bonds ........................................................................................... 5 10 20 35 50 65 70 240

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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003

$815; 2004 $825; and 2005 $830. 2

The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004

$450; and 2005 $420. 3

The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002

$26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722.

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

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1999 2000 2001 2002 2003 2004 2005 2001–

2005 1999 2000 2001 2002 2003 2004 2005 2001–2005

National Defense

1 Exclusion of benefits and allowances to

armed forces personnel ....................... ............ ............ ............ ............ ............ ............ ............ .............. 2,120 2,140 2,160 2,180 2,200 2,220 2,240 11,000

International affairs:

2 Exclusion of income earned abroad by

U.S. citizens ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,330 2,550 2,790 3,040 3,285 3,545 3,825 16,485

3 Exclusion of certain allowances for Federal employees abroad ........................ ............ ............ ............ ............ ............ ............ ............ .............. 635 665 695 725 760 795 830 3,805

4 Exclusion of income of foreign sales corporations ............................................... 3,640 3,890 4,160 4,460 4,770 5,100 5,460 23,950 ............ ............ ............ ............ .............. .............. .............. ..............

5 Inventory property sales source rules exception .................................................. 1,050 1,100 1,150 1,250 1,350 1,450 1,550 6,750 ............ ............ ............ ............ .............. .............. .............. ..............

6 Deferral of income from controlled foreign corporations (normal tax method) 5,800 6,200 6,600 7,000 7,450 7,900 8,400 37,350 ............ ............ ............ ............ .............. .............. .............. ..............

7 Deferred taxes for financial firms on certain income earned overseas .............. 960 1,190 1,290 540 0 0 0 1,830 ............ ............ ............ ............ .............. .............. .............. ..............

General science, space, and technology:

8 Expensing of research and experimentation expenditures (normal tax method) ........................................................ 1,855 1,830 1,850 1,925 2,050 2,200 2,365 10,390 35 35 35 40 40 45 45 205

9 Credit for increasing research activities .. 1,675 995 3,300 3,650 2,925 2,565 1,490 13,930 30 15 60 60 45 40 15 220

Energy:

10 Expensing of exploration and development costs, fuels .................................. –70 –15 –30 –10 15 15 15 5 –10 0 0 0 0 0 0 0

11 Excess of percentage over cost depletion, fuels .............................................. 220 225 230 230 235 240 240 1,175 45 50 50 50 50 50 50 250

12 Alternative fuel production credit ............. 975 915 860 805 125 125 125 2,040 50 45 45 40 0 0 0 85

13 Exception from passive loss limitation for

working interests in oil and gas properties ..................................................... ............ ............ ............ ............ ............ ............ ............ .............. 30 25 25 25 25 25 25 125

14 Capital gains treatment of royalties on

coal ....................................................... ............ ............ ............ ............ ............ ............ ............ .............. 65 65 70 70 75 80 85 380

15 Exclusion of interest on energy facility

bonds .................................................... 30 30 30 30 30 30 30 150 85 85 85 90 90 90 90 445

16 Enhanced oil recovery credit ................... 205 235 270 310 355 410 470 1,815 20 25 25 30 35 40 45 175

17 New technology credit .............................. 45 50 60 70 70 70 65 335 5 10 20 20 20 20 20 100

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

19 Tax credit and deduction for clean-fuel

burning vehicles ................................... 70 75 85 80 65 45 15 290 15 15 20 20 15 10 5 70

20 Exclusion from income of conservation

subsidies provided by public utilities ... –5 –5 –5 –5 0 0 0 –10 90 85 85 85 85 85 85 425

Natural resources and environment:

21 Expensing of exploration and development costs, nonfuel minerals .............. 10 10 15 15 15 15 15 75 5 5 5 5 5 5 5 25

22 Excess of percentage over cost depletion, nonfuel minerals ........................... 180 185 195 200 210 220 230 1,055 45 45 50 50 55 55 55 265

23 Exclusion of interest on bonds for water,

sewage, and hazardous waste facilities ........................................................ 115 115 120 120 120 120 125 605 345 345 350 355 360 360 365 1,790

24 Capital gains treatment of certain timber

income .................................................. ............ ............ ............ ............ ............ ............ ............ .............. 65 65 70 70 75 80 85 380

25 Expensing of multiperiod timber growing

costs ..................................................... 305 310 330 350 365 375 390 1,810 190 190 200 215 225 230 240 1,110

26 Investment credit and seven-year amortization for reforestation expenditures ... ............ ............ ............ ............ ............ ............ ............ .............. 10 10 10 15 15 15 15 70

27 Tax incentives for preservation of historic

structures .............................................. 170 180 195 205 215 230 240 1,085 40 40 45 45 50 50 55 245

Agriculture:

28 Expensing of certain capital outlays ........ 10 10 10 10 10 10 10 50 60 60 65 65 70 75 80 355

29 Expensing of certain multiperiod production costs .............................................. 10 10 10 10 15 15 15 65 75 75 80 85 90 95 95 445

30 Treatment of loans forgiven for solvent

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

31 Capital gains treatment of certain income ............ ............ ............ ............ ............ ............ ............ .............. 635 665 695 725 760 795 830 3,805

32 Income averaging for farmers .................. ............ ............ ............ ............ ............ ............ ............ .............. 75 75 80 80 80 85 85 410

33 Deferral of gain on sale of farm refiners 10 10 10 10 15 15 15 65

Commerce and housing:

Financial institutions and insurance:

34 Exemption of credit union income ....... 1,470 1,550 1,650 1,765 1,890 2,020 2,155 9,480 ............ ............ ............ ............ .............. .............. .............. ..............

35 Excess bad debt reserves of financial

institutions ........................................ 60 65 55 45 35 20 5 160 ............ ............ ............ ............ .............. .............. .............. ..............
5. TAX EXPENDITURES 113

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1999 2000 2001 2002 2003 2004 2005 2001–

2005 1999 2000 2001 2002 2003 2004 2005 2001–2005

36 Exclusion of interest on life insurance

savings ............................................. 420 450 485 520 565 605 650 2,825 13,500 14,535 15,645 16,845 18,305 19,525 21,030 91,350

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

38 Tax exemption of certain insurance

companies owned by tax-exempt

organizations .................................... 220 225 235 240 250 255 265 1,245 ............ ............ ............ ............ .............. .............. .............. ..............

39 Small life insurance company deduction ................................................... 100 100 100 100 100 105 105 510 ............ ............ ............ ............ .............. .............. .............. ..............

Housing:

40 Exclusion of interest on owner-occupied mortgage subsidy bonds ......... 230 230 230 235 235 240 240 1,180 675 685 690 695 705 710 715 3,515

41 Exclusion of interest on rental housing

bonds ............................................... 40 40 40 40 40 40 40 200 115 115 120 120 120 120 120 600

42 Deductibility of mortgage interest on

owner-occupied homes .................... ............ ............ ............ ............ ............ ............ ............ .............. 56,920 58,815 60,925 63,240 65,955 68,965 72,160 331,245

43 Deductibility of State and local property tax on owner-occupied homes ............ ............ ............ ............ ............ ............ ............ .............. 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

44 Deferral of income from post-1987 installment sales ................................. 260 265 270 275 280 285 290 1,400 735 750 765 780 795 810 825 3,975

45 Capital gains exclusion on home sales ............ ............ ............ ............ ............ ............ ............ .............. 18,000 18,540 19,095 19,670 20,260 20,870 21,495 101,390

46 Exception from passive loss rules for

$25,000 of rental loss ..................... ............ ............ ............ ............ ............ ............ ............ .............. 5,315 5,035 4,790 4,555 4,330 4,100 3,885 21,660

47 Credit for low-income housing investments ............................................... 2,115 2,290 2,395 2,475 2,555 2,615 2,655 12,695 705 765 800 825 850 870 885 4,230

48 Accelerated depreciation on rental

housing (normal tax method) .......... 110 120 135 160 180 200 230 905 3,600 3,865 4,090 4,340 4,585 4,775 4,915 22,705

Commerce:

49 Cancellation of indebtedness ............... ............ ............ ............ ............ ............ ............ ............ .............. 40 25 15 15 20 20 25 95

50 Exceptions from imputed interest rules ............ ............ ............ ............ ............ ............ ............ .............. 160 160 160 165 165 165 165 820

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

method) ............................................ ............ ............ ............ ............ ............ ............ ............ .............. 39,405 40,575 41,780 43,025 44,300 45,615 46,965 221,685

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

53 Step-up basis of capital gains at

death ................................................ ............ ............ ............ ............ ............ ............ ............ .............. 25,800 27,090 28,240 29,370 30,545 31,765 33,035 152,955

54 Carryover basis of capital gains on

gifts ................................................... ............ ............ ............ ............ ............ ............ ............ .............. 175 185 195 205 210 220 230 1,060

55 Ordinary income treatment of loss

from small business corporation

stock sale ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 35 35 40 40 40 40 40 200

56 Accelerated depreciation of buildings

other than rental housing (normal

tax method) ...................................... 1,195 655 230 15 –260 –625 –905 –1,545 465 55 –665 –770 –855 –1,070 –1,240 –4,600

57 Accelerated depreciation of machinery

and equipment (normal tax method) 21,100 22,085 26,970 27,265 27,965 29,825 30,465 142,490 5,345 5,655 5,860 6,080 6,300 6,565 6,865 31,670

58 Expensing of certain small investments (normal tax method) ............. 395 490 630 665 630 625 645 3,195 1,070 1,100 1,295 1,300 1,290 1,270 1,260 6,415

59 Amortization of start-up costs (normal

tax method) ...................................... 120 125 125 130 130 135 135 655 80 80 80 85 85 85 90 425

60 Graduated corporation income tax rate

(normal tax method) ........................ 6,360 6,300 6,275 6,460 6,490 6,710 6,815 32,750 ............ ............ ............ ............ .............. .............. .............. ..............

61 Exclusion of interest on small issue

bonds ............................................... 80 80 80 80 80 80 85 405 230 235 235 240 240 245 245 1,205

Transportation:

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

63 Exclusion of reimbursed employee parking expenses ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 1,725 1,805 1,895 1,995 2,100 2,210 2,330 10,530

64 Exclusion for employer-provided transit

passes .................................................. ............ ............ ............ ............ ............ ............ ............ .............. 130 150 170 190 215 235 260 1,070

Community and regional development:

65 Investment credit for rehabilitation of

structures (other than historic) ............ 15 15 15 15 15 15 15 75 10 10 15 15 15 15 15 75

66 Exclusion of interest for airport, dock,

and similar bonds ................................. 185 185 185 190 190 195 195 955 545 550 555 560 565 570 575 2,825

67 Exemption of certain mutuals’ and cooperatives’ income ............................... 60 60 60 65 65 65 70 325 ............ ............ ............ ............ .............. .............. .............. ..............

68 Empowerment zones and enterprise

communities ......................................... 150 205 220 185 130 110 90 735 180 240 280 280 200 190 170 1,120

69 Expensing of environmental remediation

costs ..................................................... 95 125 145 50 –25 –30 –25 115 20 25 30 10 –5 –5 –5 25
114 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1999 2000 2001 2002 2003 2004 2005 2001–

2005 1999 2000 2001 2002 2003 2004 2005 2001–2005

Education, training, employment, and social services:

Education:

70 Exclusion of scholarship and fellowship income (normal tax method) ... ............ ............ ............ ............ ............ ............ ............ .............. 1,085 1,110 1,120 1,130 1,140 1,150 1,165 5,705

71 HOPE tax credit ................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,595 4,925 5,125 5,145 4,745 4,615 5,335 24,965

72 Lifetime Learning tax credit ................. ............ ............ ............ ............ ............ ............ ............ .............. 2,170 2,375 2,420 2,465 4,405 4,430 4,630 18,350

73 Education Individual Retirement Accounts ............................................... ............ ............ ............ ............ ............ ............ ............ .............. 0 10 25 40 60 80 105 310

74 Deductibility of student-loan interest ... ............ ............ ............ ............ ............ ............ ............ .............. 240 265 310 350 375 395 430 1,860

75 Deferral for State prepaid tuition plans ............ ............ ............ ............ ............ ............ ............ .............. 120 175 225 275 320 350 385 1,555

76 Exclusion of interest on student-loan

bonds ............................................... 60 65 65 65 65 65 65 325 185 185 190 190 190 195 195 960

77 Exclusion of interest on bonds for private nonprofit educational facilities 150 150 150 150 155 155 155 765 440 445 450 450 455 460 465 2,280

78 Credit for holders of zone academy

bonds ............................................... 5 10 20 35 50 65 70 240 ............ ............ ............ ............ .............. .............. .............. ..............

79 Exclusion of interest on savings bonds

redeemed to finance educational

expenses .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 10 15 15 15 15 20 20 85

80 Parental personal exemption for students age 19 or over ...................... ............ ............ ............ ............ ............ ............ ............ .............. 915 965 1,015 1,055 1,105 1,155 1,185 5,515

81 Child credit 2 ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 19,435 19,575 19,480 18,970 18,155 17,535 16,855 90,995

82 Deductibility of charitable contributions

(education) ....................................... 485 515 545 595 615 610 650 3,015 2,040 2,135 2,220 2,315 2,420 2,530 2,650 12,135

83 Exclusion of employer-provided educational assistance .......................... ............ ............ ............ ............ ............ ............ ............ .............. 220 235 250 175 0 0 0 425

Training, employment, and social services:

84 Work opportunity tax credit ................. 230 385 395 300 185 80 30 990 40 70 70 50 30 15 5 170

85 Welfare-to-work tax credit .................... 30 50 65 70 50 20 10 215 5 10 15 10 10 5 0 40

86 Exclusion of employer-provided child

care .................................................. ............ ............ ............ ............ ............ ............ ............ .............. 645 670 700 725 765 805 850 3,845

87 Adoption assistance ............................. ............ ............ ............ ............ ............ ............ ............ .............. 125 140 140 125 40 15 10 330

88 Exclusion of employee meals and

lodging (other than military) ............ ............ ............ ............ ............ ............ ............ ............ .............. 650 680 710 740 775 810 845 3,880

89 Credit for child and dependent care

expenses .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,420 2,390 2,360 2,330 2,305 2,275 2,250 11,520

90 Credit for disabled access expenditures ................................................. 15 15 15 15 15 15 15 75 35 35 40 40 40 45 45 210

91 Expensing of costs of removing certain architectural barriers to the

handicapped ..................................... 0 0 5 5 5 5 5 25

92 Deductibility of charitable contributions, other than education and

health ............................................... 600 635 680 740 760 755 805 3,740 18,620 19,380 20,180 21,040 21,990 23,010 24,090 110,310

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

94 Exclusion of parsonage allowances .... ............ ............ ............ ............ ............ ............ ............ .............. 320 340 365 390 415 445 475 2,090

Health:

95 Exclusion of employer contributions for

medical insurance premiums and

medical care ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 69,610 75,095 80,570 86,175 90,655 95,960 102,725 456,085

96 Self-employed medical insurance premiums ................................................... ............ ............ ............ ............ ............ ............ ............ .............. 935 1,250 1,380 1,545 2,070 2,905 3,210 11,110

97 Workers’ compensation insurance premiums ................................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,420 4,585 4,555 4,935 5,120 5,315 5,515 25,440

98 Medical Savings Accounts ................... ............ ............ ............ ............ ............ ............ ............ .............. 20 30 30 30 30 30 25 145

99 Deductibility of medical expenses ........... ............ ............ ............ ............ ............ ............ ............ .............. 3,695 3,910 4,160 4,440 4,720 5,005 5,305 23,630

00 Exclusion of interest on hospital construction bonds ..................................... 305 310 310 315 320 320 325 1,590 905 915 925 935 945 955 965 4,725

101 Deductibility of charitable contributions

(health) ................................................. 585 620 660 720 740 735 780 3,635 2,090 2,180 2,270 2,360 2,470 2,580 2,710 12,390

102 Tax credit for orphan drug research ....... 70 80 90 100 115 130 140 575 ............ ............ ............ ............ .............. .............. .............. ..............

103 Special Blue Cross/Blue Shield deduction 245 315 200 135 180 245 315 1,075 ............ ............ ............ ............ .............. .............. .............. ..............

Income security:

104 Exclusion of railroad retirement system

benefits ................................................. ............ ............ ............ ............ ............ ............ ............ .............. 395 405 410 415 420 430 430 2,105

105 Exclusion of workers’ compensation benefits ....................................................... ............ ............ ............ ............ ............ ............ ............ .............. 5,185 5,330 5,785 6,040 6,310 6,575 6,865 31,575

106 Exclusion of public assistance benefits

(normal tax method) ............................. ............ ............ ............ ............ ............ ............ ............ .............. 345 360 375 390 405 420 435 2,025
5. TAX EXPENDITURES 115

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1999 2000 2001 2002 2003 2004 2005 2001–

2005 1999 2000 2001 2002 2003 2004 2005 2001–2005

107 Exclusion of special benefits for disabled

coal miners ........................................... ............ ............ ............ ............ ............ ............ ............ .............. 75 75 70 70 65 60 55 320

108 Exclusion of military disability pensions .. ............ ............ ............ ............ ............ ............ ............ .............. 130 130 135 140 140 145 150 710

Net exclusion of pension contributions

and earnings:

109 Employer plans .................................... ............ ............ ............ ............ ............ ............ ............ .............. 83,780 88,830 92,390 97,085 102,575 108,020 113,705 513,775

110 Individual Retirement Accounts ........... ............ ............ ............ ............ ............ ............ ............ .............. 13,350 15,050 15,975 17,030 17,630 18,250 18,750 87,635

111 Keogh plans ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 5,230 5,550 5,895 6,255 6,635 7,040 7,465 33,290

Exclusion of other employee benefits:

112 Premiums on group term life insurance ................................................. ............ ............ ............ ............ ............ ............ ............ .............. 1,700 1,740 1,780 1,820 1,860 1,915 1,970 9,345

113 Premiums on accident and disability

insurance .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 185 195 205 215 225 235 245 1,125

114 Income of trusts to finance supplementary unemployment benefits ..... 0 0 0 5 5 5 5 20 ............ ............ ............ ............ .............. .............. .............. ..............

115 Special ESOP rules ............................. 860 890 915 950 990 1,040 1,090 4,985 270 285 290 300 310 320 335 1,555

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

117 Additional deduction for the elderly ..... ............ ............ ............ ............ ............ ............ ............ .............. 1,785 1,830 1,890 1,955 1,985 2,030 2,110 9,970

118 Tax credit for the elderly and disabled ............ ............ ............ ............ ............ ............ ............ .............. 35 35 35 35 35 35 35 175

119 Deductibility of casualty losses ........... ............ ............ ............ ............ ............ ............ ............ .............. 255 265 275 285 295 310 325 1,490

120 Earned income tax credit 3 .................. ............ ............ ............ ............ ............ ............ ............ .............. 4,825 4,700 4,790 4,985 5,205 5,440 5,740 26,160

Social Security:

Exclusion of social security benefits:

121 Social Security benefits for retired

workers ............................................. ............ ............ ............ ............ ............ ............ ............ .............. 17,135 18,010 18,885 19,995 21,230 22,505 16,515 99,130

122 Social Security benefits for disabled ... ............ ............ ............ ............ ............ ............ ............ .............. 2,390 2,595 2,830 3,090 3,375 3,700 3,150 16,145

123 Social Security benefits for dependents and survivors ........................... ............ ............ ............ ............ ............ ............ ............ .............. 3,775 3,900 4,050 4,210 4,385 4,555 3,625 20,825

Veterans benefits and services:

124 Exclusion of veterans death benefits and

disability compensation ........................ ............ ............ ............ ............ ............ ............ ............ .............. 2,940 3,070 3,200 3,335 3,490 3,655 3,830 17,510

125 Exclusion of veterans pensions ............... ............ ............ ............ ............ ............ ............ ............ .............. 65 70 75 80 85 85 90 415

126 Exclusion of GI bill benefits ..................... ............ ............ ............ ............ ............ ............ ............ .............. 75 85 90 90 95 100 105 480

127 Exclusion of interest on veterans housing

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

General purpose fiscal assistance:

128 Exclusion of interest on public purpose

bonds .................................................... 5,735 5,790 5,850 5,910 5,965 6,025 6,085 29,835 17,015 17,185 17,355 17,530 17,705 17,880 18,060 88,530

129 Deductibility of nonbusiness State and

local taxes other than on owner-occupied homes ........................................... ............ ............ ............ ............ ............ ............ ............ .............. 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

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

possessions .......................................... 2,515 2,590 2,670 2,600 2,550 2,600 2,650 13,070 ............ ............ ............ ............ .............. .............. .............. ..............

Interest:

131 Deferral of interest on U.S. savings

bonds .................................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,015 1,065 1,115 1,175 1,235 1,295 1,355 6,175

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied

homes .............................................. ............ ............ ............ ............ ............ ............ ............ .............. 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

Nonbusiness State and local taxes

other than on owner-occupied

homes .............................................. ............ ............ ............ ............ ............ ............ ............ .............. 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

Exclusion of interest on State and local

bonds for:

Public purposes .................................... 5,735 5,790 5,850 5,910 5,965 6,025 6,085 29,835 17,015 17,185 17,355 17,530 17,705 17,880 18,060 88,530

Energy facilities .................................... 30 30 30 30 30 30 30 150 85 85 85 90 90 90 90 445

Water, sewage, and hazardous waste

disposal facilities .............................. 115 115 120 120 120 120 125 605 345 345 350 355 360 360 365 1,790

Small-issues ......................................... 80 80 80 80 80 80 85 405 230 235 235 240 240 245 245 1,205

Owner-occupied mortgage subsidies .. 230 230 230 235 235 240 240 1,180 675 685 690 695 705 710 715 3,515

Rental housing ..................................... 40 40 40 40 40 40 40 200 115 115 120 120 120 120 120 600

Airports, docks, and similar facilities ... 185 185 185 190 190 195 195 955 545 550 555 560 565 570 575 2,825

Student loans ....................................... 60 65 65 65 65 65 65 325 185 185 190 190 190 195 195 960

Private nonprofit educational facilities 150 150 150 150 155 155 155 765 440 445 450 450 455 460 465 2,280

Hospital construction ............................ 305 310 310 315 320 320 325 1,590 905 915 925 935 945 955 965 4,725

Veterans’ housing ................................ 10 10 10 10 10 10 10 50 30 30 30 30 30 30 30 150
116 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Revenue Loss

Corporations Individuals

1999 2000 2001 2002 2003 2004 2005 2001–

2005 1999 2000 2001 2002 2003 2004 2005 2001–2005

Credit for holders of zone academy

bonds .................................................... 5 10 20 35 50 65 70 240 ............ ............ ............ ............ .............. .............. .............. ..............

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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003

$815; 2004 $825; and 2005 $830. 2

The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004

$450; and 2005 $420. 3

The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002

$26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the table.
5. TAX EXPENDITURES 117

Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2001 REVENUE LOSS

(In millions of dollars)

Provision 2001 2001–2005

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 92,390 513,775

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 80,570 456,085

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 60,925 331,245

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .............................................. 42,390 238,745

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 41,780 221,685

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 32,830 174,160

Step-up basis of capital gains at death .............................................................................................................................. 28,240 152,955

Deductibility of charitable contributions, total ...................................................................................................................... 26,555 145,225

Exclusion of interest on public purpose bonds ................................................................................................................... 23,205 118,365

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 23,075 124,810

Child credit 2 ......................................................................................................................................................................... 19,480 90,995

Capital gains exclusion on home sales ............................................................................................................................... 19,095 101,390

Exclusion of Social Security benefits for retired workers ................................................................................................... 18,885 99,130

Exclusion of interest on life insurance savings ................................................................................................................... 16,130 94,175

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 15,975 87,635

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 6,600 37,350

Graduated corporation income tax rate (normal tax method) ............................................................................................ 6,275 32,750

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 5,895 33,290

Exclusion of workers’ compensation benefits ...................................................................................................................... 5,785 31,575

HOPE tax credit ................................................................................................................................................................... 5,125 24,965

Exclusion of interest on non-public purpose State and local debt .................................................................................... 4,850 24,720

Earned income tax credit 3 ................................................................................................................................................... 4,790 26,160

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,790 21,660

Workers’ compensation insurance premiums ...................................................................................................................... 4,555 25,440

Accelerated depreciation on rental housing (normal tax method) ...................................................................................... 4,225 23,610

Exclusion of income of foreign sales corporations ............................................................................................................. 4,160 23,950

Deductibility of medical expenses ........................................................................................................................................ 4,160 23,630

Exclusion of Social Security benefits for dependents and survivors ................................................................................. 4,050 20,825

Credit for increasing research activities .............................................................................................................................. 3,360 14,150

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,200 17,510

Credit for low-income housing investments ......................................................................................................................... 3,195 16,925

Exclusion of Social Security benefits for disabled .............................................................................................................. 2,830 16,145

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,790 16,485

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 2,670 13,070

Lifetime Learning tax credit .................................................................................................................................................. 2,420 18,350

Credit for child and dependent care expenses ................................................................................................................... 2,360 11,520

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,160 11,000

Expensing of certain small investments (normal tax method) ............................................................................................ 1,925 9,610

Exclusion of reimbursed employee parking expenses ........................................................................................................ 1,895 10,530

Additional deduction for the elderly ..................................................................................................................................... 1,890 9,970

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 1,885 10,595

Exclusion of other employee benefits: Premiums on group term life insurance ............................................................... 1,780 9,345

Exemption of credit union income ....................................................................................................................................... 1,650 9,480

Self-employed medical insurance premiums ....................................................................................................................... 1,380 11,110

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 1,290 1,830

Special ESOP rules .............................................................................................................................................................. 1,205 6,540

Inventory property sales source rules exception ................................................................................................................. 1,150 6,750

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,120 5,705

Deferral of interest on U.S. savings bonds ......................................................................................................................... 1,115 6,175

Deferral of income from post-1987 installment sales ......................................................................................................... 1,035 5,375

Parental personal exemption for students age 19 or over ................................................................................................. 1,015 5,515

Alternative fuel production credit ......................................................................................................................................... 905 2,125

Exclusion of employee meals and lodging (other than military) ........................................................................................ 710 3,880

Exclusion of employer-provided child care .......................................................................................................................... 700 3,845

Capital gains treatment of certain income from agriculture ................................................................................................ 695 3,805

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 695 3,805

Expensing of multiperiod timber growing costs ................................................................................................................... 530 2,920

Excess of percentage over cost depletion, fuels and nonfuel minerals ............................................................................ 525 2,745

Empowerment zones and enterprise communities ............................................................................................................. 500 1,855

Work opportunity tax credit .................................................................................................................................................. 465 1,160

Exclusion of railroad retirement system benefits ................................................................................................................ 410 2,105

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 375 2,025

Exclusion of parsonage allowances ..................................................................................................................................... 365 2,090

Deductibility of student-loan interest .................................................................................................................................... 310 1,860

Enhanced oil recovery credit ............................................................................................................................................... 295 1,990

Deductibility of casualty losses ............................................................................................................................................ 275 1,490

Exclusion of employer-provided educational assistance ..................................................................................................... 250 425

Tax incentives for preservation of historic structures ......................................................................................................... 240 1,330

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 235 1,245
118 ANALYTICAL PERSPECTIVES

Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2001 REVENUE LOSS—

Continued

(In millions of dollars)

Provision 2001 2001–2005

Deferral for State prepaid tuition plans ............................................................................................................................... 225 1,555

Amortization of start-up costs (normal tax method) ............................................................................................................ 205 1,080

Exclusion of other employee benefits: Premiums on accident and disability insurance ................................................... 205 1,125

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 200 1,075

Carryover basis of capital gains on gifts ............................................................................................................................. 195 1,060

Expensing of environmental remediation costs ................................................................................................................... 175 140

Exclusion for employer-provided transit passes .................................................................................................................. 170 1,070

Exceptions from imputed interest rules ............................................................................................................................... 160 820

Adoption assistance .............................................................................................................................................................. 140 330

Exclusion of military disability pensions .............................................................................................................................. 135 710

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 105 360

Small life insurance company deduction ............................................................................................................................. 100 510

Expensing of certain multiperiod production costs .............................................................................................................. 90 510

Exclusion of GI bill benefits ................................................................................................................................................. 90 480

Tax credit for orphan drug research .................................................................................................................................... 90 575

Welfare-to-work tax credit .................................................................................................................................................... 80 255

Income averaging for farmers .............................................................................................................................................. 80 410

New technology credit .......................................................................................................................................................... 80 435

Exclusion from income of conservation subsidies provided by public utilities ................................................................... 80 415

Exclusion of veterans pensions ........................................................................................................................................... 75 415

Expensing of certain capital outlays .................................................................................................................................... 75 405

Capital gains treatment of royalties on coal ....................................................................................................................... 70 380

Exclusion of special benefits for disabled coal miners ....................................................................................................... 70 320

Capital gains treatment of certain timber income ............................................................................................................... 70 380

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 325

Credit for disabled access expenditures ............................................................................................................................. 55 285

Excess bad debt reserves of financial institutions .............................................................................................................. 55 160

Ordinary income treatment of loss from small business corporation stock sale ............................................................... 40 200

Exclusion of certain foster care payments .......................................................................................................................... 40 230

Tax credit for the elderly and disabled ............................................................................................................................... 35 175

Medical Savings Accounts ................................................................................................................................................... 30 145

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

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

Education Individual Retirement Accounts .......................................................................................................................... 25 310

Exception from passive loss limitation for working interests in oil and gas properties ..................................................... 25 125

Credit for holders of zone academy bonds ......................................................................................................................... 20 240

Expensing of exploration and development costs, nonfuel minerals ................................................................................. 20 100

Cancellation of indebtedness ............................................................................................................................................... 15 95

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

Exclusion of interest on savings bonds redeemed to finance educational expenses ....................................................... 15 85

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

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 65

Investment credit and seven-year amortization for reforestation expenditures ................................................................. 10 70

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

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

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

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

Income of trusts to finance supplementary unemployment benefits .................................................................................. 0 20

Expensing of exploration and development costs, fuels .................................................................................................... –30 5

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... –435 –6,145

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: 1999

$760; 2000 $800; 2001 $805; 2002 $810; 2003 $815; 2004 $825; and 2005 $830. 2

The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000

$550; 2001 $520; 2002 $505; 2003 $460; 2004 $450; and 2005 $420. 3

The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999

$25,630; 2000 $25,675; 2001 $25,800; 2002 $26,875; 2003 $27,640; 2004 $28,700; and 2005 $29,720.

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

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

debt, and excess of percentage over cost depletion for fuels and nonfuel minerals.
5. TAX EXPENDITURES 119

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

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

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

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

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

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

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

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

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

CALENDAR YEAR 1999

(In millions of dollars)

Provision

Present

Value of

Revenue

Loss

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 5,960

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 965

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 2,570

4 Expensing of exploration and development costs—fuels .................................................................................... 110

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

6 Expensing of multiperiod timber growing costs ................................................................................................... 240

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

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

9 Deferral of income on life insurance and annuity contracts ................................................................................ 22,100

10 Accelerated depreciation of rental housing (normal tax method) ....................................................................... 2,845

11 Accelerated depreciation of buildings other than rental housing (normal tax method) ...................................... 335

12 Accelerated depreciation of machinery and equipment (normal tax method) .................................................... 32,780

13 Expensing of certain small investments (normal tax method) ............................................................................ 1,030

14 Amortization of start-up costs (normal tax method) ............................................................................................. 170

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

16 Deferral for state prepaid tuition plans ................................................................................................................. 170

17 Credit for holders of zone academy bonds ......................................................................................................... 220

18 Credit for low-income housing investments ......................................................................................................... 2,730

19 Exclusion of pension contributions—employer plans ........................................................................................... 95,620

20 Exclusion of IRA contributions and earnings ....................................................................................................... 6,005

21 Exclusion of contributions and earnings for Keogh plans ................................................................................... 3,510

22 Exclusion of interest on public-purpose bonds .................................................................................................... 26,995

23 Exclusion of interest on non-public purpose bonds ............................................................................................. 3,950

24 Deferral of interest on U.S. savings bonds .......................................................................................................... 405

Outlay Equivalents

The concept of ‘‘outlay equivalents’’ complements

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

tax expenditures. It is the amount of outlay that would

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

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

The outlay-equivalent measure is larger than the revenue-loss estimate when the tax expenditure is judged

to function as a Government payment for service. This

occurs because an outlay program would increase the

taxpayer’s pre-tax income. For some tax expenditures,

however, the revenue loss equals the outlay equivalent

measure. This occurs when the tax expenditure is

judged to function like a price reduction or tax deferral

that does not directly enter the taxpayer’s pre-tax income.1
120 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Outlay Equivalents

1999 2000 2001 2002 2003 2004 2005 2001–2005

National Defense

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,470 2,495 2,520 2,545 2,570 2,600 2,630 12,865

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 3,940 4,270 4,625 5,000 5,370 5,760 6,185 26,940

3 Exclusion of income of foreign sales corporations ................................................................................ 5,600 5,980 6,400 6,860 7,340 7,850 8,400 36,850

4 Inventory property sales source rules exception ................................................................................... 1,620 1,690 1,770 1,920 2,080 2,230 2,380 10,380

5 Deferral of income from controlled foreign corporations (normal tax method) .................................... 5,800 6,200 6,600 7,000 7,450 7,900 8,400 37,350

6 Deferred taxes for financial firms on income earned overseas ............................................................ 960 1,190 1,290 540 0 0 0 1,830

General science, space, and technology:

7 Expensing of research and experimentation expenditures (normal tax method) ................................. 1,890 1,865 1,875 1,960 2,090 2,245 2,415 10,585

8 Credit for increasing research activities ................................................................................................. 2,625 1,550 5,175 5,710 4,570 4,010 2,320 21,785

Energy:

9 Expensing of exploration and development costs, fuels ....................................................................... –80 –20 –30 –10 15 15 15 5

10 Excess of percentage over cost depletion, fuels .................................................................................. 325 330 335 340 345 350 355 1,725

11 Alternative fuel production credit ............................................................................................................ 1,495 1,400 1,315 1,235 775 180 180 3,685

12 Exception from passive loss limitation for working interests in oil and gas properties ....................... 30 25 25 25 25 25 25 125

13 Capital gains treatment of royalties on coal .......................................................................................... 85 85 95 95 100 105 115 510

14 Exclusion of interest on energy facility bonds ....................................................................................... 165 165 165 170 170 170 170 845

15 Enhanced oil recovery credit .................................................................................................................. 315 360 415 480 550 635 730 2,810

16 New technology credit ............................................................................................................................ 70 85 120 130 125 125 125 625

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

18 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 110 125 135 125 105 70 25 460

19 Exclusion from income of conservation subsidies provided by public utilities ..................................... 115 110 105 110 115 115 115 560

Natural resources and environment:

20 Expensing of exploration and development costs, nonfuel minerals .................................................... 15 15 15 15 15 20 20 85

21 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 275 285 295 310 320 335 350 1,610

22 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 660 660 670 680 685 685 705 3,425

23 Capital gains treatment of certain timber income ................................................................................. 85 85 95 95 100 105 115 510

24 Expensing of multiperiod timber growing costs ..................................................................................... 495 500 530 565 585 610 630 2,920

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

26 Tax incentives for preservation of historic structures ............................................................................ 205 225 240 255 265 280 295 1,335

Agriculture:

27 Expensing of certain capital outlays ...................................................................................................... 65 70 75 75 80 85 85 400

28 Expensing of certain multiperiod production costs ................................................................................ 85 85 90 95 100 105 110 500

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

30 Capital gains treatment of certain income ............................................................................................. 845 885 925 965 1,015 1,060 1,105 5,070

31 Income averaging for farmers ................................................................................................................ 75 75 80 80 80 85 85 410

32 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 15 15 15 65

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ..................................................................................................... 1,910 2,015 2,160 2,320 2,490 2,675 2,865 12,510

34 Excess bad debt reserves of financial institutions ............................................................................ 75 85 70 55 40 25 5 195

35 Exclusion of interest on life insurance savings ................................................................................. 13,920 14,985 16,130 17,365 18,870 20,130 21,680 94,175

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 295 300 315 320 335 340 355 1,665

38 Small life insurance company deduction ........................................................................................... 135 135 135 135 135 140 140 685

Housing:

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 1,300 1,310 1,320 1,330 1,345 1,365 1,370 6,730

40 Exclusion of interest on rental housing bonds .................................................................................. 220 220 230 230 230 230 230 1,150

41 Deductibility of mortgage interest on owner-occupied homes .......................................................... 56,920 58,815 60,925 63,240 65,955 68,965 72,160 331,245

42 Deductibility of State and local property tax on owner-occupied homes ......................................... 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

43 Deferral of income from post-1987 installment sales ....................................................................... 995 1,015 1,035 1,055 1,075 1,095 1,115 5,375

44 Capital gains exclusion on home sales ............................................................................................. 22,500 23,175 23,870 24,590 25,325 26,090 26,870 126,745

45 Exception from passive loss rules for $25,000 of rental loss .......................................................... 5,315 5,035 4,790 4,555 4,330 4,100 3,885 21,660

46 Credit for low-income housing investments ....................................................................................... 0 0 0 5 5 5 5 20

47 Accelerated depreciation on rental housing (normal tax method) .................................................... 3,710 3,985 4,225 4,495 4,760 4,975 5,145 23,600

Commerce:

48 Cancellation of indebtedness ............................................................................................................. 40 25 15 15 20 20 25 95

49 Exceptions from imputed interest rules ............................................................................................. 160 160 160 165 165 165 165 820

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 52,540 54,100 55,705 57,365 59,065 60,820 62,620 295,575

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

52 Step-up basis of capital gains at death ............................................................................................ 34,400 36,120 37,655 39,160 40,725 42,355 44,045 203,940

53 Carryover basis of capital gains on gifts ........................................................................................... 175 185 195 205 210 220 230 1,060

54 Ordinary income treatment of loss from small business corporation stock sale ............................. 45 45 55 55 55 55 55 275

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 1,655 705 –435 –755 –1,110 –1,695 –2,140 –6,135
5. TAX EXPENDITURES 121

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

(In millions of dollars)

Outlay Equivalents

1999 2000 2001 2002 2003 2004 2005 2001–2005

56 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 26,440 27,735 32,825 33,340 34,260 36,380 37,325 174,130

57 Expensing of certain small investments (normal tax method) .......................................................... 1,465 1,590 1,920 1,965 1,915 1,890 1,900 9,590

58 Amortization of start-up costs (normal tax method) .......................................................................... 200 205 205 215 215 220 225 1,080

59 Graduated corporation income tax rate (normal tax method) .......................................................... 9,790 9,690 9,655 9,940 9,985 10,325 10,485 50,390

60 Exclusion of interest on small issue bonds ....................................................................................... 445 450 450 460 460 465 475 2,310

Transportation:

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

62 Exclusion of reimbursed employee parking expenses .......................................................................... 2,225 2,330 2,450 2,575 2,710 2,855 3,005 13,595

63 Exclusion for employer-provided transit passes .................................................................................... 180 205 235 265 295 330 360 1,485

Community and regional development:

64 Investment credit for rehabilitation of structures (other than historic) .................................................. 25 25 25 25 25 25 30 130

65 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 1,045 1,050 1,060 1,075 1,085 1,095 1,105 5,420

66 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 65 65 65 70 325

67 Empowerment zones and enterprise communities ................................................................................ 325 445 500 470 325 300 265 1,860

68 Expensing of environmental remediation costs ..................................................................................... 150 200 235 80 –40 –50 –40 185

Education, training, employment, and social services:

Education:

69 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,190 1,220 1,235 1,240 1,255 1,265 1,280 6,275

70 HOPE tax credit .................................................................................................................................. 5,890 6,310 6,570 6,595 6,080 5,915 6,845 32,005

71 Lifetime Learning tax credit ................................................................................................................ 2,780 3,045 3,100 3,160 5,645 5,675 5,935 23,515

72 Education Individual Retirement Accounts ........................................................................................ 0 10 25 40 60 80 105 310

73 Deductibility of student-loan interest .................................................................................................. 300 335 390 440 470 495 535 2,330

74 Deferral for State prepaid tuition plans ............................................................................................. 120 175 225 275 320 355 385 1,560

75 Exclusion of interest on student-loan bonds ..................................................................................... 355 360 365 365 365 370 370 1,835

76 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 845 855 860 860 875 880 890 4,365

77 Credit for holders of zone academy bonds ....................................................................................... 5 15 30 50 75 90 100 345

78 Exclusion of interest on savings bonds redeemed to finance educational expenses ..................... 15 20 20 20 20 30 30 120

79 Parental personal exemption for students age 19 or over ............................................................... 1,010 1,070 1,125 1,165 1,225 1,280 1,310 6,105

80 Child credit 2 ........................................................................................................................................ 25,915 26,100 25,975 25,290 24,205 23,385 22,475 121,330

81 Deductibility of charitable contributions (education) .......................................................................... 3,435 3,685 3,850 4,040 4,250 4,395 4,610 21,145

82 Exclusion of employer-provided educational assistance ................................................................... 275 290 310 215 0 0 0 525

Training, employment, and social services:

83 Work opportunity tax credit ................................................................................................................ 270 455 465 350 215 95 35 1,160

84 Welfare-to-work tax credit .................................................................................................................. 35 60 80 80 60 25 10 255

85 Exclusion of employer provided child care ........................................................................................ 860 890 930 970 1,020 1,075 1,135 5,130

86 Adoption assistance ............................................................................................................................ 160 175 180 160 55 20 10 425

87 Exclusion of employee meals and lodging (other than military) ...................................................... 795 830 865 905 945 990 1,030 4,735

88 Credit for child and dependent care expenses ................................................................................. 3,225 3,185 3,145 3,110 3,075 3,035 3,000 15,365

89 Credit for disabled access expenditures ........................................................................................... 65 65 75 75 75 80 80 385

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

91 Deductibility of charitable contributions, other than education and health ....................................... 25,750 26,955 28,115 29,380 30,790 32,200 33,755 154,240

92 Exclusion of certain foster care payments ........................................................................................ 45 50 50 55 55 60 60 280

93 Exclusion of parsonage allowances ................................................................................................... 395 420 450 480 515 550 585 2,580

Health:

94 Exclusion of employer contributions for medical insurance premiums and medical care ................... 88,730 95,950 103,085 110,390 115,840 122,545 131,495 583,355

95 Self-employed medical insurance premiums ......................................................................................... 1,145 1,535 1,700 1,900 2,550 3,580 3,955 13,685

96 Workers’ compensation insurance premiums ........................................................................................ 5,520 5,730 5,945 6,170 6,400 6,645 3,895 29,055

97 Medical Savings Accounts ...................................................................................................................... 30 40 45 45 45 40 35 210

98 Deductibility of medical expenses .......................................................................................................... 3,695 3,910 4,160 4,440 4,720 5,005 5,305 23,630

99 Exclusion of interest on hospital construction bonds ............................................................................ 1,735 1,755 1,770 1,790 1,815 1,830 1,850 9,055

100 Deductibility of charitable contributions (health) .................................................................................... 3,640 3,910 4,095 4,300 4,525 4,665 4,900 22,485

101 Tax credit for orphan drug research ...................................................................................................... 70 80 90 100 115 130 140 575

102 Special Blue Cross/Blue Shield deduction ............................................................................................. 325 420 270 180 240 325 420 1,435

Income security:

103 Exclusion of railroad retirement system benefits ................................................................................... 395 405 410 415 420 430 430 2,105

104 Exclusion of workers’ compensation benefits ........................................................................................ 5,185 5,330 5,785 6,040 6,310 6,575 6,865 31,575

105 Exclusion of public assistance benefits (normal tax method) ............................................................... 345 360 375 390 405 420 435 2,025

106 Exclusion of special benefits for disabled coal miners ......................................................................... 75 75 70 70 65 60 55 320

107 Exclusion of military disability pensions ................................................................................................. 130 130 135 140 140 145 150 710

Net exclusion of pension contributions and earnings:

108 Employer plans ................................................................................................................................... 97,960 104,060 108,190 113,770 120,275 126,700 133,400 602,335

109 Individual Retirement Accounts .......................................................................................................... 18,290 20,025 21,360 22,770 23,695 24,645 25,445 117,915

110 Keogh plans ........................................................................................................................................ 6,630 7,040 7,475 7,930 8,415 8,925 9,465 42,210

Exclusion of other employee benefits:

111 Premiums on group term life insurance ............................................................................................ 2,240 2,290 2,340 2,395 2,445 2,520 2,590 12,290
122 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Outlay Equivalents

1999 2000 2001 2002 2003 2004 2005 2001–2005

112 Premiums on accident and disability insurance ................................................................................ 235 250 260 275 290 305 315 1,445

113 Income of trusts to finance supplementary unemployment benefits .................................................... 0 0 0 5 5 5 5 20

114 Special ESOP rules ................................................................................................................................ 1,565 1,630 1,670 1,730 1,800 1,885 1,975 9,060

115 Additional deduction for the blind ........................................................................................................... 35 35 40 40 40 45 45 210

116 Additional deduction for the elderly ........................................................................................................ 2,155 2,215 2,285 2,360 2,400 2,455 2,555 12,055

117 Tax credit for the elderly and disabled .................................................................................................. 45 45 45 45 45 45 45 225

118 Deductibility of casualty losses .............................................................................................................. 280 290 300 315 325 340 355 1,635

119 Earned income tax credit 3 ..................................................................................................................... 5,360 5,220 5,320 5,540 5,785 6,045 6,380 29,070

Social Security:

Exclusion of social security benefits:

120 Social Security benefits for retired workers ....................................................................................... 17,135 18,010 18,885 19,995 21,230 22,505 16,515 99,130

121 Social Security benefits for disabled ................................................................................................. 2,390 2,595 2,830 3,090 3,375 3,700 3,150 16,145

122 Social Security benefits for dependents and survivors ..................................................................... 3,775 3,900 4,050 4,210 4,385 4,555 3,625 20,825

Veterans benefits and services:

123 Exclusion of veterans death benefits and disability compensation ...................................................... 2,940 3,070 3,200 3,335 3,490 3,655 3,830 17,510

124 Exclusion of veterans pensions .............................................................................................................. 65 70 75 80 85 85 90 415

125 Exclusion of GI bill benefits .................................................................................................................... 75 85 90 90 95 100 105 480

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

General purpose fiscal assistance:

127 Exclusion of interest on public purpose bonds ..................................................................................... 32,600 32,925 33,250 33,590 33,920 34,255 34,600 169,615

128 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ................ 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

129 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 3,590 3,700 3,815 3,715 3,640 3,715 3,785 18,670

Interest:

130 Deferral of interest on U.S. savings bonds ........................................................................................... 1,015 1,065 1,115 1,175 1,235 1,295 1,355 6,175

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 32,600 32,925 33,250 33,590 33,920 34,255 34,600 169,615

Energy facilities ................................................................................................................................... 165 165 165 170 170 170 170 845

Water, sewage, and hazardous waste disposal facilities ................................................................. 660 660 670 680 685 685 705 3,425

Small-issues ........................................................................................................................................ 445 450 450 460 460 465 475 2,310

Owner-occupied mortgage subsidies ................................................................................................. 1,300 1,310 1,320 1,330 1,345 1,365 1,370 6,730

Rental housing .................................................................................................................................... 220 220 230 230 230 230 230 1,150

Airports, docks, and similar facilities ................................................................................................. 1,045 1,050 1,060 1,075 1,085 1,095 1,105 5,420

Student loans ...................................................................................................................................... 355 360 365 365 365 370 370 1,835

Private nonprofit educational facilities ............................................................................................... 845 855 860 860 875 880 890 4,365

Hospital construction .......................................................................................................................... 1,735 1,755 1,770 1,790 1,815 1,830 1,850 9,055

Veterans’ housing ............................................................................................................................... 60 60 60 60 60 60 60 300

Credit for holders of zone academy bonds ........................................................................................... 5 15 30 50 75 90 100 345

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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003

$815; 2004 $825; and 2005 $830. 2

The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004

$450; and 2005 $420. 3

The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002

$26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $5 million. Provisions with estimates that rounded to zero in each year are not included in the table.
5. TAX EXPENDITURES 123

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

such as social security benefits. 3 In the case of individuals who hold ‘‘passive’’ equity interests in businesses, however,

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

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

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

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

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

in subsequent years, or when the interest is liquidated.

Tax Expenditure Baselines

A tax expenditure is a preferential exception to the

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

baseline provisions of the tax law. Deciding whether

provisions are preferential exceptions, therefore, is a

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

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

Joint Committee on Taxation, and the reference tax

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

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

sum of consumption and the change in net wealth in

a given period of time. The normal tax baseline allows

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

is not limited to a particular structure of tax rates,

or by a specific definition of the taxpaying unit.

The reference tax law baseline is also patterned on

a comprehensive income tax, but is closer to existing

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

functions. These functions correspond to specific budget

categories such as national defense, agriculture, or

health care. 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.

• There is a separate corporation income tax. Under

a comprehensive income tax, corporate income

would be taxed only once—at the shareholder

level, whether or not distributed in the form of

dividends.

• Values of assets and debt are not adjusted for

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

changes in the price level during the time the

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

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

and failure to take account of inflation in measuring interest costs would be regarded as a positive tax expenditure (i.e., a tax subsidy).

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 it specifies the current maximum rate as the baseline for the corporate income tax. The lower tax rates applied to the first

$10 million of corporate income are thus regarded

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

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

ore royalties and the sale of timber and certain

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

part of the baseline rate structure under both the

reference and normal tax methods.

• Income subject to the tax. Income subject to tax

is defined as gross income less the costs of earning

that income. The Federal income tax defines gross

income to include: (1) consideration received in

the exchange of goods and services, including labor

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

of gross or net income earned and/or reported by

another entity (such as a partnership). Under the

reference tax rules, therefore, gross income does

not include gifts—defined as receipts of money or

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

thought of as gifts from the Government.2 The

normal tax baseline also excludes gifts between

individuals from gross income. Under the normal

tax baseline, however, all cash transfer payments

from the Government to private individuals are

counted in gross income, and exemptions of such

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

deductible in determining taxable income under

both the reference and normal tax baselines.3

• Capital recovery. Under the reference tax law

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

the depreciation allowance for machinery and

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

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

tax baseline for real property is computed using

40-year straight-line depreciation.

• Treatment of foreign income. Both the normal and

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

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

Results Act of 1993’’ (Report 103–58, 1993). 5 Joint Committee on Taxation, ‘‘Estimates of Federal Tax Expenditures for Fiscal Years

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

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

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

6 Although this section focuses upon tax expenditures under the income tax, tax preferences

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

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

for certain types of consumption that are deemed meritorious.

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.

Beyond these examples, there are still more areas

of difference where the Joint Committee on Taxation

considers a somewhat broader set of tax expenditures

under its normal tax baseline than under the reference

baseline considered here.

Performance Measures and the Economic

Effects of Tax Expenditures

The Government Performance and Results Act of

1993 (GPRA) directs Federal agencies to develop annual

and strategic plans for their programs and activities.

These plans set out performance objectives to be

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

to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA 4 calls on the

Executive branch to undertake a series of analyses to

assess the effect of specific tax expenditures on the

achievement of agencies’ performance objectives.

One finding of pilot studies on selected tax expenditures undertaken by Treasury’s Office of Tax Analysis

is that much of the data needed for thorough analysis

are not currently available. Hence, assessment of data

needs and availability from Federal statistical agencies,

program-agency studies, or private-sector sources,

should prove valuable to broader efforts to assess the

effects of tax expenditures and to compare their effectiveness with other policy means of achieving important

public objectives. This effort will complement information published by the Joint Committee on Taxation and

the Senate Budget Committee on tax expenditures.5

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. As one part of this effort, Treasury’s Office

of Tax Analysis and its Statistics of Income Division

(IRS) are developing the specifications for a new data

sample which will follow the same individual income

tax filers over an extended period of time. Such a sample is called a ‘‘panel’’ sample. Current economic analyses of the effect of Federal tax laws are generally

based on data from ‘‘cross-section’’ samples, which capture the demographic and economic circumstances of

individuals and the provisions of Federal tax law only

at a single point in time. However, over time, the demographic and economic status of individuals changes in

ways that can significantly change how they are affected by current (or proposed) Federal tax laws. In

addition, some provisions of the tax law have effects

over multiple years, and the effects of some tax provisions change over time due to phase-ins, phase-outs,

and other factors. The new panel 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 panel

sample will therefore permit more extensive, and better, analyses of many tax provisions than can be performed using only cross-section data. In particular, data

from the panel sample will enhance our ability to analyze the effect of tax expenditures designed to increase

savings. Other efforts to improve data available for the

analysis of savings tax expenditures will be undertaken

over the next several years by OMB, Treasury and

other agencies.

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.6

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 some 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 and deferrals; floors and ceilings;

and phase-ins and 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, various holding periods and tax rates for

capital gains 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 inquire into certain characteristics of individ-
5. TAX EXPENDITURES 125

uals 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 outlay programs. For example, grant or direct Federal service

delivery programs can prioritize which activities are

addressed with what amount of resources in a way

that is difficult to emulate with tax expenditures. Finally, tax expenditures may not receive the same frequency or level of scrutiny afforded to other programs.

Outlay programs, in contrast, have advantages where

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

forces or administering the system of justice. Outlay

programs may also be specifically designed to meet the

needs of low-income families who would not otherwise

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

Outlay programs may also receive more year-to-year

oversight and fine tuning through the legislative and

executive budget process. In addition, the availability

of 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—provides flexibility for policy design. On the

other hand, certain outlay programs—such as direct

government service provision—may rely less directly on

economic incentives and private-market provision than

tax incentives, which may reduce the relative efficiency

of spending programs for some goals. Spending programs also require resources to be raised via taxes,

user charges, or government borrowing. Finally, spending programs, particularly on the discretionary side,

may respond less readily to changing activity levels

and economic conditions than tax expenditures.

Regulations have more direct and immediate effects

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

private sector. Regulations can also be fine-tuned more

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

largely upon voluntary compliance, rather than detailed

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

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

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

this feature can also promote full compliance where

(as in certain safety-related cases) policymakers believe

that trade-offs with economic considerations are not of

paramount importance. Also, regulations generally do

not directly affect Federal outlays or receipts. Thus,

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

analysis that goes well beyond the analysis required

for outlays and tax-expenditures. To some extent, the

GPRA requirement for performance evaluation will address this lack of formal analysis.

Some policy objectives are achieved using multiple

approaches. For example, minimum wage legislation,

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

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

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

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

saving for retirement or investing in certain sectors);

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

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

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

Also, many tax expenditures, including those cited

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

accelerated depreciation may encourage investment. In

addition, the economic effects of particular provisions

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

incomes may have positive or negative effects on tax

neutrality).

Performance measurement is generally concerned

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

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

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

society, or environment that are the ultimate goals of

programs.

Thus, for a provision that reduces taxes on certain

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

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

inequity or unintended consequence in the tax code,

an important performance measure might be how they

change effective tax rates (the discounted present value

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

distortions caused by taxes). 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 devel-
126 ANALYTICAL PERSPECTIVES

oped. 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 promoting U.S. exports. These include the

exclusion for income earned abroad by nongovernmental

employees and preferences for income from exports and

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

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

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

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

of export promotion programs supported by outlays.

General science, space and technology; energy;

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

tax expenditures reduces the cost of investment, both

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

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

incentives by measuring their effects on the cost of

capital (the interest rate which investments must yield

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

of these provisions on the amounts of corresponding

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

numbers or values of patents, energy production and

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

producers) and their cost-effectiveness relative to other

policies. Analysis could also consider objectives that are

more difficult to measure but still are ultimate goals,

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

growth. Such an assessment is likely to involve tax

analysis as well as consideration of non-tax matters

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

of various energy sources on the environment).

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

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

ownership and the quality of housing. In addition, the

mortgage interest deduction offsets the taxable nature

of investment income received by homeowners, so the

relationship between the deduction and such earnings

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

gains is likely to be relevant to evaluation of the capital

gains preference for home sales. Deductibility of State

and local property taxes assists with making housing

more affordable as well as easing the cost of providing

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

be evaluated for their effects on making such housing

more available and affordable. These provisions should

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

Transportation.—Employer-provided parking is a

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

taxation. The tax expenditure revenue loss estimates

reflect the cost of parking that is leased by employers

for employees; an estimate is not currently available

for the value of parking owned by employers and provided to their employees. The exclusion for employerprovided transit passes is intended to promote use of

this mode of transportation, which has environmental

and congestion benefits. The tax treatments of these

different benefits could be compared with alternative

transportation policies.

Community and regional development.—A series

of tax expenditures is intended to promote community

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

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

activity in disadvantaged areas. These provisions can

be compared with grants and other policies designed

to spur economic development.
5. TAX EXPENDITURES 127

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 benefits provided 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 lowerincome 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, 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.

National Defense

1. Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, as well as certain

amounts of pay related to combat service, are excluded

from income subject to tax.

International Affairs

2. Income earned abroad.—U.S. citizens who lived

abroad, worked in the private sector, and satisfyied

a foreign residency requirement in 1999 may exclude

up to $74,000 in foreign earned income from U.S. taxes.

The exclusion increases in 2000, 2001, and 2002 to

$76,000, $78,000, and $80,000, respectively. 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 ($63,567 in 1999). Beginning this year, the value of U.S. tax benefits provided

to employees of the U.S. government who live and work

overseas is not included under this heading. Those tax

benefits now are included under their own heading,

Exclusion of Certain Allowances for Federal Employees

Abroad (#3).

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.
128 ANALYTICAL PERSPECTIVES

4. Income of Foreign Sales Corporations.—The

Foreign Sales Corporation (FSC) provisions exempt

from tax a portion of U.S. exporters’ foreign trading

income to reflect the FSC’s sales functions as foreign

corporations. These provisions conform to the General

Agreement on Tariffs and Trade.

5. Sales source rule exceptions.—The worldwide

income of U.S. persons is taxable by the United States

and a credit for foreign taxes paid is allowed. The

amount of foreign taxes that can be credited is limited

to the pre-credit U.S. tax on the foreign source income.

The sales source rules for inventory property allow U.S.

exporters to use more foreign tax credits by allowing

the exporters to attribute a larger portion of their earnings abroad than would be the case if the allocation

of earnings was based on actual economic activity.

6. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled

by U.S. shareholders is not subject to U.S. taxation.

The income becomes taxable only when the controlling

U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal

tax method, the currently attributable foreign source

pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not

distributed. Thus, the normal tax method considers the

amount of controlled foreign corporation income not distributed to a U.S. shareholder as tax-deferred income.

7. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. Taxes on

income earned through December 31, 2001 can be deferred. The Tax Relief Extension Act of 1999 extended

the expiration date from December 31, 1999 to December 31, 2001.

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, which expired on June 30, 1999, was

reinstated (retroactively) in the Tax Relief Extension

Act of 1999 for five years (through June 30, 2004).

The Act also increased the credit rates for the alternative credit by one percentage point and extended the

research credit to include research conducted in Puerto

Rico and the U.S. possessions. The tax credit is 20

percent of qualified research expenditures in excess of

a base amount. The base amount is generally determined by multiplying a ‘‘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 threetiered 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.

Energy

10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of

unsalvageable materials used in constructing wells)

may be expensed rather than amortized over the productive life of the property. Integrated oil companies

may deduct only 70 percent of such costs and must

amortize the remaining 30 percent over five years. The

same rule applies to the exploration and development

costs of surface stripping and the construction of shafts

and tunnels for other fuel minerals.

11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed

to take percentage depletion deductions rather than

cost depletion on limited quantities of output. Under

cost depletion, outlays are deducted over the productive

life of the property based on the fraction of the resource

extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent

for oil, gas and oil shale; and 10 percent for coal. The

deduction is limited to 50 percent of net income from

the property, except for oil and gas where the deduction

can be 100 percent of net property income. Production

from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit

on output and no limitation with respect to qualified

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

investment.

12. Alternative fuel production credit.—A nontaxable credit of $3 per barrel (in 1979 dollars) of oilequivalent production is provided for several forms of

alternative fuels. The credit is generally available if

the price of oil stays below $29.50 (in 1979 dollars).

The credit generally expires on December 31, 2002.

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.
5. TAX EXPENDITURES 129

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 and biomass. The

renewable resources credit applies only to electricity

produced by a facility placed in service on or before

December 31, 2001. The Tax Relief Extension Act of

1999 extended the expiration date from June 30, 1999

to December 31, 2001 and expanded the credit to apply

to electricity produced from poultry waste facilities

(placed in service after December 31, 1999).

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 54 cents

per gallon in 1998, 1999, and 2000; 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 2002 through 2005.

20. Exclusion of utility conservation subsidies.—

Subsidies by public utilities for non-business customer

expenditures on energy conservation measures are excluded from the gross income of the customer.

Natural Resources and Environment

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, and hazardous waste

bonds.—Interest earned on State and local bonds used

to finance the construction of sewage, water, or hazardous waste facilities is tax-exempt. These bonds are

generally subject to the State private-activity bond annual volume cap.

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. Credit and seven-year amortization for reforestation.—A 10-percent investment tax credit is allowed for up to $10,000 invested annually to clear land

and plant trees for the production of timber. Up to

$10,000 in forestation investment may also be amortized over a seven-year period rather than capitalized

and deducted when the trees are sold or harvested.

The amount of forestation investment that may be amortized is not reduced by any of the allowable investment credit.

27. 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

28. 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.

29. Expensing multiperiod livestock and crop

production costs.—The production of livestock and

crops with a production period of less than two years

is exempt from the uniform cost capitalization rules.

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale

with a production period of two years or more may

elect not to capitalize costs. If they do, they must apply

straight-line depreciation to all depreciable property

they use in farming.

30. Loans forgiven solvent farmers.—Farmers are

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

the property to which the loan relates. If the debtor

elects to reduce basis and the amount of forgiveness

exceeds his basis in the property, the excess forgiveness

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

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.
130 ANALYTICAL PERSPECTIVES

31. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops,

can be treated as capital gains rather than ordinary

income.

32. Income averaging for farmers.—Taxpayers can

lower their tax liability by averaging, over the prior

three-year period, their taxable income from farming.

33. 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.

34. Credit union income.—The earnings of credit

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

35. 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.

36. 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.

37. 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.

38. 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.

39. 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.

40. Mortgage housing bonds.—Interest earned on

State and local bonds used to finance homes purchased

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds

that can be issued to finance such private activity is

limited. The combined volume cap for mortgage housing

bonds, rental housing bonds, student loan bonds, and

industrial development bonds is $50 per capita ($150

million minimum) per State. The volume cap increases

to $55 per capita ($165 million minimum) in 2003 and

ratably annually thereafter until the cap reaches $75

per capita ($225 million minimum) in 2007. States may

issue mortgage credit certificates (MCCs) in lieu of

mortgage revenue bonds. MCCs entitle home buyers

to income tax credits for a specified percentage of interest on qualified mortgages. The total amount of MCCs

issued by a State cannot exceed 25 percent of its annual

ceiling for mortgage-revenue bonds.

41. 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.

42. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on

their primary and secondary residences as itemized

nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the

owner’s basis in the residence and, for debt incurred

after October 13, 1987, it is limited to no more than

$1 million. Interest on up to $100,000 of other debt

secured by a lien on a principal or second residence

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions

on personal residences are tax expenditures because

the taxpayers are not required to report the value of

owner-occupied housing services as gross income.

43. 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.

44. 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 pay-
5. TAX EXPENDITURES 131

ment 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.

45. 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.

46. 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.

47. Low-income housing credit.—Taxpayers who

invest in certain low-income housing are eligible for

a tax credit. The credit rate is set so that the present

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other

Federal benefits (such as tax-exempt bond financing),

or (2) substantially rehabilitated existing housing. The

credit is allowed in equal amounts over 10 years. State

agencies determine who receives the credit; States are

limited in the amount of credit they may authorize

annually to $1.25 per resident.

48. 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, a 40-year tax life

for depreciable real property is the norm. Thus, a statutory depreciation period for rental property of 27.5

years is a tax expenditure. In addition, tax expenditures arise from pre-1987 tax allowances for rental

property.

49. 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.

50. 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.

51. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held

for more than 1 year are taxed at a lower rate than

ordinary income. The lower rate on capital gains is

considered a tax expenditure under the normal tax

method but not under the reference law method.

For assets held for more than 1 year, the top tax

rate is 20 percent (10 percent for taxpayers who would

otherwise pay capital gains tax at the 15-percent rate).

In addition, for assets acquired after December 31,

2000, the maximum capital gains tax rates for assets

held more than 5 years are 8 percent and 18 percent

(rather than 10 percent and 20 percent). On January

1, 2001, taxpayers may mark-to-market existing assets

to start the 5-year holding period.

52. 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.

53. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are

not subject to capital gains taxes. The cost basis of

the appreciated assets is adjusted upward to the market value at the owner’s date of death. The step-up

in the heir’s cost basis means that, in effect, the tax

on the capital gain is forgiven.

54. 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.

55. 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.

56. 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, a 40-year life for nonrental-housing buildings is the norm. Thus, the 39-year

depreciation period for property placed in service after

February 25, 1993, the 31.5-year depreciation period

for property placed in service from 1987 to February

25, 1993, and the pre-1987 depreciation periods create

a tax expenditure.

57. 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. Statutory depreciation of machinery and equipment, however, is accelerated somewhat relative to the normal

tax baseline, creating a tax expenditure.

58. Expensing of certain small investments.—In

1999, qualifying investments in tangible property up

to $19,000 can be expensed rather than depreciated
132 ANALYTICAL PERSPECTIVES

over time. (The expensing limit increases annually until

2003, when it reaches $25,000). To the extent that

qualifying investment during the year exceeds

$200,000, the amount eligible for expensing is decreased. In 1999, the amount expensed is completely

phased out when qualifying investments exceed

$219,000.

59. 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.

60. Graduated corporation income tax rate

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000

of taxable income, 25 percent on the next $25,000, and

34 percent on the next $9.925 million. Compared with

a flat 34-percent rate, the lower rates provide an

$11,750 reduction in tax liability for corporations with

taxable income of $10 million. This benefit is recaptured for corporations with taxable incomes exceeding

$100,000 by a 5-percent additional tax on corporate

incomes in excess of $100,000, but less than $335,000.

The corporate tax rate is 35 percent on income over

$10 million. Compared with a flat 35-percent tax rate,

the 34-percent rate provides a $100,000 reduction in

tax liability for corporations with taxable incomes of

$10 million. This benefit is recaptured for corporations

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but

less than $18.33 million. Because the corporate rate

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method.

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower

rates is considered a tax expenditure under this concept.

61. 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

62. 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.

63. Exclusion of employee parking expenses.—

Employee parking expenses that are paid for by the

employer or that are received in lieu of wages are excludable from the income of the employee. In 1999,

the maximum amount of the parking exclusion was

$175 (indexed, except in 1999) per month. The tax expenditure estimate does not include parking at facilities

owned by the employer.

64. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in

lieu of wages to defray an employee’s commuting costs

are excludable from the employee’s income. In 1999,

the maximum amount of the exclusion wasis $65 (indexed, except in 1999) per month.

Community and Regional Development

65. 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.

66. 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.

67. 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.

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

an employer wage credit, increased expensing of investment in equipment, special tax-exempt financing, and

accelerated depreciation. A tax credit for contributions

to certain community development corporations can also

be available. In addition, certain first-time buyers of

a principal residence in the District of Columbia can

receive a tax credit on homes purchased on or before

December 31, 2001, and investors in certain D.C. property can receive a capital gains break.

69. Expensing of environmental remediation

costs.—Taxpayers who clean up hazardous substances

at a qualified site may expense the clean-up costs, rather than capitalize the costs, even though the expenses

will generally increase the value of the property significantly or appreciably prolong the life of the property.

The expensing only applies to clean-up costs incurred

on or before December 31, 2001. Tax Relief Extension

Act of 1999 extended the expiration date from December 31, 2000 to December 31, 2001.
5. TAX EXPENDITURES 133

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. The credit is

phased out ratably for taxpayers with modified AGI

between $80,000 and $100,000 ($40,000 and $50,000

for singles).

72. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for

20 percent of an eligible student’s tuition and fees. For

tuition and fees paid before January 1, 2003, the maximum credit per return is $1,000. For tuition and fees

paid after December 31, 2002, the maximum credit per

return is $2,000. The credit is phased out ratably for

taxpayers with modified AGI between $80,000 and

$100,000 ($40,000 and $50,000 for singles). The credit

applies to both undergraduate and graduate students.

73. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is

not taxed when earned, and investment income from

an education IRA is tax-exempt when withdrawn to

pay for a student’s tuition and fees. The maximum contribution to an education IRA is $500 per year per

beneficiary. The maximum contribution is phased down

ratably for taxpayers with modified AGI between

$150,000 and $160,000 ($95,000 and $110,000 for singles). Contributions may not be made to an education

IRA in any year in which a contribution has been made

to a State tuition plan for the same beneficiary.

74. Student-loan interest.—Taxpayers may claim

an above-the-line deduction of up to $2,500 ($1,000 in

1998, $1,500 in 1999, and $2,000 in 2000) on interest

paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. The maximum deduction is phased

down ratably for taxpayers with modified AGI between

$60,000 and $75,000 ($40,000 and $55,000 for singles).

75. State prepaid tuition plans.—Some States

have adopted prepaid tuition plans and prepaid room

and board plans, which allow persons to pay in advance

for college expenses for designated beneficiaries. Taxes

on the earnings from these plans are paid by the beneficiaries and are deferred until the tuition is actually

paid.

76. 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.

77. Bonds for private nonprofit educational institutions.—Interest earned on State and local government bonds issued to finance the construction of facilities used by private nonprofit educational institutions

is not taxed. The aggregate volume of all such private

activity bonds that each State may issue during any

calendar year is limited.

78. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds

receive a non-refundable tax credit (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 improve impoverished

schools. The total amount of zone academy bonds that

may be issued is limited to $1.6 billion—$400 million

in each year between 1998 and 2001. The Tax Relief

Extension Act of 1999 allowed bonds to be issued in

2000 and 2001.

79. 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 $79,650 and $109,650 ($53,100 and

$68,100 for singles) in 1999.

80. 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.

81. Child credit.—Taxpayers with children under

age 17 can qualify for a $500 child credit. The credit

is phased out for taxpayers at the rate of $50 per

$1,000 of modified AGI above $110,000 ($75,000 for

singles). The child credit is refundable for taxpayers

with three or more children.

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
134 ANALYTICAL PERSPECTIVES

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. This exclusion applies only to non-graduate courses beginning on or before December 31, 2001.

The Tax Relief Extension Act of 1999 extended the

expiration date from May 31, 2000 to December 31,

2001.

84. Work opportunity tax credit.—Employers can

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2000

and who are certified as members of various targeted

groups. The Tax Relief Extension Act of 1999 extended

the expiration date from June 30, 1999 to December

31, 2000. The amount of the credit that can be claimed

is 25 percent for employment of less than 400 hours

and 40 percent for employment of 400 hours or more.

The maximum credit per employee is $2,400 and can

only be claimed on the first year of wages an individual

earns from an employer. Employers must reduce their

deduction for wages paid by the amount of the credit

claimed.

85. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible

wages paid to qualified long-term family assistance recipients during the first two years of employment. The

credit is 35 percent of the first $10,000 of wages in

the first year of employment and 50 percent of the

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The

credit applies to wages paid to employees who are hired

on or before December 31, 2001. The Tax Relief Extension Act of 1999 extended the expiration date from June

30, 1999 to December 31, 2001.

86. Employer-provided child care.—Employer-provided child care is excluded from an employee’s gross

income even though the employer’s costs for the child

care are a deductible business expense.

87. Adoption credit and exclusion.—Taxpayers can

receive a nonrefundable tax credit for qualified adoption

expenses. The maximum credit is $5,000 per child

($6,000 for special needs adoptions, except foreign adoptions). The credit is phased-out ratably for taxpayers

with modified AGI between $75,000 and $115,000. Unused credits may be carried forward. In lieu of the

tax credit, taxpayers may exclude qualified adoption

expenses from income, subject to the same maximum

amounts and phase-out as the credit. The non-special

needs adoption assistance and foreign special needs assistance expire on December 31, 2001.

88. 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.

89. Child and dependent care expenses.—Married

couples with child and dependent care expenses may

claim a tax credit when one spouse works full time

and the other works at least part time or goes to school.

The credit may also be claimed by divorced or separated

parents who have custody of children, and by single

parents. Expenditures up to a maximum $2,400 for one

dependent and $4,800 for two or more dependents are

eligible for the credit. The credit is equal to 30 percent

of qualified expenditures for taxpayers with incomes

of $10,000 or less. The credit is reduced to a minimum

of 20 percent by one percentage point for each $2,000

of income between $10,000 and $28,000.

90. 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.

91. Expensing costs of removing architectural

barriers.—Taxpayers can expense (up to $15,000 annually) the cost of removing architectural barriers to the

handicapped rather than depreciate the cost over the

useful life of the asset.

92. 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.

93. 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.

94. 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

95. 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.

96. 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 1999 through 2001,

70 percent in 2002, and 100 percent in 2003 and thereafter.

97. Workers compensation insurance premiums.—Workers compensation insurance premiums

are paid by employers and deducted as a business expense, but the premiums are not included in employee

gross income.

98. Medical savings accounts.—Some employees

may deduct annual contributions to a medical savings
5. TAX EXPENDITURES 135

account (MSA); employer contributions to MSAs (except

those made through cafeteria plans) for qualified employees are also excluded from income. An employee

may contribute to an MSA in a given year only if the

employer does not contribute to the MSA in that year.

MSAs are only available to self-employed individuals

or employees covered under an employer-sponsored high

deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the

deductible under the high deductible plan for family

coverage (65 percent for individual coverage). Earnings

from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No

new MSAs may be established after December 31, 2000.

99. 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.

100. Hospital construction bonds.—Interest earned

on State and local government debt issued to finance

hospital construction is excluded from income subject

to tax.

101. 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.

102. 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.

103. Blue Cross and Blue Shield.—Blue Cross and

Blue Shield health insurance providers in existence on

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that

substantially reduce (or even eliminate) their tax liabilities.

Income Security

104. 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.

105. Workers’ compensation benefits.—Workers

compensation provides payments to disabled workers.

These benefits, although income to the recipients, are

not subject to the income tax.

106. 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.

107. 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.

108. Military disability pensions.—Most of the

military pension income received by current disabled

retired veterans is excluded from their income subject

to tax.

109. 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.

110. 401(k) plans and Individual Retirement Accounts.—Individual taxpayers can take advantage of

several different tax-preferenced retirement plans: deductible IRAs, non-deductible IRAs, Roth IRAs, and

401(k) plans (and 401(k)-type plans like 403(b) plans

and the government’s Thrift Savings Plan).

In 1999, an employee could exclude up to $10,000

(indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k). Employees can annually contribute to a deductible IRA up to $2,000 (or

100 percent of compensation, if less) or $4,000 on a

joint return with only one working spouse if: (a) neither

the individual nor spouse is an active participant in

an employer-provided retirement plan, or (b) their AGI

is below $40,000 ($25,000 for singles). The IRA deduction is phased out for taxpayers with AGI between

$50,000 and $60,000 ($30,000 and $40,000 for singles).

The phase-out range increases annually until it reaches

$80,000 to $100,000 in 2007 ($50,000 to $60,000 for

singles). Taxpayers whose AGI is above the start of

the IRA phase-out range or who are active participants

in an employer-provided retirement plan can contribute

to a non-deductible IRA. The tax on the investment

income earned by 401(k) plans, non-deductible IRAs,

and deductible IRAs is deferred until the money is

withdrawn.

An employed taxpayer can make a non-deductible

contribution of up to $2,000 (a non-employed spouse

can also contribute up to $2,000 if a joint return is

filed) to a Roth IRA. Investment income of a Roth IRA

is not taxed when earned. Withdrawals from a Roth

IRA are tax free if (1) the Roth IRA was opened at

least 5 years before the withdrawal, and (2) the taxpayer either (a) is at least 59-1/2, (b) dies, (c) is disabled, or (d) purchases a first-time house. The maximum contribution to a Roth IRA is phased out for

taxpayers with AGI between $150,000 and $160,000

($95,000 and $110,000 for singles). Total annual contributions to a taxpayer’s deductible, non-deductible,

and Roth IRAs cannot exceed $2,000 ($4,000 for joints).

111. Keogh plans.—Self-employed individuals can

make deductible contributions to their own retirement

(Keogh) plans equal to 25 percent of their income, up

to a maximum of $30,000 per year. In addition, the

tax on the investment income earned by Keogh plans

is deferred until the money is withdrawn.
136 ANALYTICAL PERSPECTIVES

112. 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.

113. 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.

114. Employer-provided supplementary unemployment benefits.—Employer-provided supplementary unemployment benefits are excluded from an

employee’s gross income even though the employer’s

costs for the benefits are a deductible business expense.

115. 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.

116. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,000

standard deduction if single, or $800 if married.

117. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,000 standard deduction if single, or $800 if

married.

118. 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.

119. 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.

120. Earned income tax credit (EITC).—The EITC

may be claimed by low income workers. For a family

with one qualifying child, the credit is 34 percent of

the first $6,800 of earned income in 1999. The credit

is 40 percent of the first $9,540 of income for a family

with two or more qualifying children. When the taxpayer’s income exceeds $12,460, the credit is phased

out at the rate of 15.98 percent (21.06 percent if two

or more qualifying children are present). It is completely phased out at $26,928 of modified adjusted gross

income ($30,580 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 1999,

the credit is 7.65 percent of the first $4,530 of earned

income. When the taxpayer’s income exceeds $5,670,

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

It is completely phased out at $10,200 of modified adjusted gross income.

For workers with or without children, the income

level at which the credit’s phase-outs begin and the

maximum amounts of income on which the credit can

be taken are adjusted for inflation. Earned income tax

credits in excess of tax liabilities owed through the

individual income tax system are refundable to individuals. This portion of the credit is shown as an outlay,

while the amount that offsets tax liabilities is shown

as a tax expenditure.

Social Security

121. Social Security benefits for retired workers.—Social security benefits that exceed the beneficiary’s contributions out of taxed income are deferred

employee compensation and the deferral of tax on that

compensation is a tax expenditure. These additional

retirement benefits are paid for partly by employers’

contributions that were not included in employees’ taxable compensation. Portions (reaching as much as 85

percent) of recipients’ social security and tier 1 railroad

retirement benefits are included in the income tax base,

however, if the recipient’s provisional income exceeds

certain base amounts. Provisional income is equal to

adjusted gross income plus foreign or U.S. possession

income and tax-exempt interest, and one half of social

security and tier 1 railroad retirement benefits. The

tax expenditure is limited to the portion of the benefits

received by taxpayers who are below the base amounts

at which 85 percent of the benefits are taxable.

122. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund,

for disability and for dependents and survivors, are excluded from the beneficiaries’ gross incomes.

123. Social Security benefits for dependents and

survivors.—Benefit payments from the Social Security
5. TAX EXPENDITURES 137

7 An additional tax, at a flat rate of 55 percent, is imposed on lifetime, generationskipping transfers in excess of $1 million. It is considered a generation-skipping transfer

whenever the transferee is at lease two generations younger than the transferor, as it

would be in the case of transfers to grandchildren or great-grandchildren. The liability

of this tax is on the recipients of the transfer.

Trust Fund for dependents and survivors are excluded

from the beneficiaries’ gross income.

Veterans Benefits and Services

124. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded

from taxable income.

125. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income.

126. G.I. Bill benefits.—G.I. Bill benefits paid by

the Veterans Administration are excluded from gross

income.

127. 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

128. Public purpose State and local bonds.—Interest earned on State and local government bonds

issued to finance public purpose construction (e.g.,

schools, roads, sewers) is tax-exempt.

129. 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.

130. Business income earned in U.S. possessions.—U.S. corporations receiving income from investments or businesses located in a U.S. possession (e.g.,

Puerto Rico) can claim a credit against U.S. tax, which

effectively excludes some of this income from tax. The

credit expires December 31, 2005.

Interest

131. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until

the bonds are redeemed.

TAX EXPENDITURES IN THE UNIFIED TRANSFER TAX

Exceptions to the general terms of the Federal unified

transfer tax favor particular transferees or dispositions

of transferors, similar to Federal direct expenditure or

loan programs. The transfer tax provisions identified

as tax expenditures satisfy the reference law criteria

for inclusion in the tax expenditure budget that were

described above. There is no generally accepted normal

tax baseline for transfer taxes.

Unified Transfer Tax Reference Rules

The reference tax rules for the unified transfer tax

from which departures represent tax expenditures include:

• Definition of the taxpaying unit. The payment of

the tax is the liability of the transferor whether

the transfer of cash or property was made by gift

or bequest.

• Definition of the tax base. The base for the tax

is the transferor’s cumulative, taxable lifetime

gifts made plus the net estate at death. Gifts in

the tax base are all annual transfers in excess

of $10,000 (indexed) to any donee except the donor’s spouse. Excluded are, however, payments on

behalf of family members’ educational and medical

expenses, as well as the cost of ceremonial gatherings and celebrations that are not in honor of

the donor.

• Property valuation. In general, property is valued

at its fair market value at the time it is transferred. This is not necessarily the case in the valuation of property for transfer tax purposes. Executors of estates are provided the option to value

assets at the time of the testator’s death or up

to six months later.

• Tax rate schedule. A single graduated tax rate

schedule applies to all taxable transfers. This is

reflected in the name of the ‘‘unified transfer tax’’

that has replaced the former separate gift and

estate taxes. The tax rates vary from 18 percent

on the first $10,000 of aggregate taxable transfers,

to 55 percent on amounts exceeding $3 million.

A lifetime credit is provided against the tax in

determining the final amount of transfer taxes

that are due and payable. For decedents dying

in 1999, this credit allows each taxpayer to make

a $650,000 tax-free transfer of assets that otherwise would be liable to the unified transfer tax.

This figure is scheduled to increase in steps to

$1 million in 2005.7

• Time when tax is due and payable. Donors are

required to pay the tax annually as gifts are

made. The generation-skipping transfer tax is payable by the donees whenever they accede to the

gift. The net estate tax liability is due and payable

within nine months after the decedent’s death.

The Internal Revenue Service may grant an extension of up to 10 years for a reasonable cause.

Interest is charged on the unpaid tax liability at

a rate equal to the cost of Federal short-term borrowing, plus three percentage points.

Tax Expenditures by Function

The estimates of tax expenditures in the Federal unified transfer tax for fiscal years 1999–2005 are dis-
138 ANALYTICAL PERSPECTIVES

played by functional category in Table 5–6. Outlay

equivalent estimates are similar to revenue loss estimates for transfer tax expenditures and, therefore, are

not shown separately. A description of the provisions

follows.

Natural Resources and Environment

1. Donations of conservation easements.—Bequests of property and easements (in perpetuity) for

conservation purposes can be excluded from taxable estates. Use of the property and easements must be restricted to at least one of the following purposes: outdoor recreation or scenic enjoyment for the general public; protection of the natural habitats of fish, wildlife,

plants, etc.; and preservation of historic land areas and

structures. Conservation gifts are similarly excluded

from the gift tax. Up to 40 percent of the value of

land subject to certain conservation easements may be

excluded from taxable estates; the maximum amount

of the exclusion is $200,000 in 1999 and increases by

$100,000 in each year through 2002.

Agriculture

2. Special-use valuation of farms.—Up to $750,000

(indexed) in farmland owned and operated by a decedent and/or a member of the family may be valued

for estate tax purposes on the basis of its ‘‘continued

use’’ as farmland if: (1) the value of the farmland is

at least 25 percent of the gross estate; (2) the entire

value of all farm property is at least 50 percent of

the gross estate; and (3) family heirs to the farm agree

to continue to operate the property as a farm for at

least 10 years.

3. Tax deferral of closely held farms.—The tax

on a decedent’s farm can be deferred for up to 14 years

if the value of the farm is at least 35 percent of the

net estate. For the first 4 years of deferral, no tax

need be paid. During the last 10 years of deferral, the

tax liability must be paid in equal annual installments.

Throughout the 14 year period, interest is charged at

a special, favorable rate.

Commerce and Housing

4. Special-use valuation of closely-held businesses.—The special-use valuation rule available for

family farms is also available for nonfarm family businesses. To be eligible for the special-use valuation, the

same three conditions previously described must be

met.

5. Tax deferral of closely-held businesses.—The

tax-deferral rule available for family farms is also available for nonfarm family businesses. To be eligible for

the tax deferral, the value of stock in closely-held corporations must exceed 35 percent of the decedent’s

gross estate, less debt and funeral expenses.

6. Exclusion for family-owned businesses.—Certain family-owned businesses that are bequeathed to

qualified heirs can be excluded from taxable estates.

The exclusion generally cannot exceed $1.3 million less

the exemption value of the unified credit. The exclusion

is recaptured if certain conditions are not maintained

for 10 years.

Education, Training, Employment, and Social

Services

7. Charitable contributions to educational institutions.—Bequests to educational institutions can be

deducted from taxable estates.

8. Charitable contributions, other than education and health.—Bequests to charitable, religious,

and certain other nonprofit organizations can be deducted from taxable estates.

Health

9. Charitable contributions to health institutions.—Bequests to health institutions can be deducted

from taxable estates.

General Government

10. State and local death taxes.—A credit against

the Federal estate tax is allowed for State taxes on

bequests. The amount of this credit is determined by

a rate schedule that reaches a maximum of 16 percent

of the taxable estate in excess of $60,000.
5. TAX EXPENDITURES 139

Table 5–6. REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED TRANSFER TAX

(In millions of dollars)

Description 1999 2000 2001 2002 2003 2004 2005 2001–2005

Natural Resources and Environment:

1 Donations of conservation easements .......................................................... 10 25 40 55 75 95 105 370

Agriculture:

2 Special use valuation of farm real property .................................................. 95 100 105 110 115 125 120 575

3 Tax deferral of closely held farms ................................................................. 5 15 20 20 20 25 30 115

Commerce:

4 Special use valuation of real property used in closely held businesses ..... 10 10 10 10 15 15 15 65

5 Tax deferral of closely held business ............................................................ 35 100 110 110 120 130 180 650

6 Exclusion for family owned businesses ......................................................... 505 520 535 550 495 440 395 2,415

Education, training, employment, and social services:

7 Deduction for charitable contributions (education) ........................................ 682 760 830 855 910 930 1,020 4,545

8 Deduction for charitable contributions (other than education and health) ... 2,015 2,240 2,450 2,525 2,680 2,750 3,015 13,420

Health:

9 Deduction for charitable contributions (health) .............................................. 615 685 750 775 820 840 925 4,110

General government:

10 Credit for State death taxes .......................................................................... 5,825 6,070 6,345 6,640 6,945 7,265 7,595 34,790