95

6. TAX EXPENDITURES

The Congressional Budget Act of 1974 (Public Law

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

included in the budget. Tax expenditures are defined

in the law as ‘‘revenue losses attributable to provisions

of the Federal tax laws which allow a special exclusion,

exemption, or deduction from gross income or which

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

a deferral of liability.’’ The Act suggests that tax expenditures are exceptions to some norm or standard

tax concept that is not specified in the law. Hence,

different analyses may use different baseline tax structures; indeed, the budget presentation here provides

tax expenditure estimates measured against more than

one baseline.

Due, in part, to the degree of arbitrariness in the

tax expenditure baseline, the Administration believes

the meaningfulness of tax expenditure estimates is uncertain and that the ‘‘tax expenditure’’ presentation can

be improved by consideration of alternative or additional tax bases. A description of an ongoing Treasury

study to reevaluate the tax expenditure concept is presented at the beginning of this chapter. The tax expenditure estimates and related discussion following the description of this study, however, are based on materials

and formats developed and included in previous budgets. Tax expenditure estimates under the unified transfer (i.e., estate and gift) tax have been eliminated from

the presentation because there is no generally accepted

normal baseline for transfer taxes and this tax has

been repealed under the Economic Growth and Tax

Relief Reconciliation Act of 2001 (EGTRRA).

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

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

contributions for medical insurance, mortgage interest

payments on owner-occupied homes, capital gains, and

payments of State and local individual income and

property taxes. Reported tax expenditures under the

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

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

Each tax expenditure estimate in this chapter was

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

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

interactions among provisions. For that reason, this

chapter does not present a grand total for the estimated

tax expenditures. Moreover, past tax changes entailing

broad elimination of tax expenditures were generally

accompanied by changes in tax rates or other basic

provisions, so that the net effects on Federal revenues

were considerably (if not totally) offset.

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

2001–2007 using three methods of accounting: revenue

effects, outlay equivalent, and present value. The

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

of tax payments into the future or have similar longterm effects.

The section of the chapter on performance measures

and economic effects presents information related to

assessment of the effect of tax expenditures on the

achievement of program performance goals. This section

is a complement to the government-wide performance

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

FUTURE REVISIONS TO THE TAX EXPENDITURE PRESENTATION

Policymakers and researchers have long recognized

that certain income tax code provisions have policy purposes other than simply raising revenue and that it

is useful to understand better the nature of these provisions. It is important to know the amounts of revenue

associated with them, whether they are achieving desired results, and their consequences for the economy.

The answers to these questions are important simply

as a source of information, but also so that policymakers and the public can review these features of

the income tax regularly to see if change is warranted.

Thus it was that in 1974 the Congress mandated as

part of the Congressional Budget Act of 1974 that the

annual Federal budget presentation include a list of

‘‘tax expenditures’’, where tax expenditures were defined as:

...those revenue losses attributable to provisions

of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income

or which provide a special credit, a preferential

rate of tax, or a deferral of tax liability....

Though imperfect, the tax expenditure budget has

expanded our understanding of policy programs operating through the Federal income tax and, more generally, the workings of the Federal income tax.

The complexity of our economy and society on the

one hand, and the complexity of the income tax on

the other, suggest the need for a variety of analyses
96 ANALYTICAL PERSPECTIVES

1 Analytical Perspectives, Budget of the United States, Fiscal Year 2002, Chapter 5.

to understand their interaction better. The Treasury

Department has begun an effort to review the tax expenditure presentation, and will be considering possible

revisions and improvements in methodology and approach. The need for this effort was raised in the President’s Fiscal Year 2002 budget submission, which noted

that the current tax expenditure analysis was developed relative to an arbitrary tax base and that:

Because of the breadth of this arbitrary tax base,

the Administration believes that the concept of

‘‘tax expenditure’’ is of questionable analytic

value. 1

This review is intended to improve the quality and

range of information available regarding the Federal

income tax and its effects on the economy. The Treasury Department’s efforts in this area will continue over

the coming year, assisted by public debate and comment.

The Need for Change

The definition of the baseline against which tax expenditures are measured is crucial to the definition and

calculation of tax expenditures. For purposes of calculating tax expenditures, the 1974 Budget Act did not

specify the provisions of the baseline tax law, which,

quoting further from the Fiscal Year 2002 budget,

means that: ‘‘Deciding whether provisions are exceptions (from the normal baseline), therefore, is a matter

of judgement.’’ As the normal baseline and deviations

from the baseline are constructed from a set of potentially subjective judgements, differences of opinion can

arise as to the correct classification of specific provisions of the tax code. While the normal baseline follows

a theoretically appealing measure of a comprehensive

income tax in many ways, it deviates in other important ways. These deviations may reflect judgements

along a number of dimensions, including administrative

concerns, political judgements, social policy, and historical methods of taxing income. But these deviations

inject a degree of subjectivity that can limit the value

of the underlying analysis.

One problem with injecting subjective elements into

the definition of the baseline income tax is that common

notions of what constitutes a ‘‘normal’’ income tax will

change over time. For example, although the tax exemption for employer-provided pensions is labeled a tax

expenditure, the growing presence of tax-deferred savings vehicles in the tax code suggests that these may

today be part of ‘‘normal’’ income tax circa 2002. It

is not clear, however, whether the ‘‘normal’’ income tax

of 2002 is more appropriate than that in place in any

other year if one is interested in better understanding

deviations of the current income tax from a more objective standard of a comprehensive income tax.

A highly subjective baseline also may not inform policymakers and the public about those aspects of social

or economic policy that are implemented through the

tax code. The Federal income tax contains many provisions for providing income support for lower-income citizens. Examples include the Earned Income Tax Credit,

the Work Opportunity Credit, and the Child Tax Credit.

Each of these provisions is appropriately labeled a tax

expenditure in the current tax expenditure presentation. The personal exemption, which cannot be

claimed by higher-income taxpayers because of a phaseout of the exemption, however, is not presently labeled

a tax expenditure although it can also be viewed as

a component of the income support policies effected

through the income tax. In many other ways, the ‘‘normal tax’’ baseline may fail to capture the extent to

which the tax system serves such programmatic purposes.

Finally, the public and policymakers are interested

in the tax subsidies and excises imbedded in the tax

code and their effects on individual behavior and on

economic activity. Tax subsidies and excises arise when

the relative prices of goods, services, or activities are

distorted by the tax system. A highly subjective ‘‘normal

tax’’ may shed little light on these issues.

Because of the controversy that accompanies the existing ‘‘normal tax’’ concept, it may be appropriate to

reconsider a comprehensive income tax as a baseline

for the tax expenditure budget. Comprehensive income

is a well-accepted theoretical concept, and so avoids

some subjectivity that plagues the ‘‘normal tax’’ baseline. A comprehensive measure of income, however,

would not eliminate all contentious issues. Any practical implementation of a comprehensive tax base would

involve judgements, e.g., about which items of theoretical income or expense are too abstract or difficult

to estimate to include in the baseline, but that other

analysts may see as necessary.

Focus of the Reconsideration and Revision

Effort

The effort to improve the tax expenditure presentation will focus on three aspects. The first relates to

the definition of an income tax or standard against

which tax expenditures are identified and measured

as discussed above. The study will consider redefining

the baseline income concept to be more consistent with

a comprehensive income tax base, as well as other alternative definitions of income.

The study will also consider issues involved in estimating ‘‘negative’’ tax expenditures in addition to the

conventional positive tax expenditures currently reported in the Budget. A negative tax expenditure arises

whenever a tax provision causes a taxpayer to pay more

tax than would be consistent with the baseline income

tax. Negative tax expenditures have not been identified

and calculated in the past, in part because they did

not appear to relate to the original purpose of the tax

expenditure analysis to identify implicit spending programs operating through the tax system. Nevertheless,

negative tax expenditures provide an important additional perspective and may offer a useful source of information to analysts and policy makers.

Academics and tax specialists have studied intensively whether the United States should adopt a con-
6. TAX EXPENDITURES 97

sumption tax at the Federal level, either as a source

of additional revenue, or in place of some or all of

the current sources of Federal revenue. Though the existing Federal individual income tax is thought of as

a tax on income, in many respects it has evolved into

a hybrid tax containing some elements consistent both

with a comprehensive income tax and a consumption

tax, as well as many elements consistent with neither

an income nor a consumption tax. Therefore, the third

aspect of the Treasury’s effort will be to consider estimating tax expenditures relative to a hypothetical consumption tax, as well as relative to an income tax.

This would allow a comparison of the Federal income

tax vis-a`-vis the two baseline systems. It would also

serve to give additional perspective on the tax expenditure analysis by highlighting those provisions in the

Federal income tax that may give rise to a tax expenditure or negative expenditure in one system but not

in the other.

When completed, this review can significantly improve the overall understanding of the effects of the

Federal income tax on the economy. For example, reconsideration of the income tax baseline is intended to

provide a baseline definition that can better capture

the numerous ways in which the tax system influences

economic behavior relative to a comprehensive income

tax system. Similarly, the definition and calculation of

negative tax expenditures can provide useful new information about those activities subject to a tax surcharge

relative to the baseline tax. Viewing these negative tax

expenditures alongside the traditional tax expenditure

presentation can provide important context for the overall tax expenditure budget. The calculation of tax expenditures and negative tax expenditures relative to

a consumption tax budget can provide further context

for the traditional tax expenditure presentation while

providing important new information about the effects

of the tax system on the economy. Finally, a consumption tax base analysis can help illuminate some of the

central issues that would arise in any effort to enact

a Federal consumption tax.

TAX EXPENDITURES IN THE INCOME TAX

Tax Expenditure Estimates

All tax expenditure estimates presented here are

based upon current tax law enacted as of December

31, 2001. Expired or repealed provisions are not listed

if their revenue effects result only from taxpayer activity occurring before fiscal year 2001. Due to the time

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

assumptions; exceptions are the earned income tax

credit and child credit provisions, which involve outlay

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

The total revenue effects for tax expenditures for fiscal years 2001–2007 are displayed according to the

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

the tables of estimates and the discussion of general

features of the tax expenditure concept.

As in prior years, two baseline concepts—the normal

tax baseline and the reference tax law baseline—are

used to identify tax expenditures. For the most part,

the two concepts coincide. However, items treated as

tax expenditures under the normal tax baseline, but

not the reference tax law baseline, are indicated by

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

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

discussed in detail following the tables.

Table 6–2 reports the respective portions of the total

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

not imply that these categories of filers benefit from

the special tax provisions in proportion to the respective

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

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

capital, depending on economic forces.

Table 6–3 ranks the major tax expenditures by the

size of their FY 2003 revenue effect.

Interpreting Tax Expenditure Estimates

The estimates shown for individual tax expenditures

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

the increase in Federal revenues (or the change in the

budget balance) that would result from repealing these

special provisions, for the following reasons:

Eliminating a tax expenditure may have incentive

effects that alter economic behavior. These incentives

can affect the resulting magnitudes of the activity or

of other tax provisions or Government programs. For

example, if 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. Such indirect effects

are not reflected in the estimates.

Tax expenditures are interdependent even without

incentive effects. Repeal of a tax expenditure provision

can increase or decrease the tax revenues associated

with other provisions. For example, even if behavior

does not change, repeal of an itemized deduction could

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

brackets. Alternatively, repeal of an itemized deduction

could lower the revenue cost from other deductions if

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

repealed simultaneously, the increase in tax liability

could be greater or less than the sum of the two separate tax expenditures, because each is estimated assum-
98 ANALYTICAL PERSPECTIVES

ing that the other remains in force. In addition, the

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

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

Table 6–1 (as well as those in Table 6–5, which are

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

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

Table 6–4. Cash-based estimates reflect the difference

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

from prior years. Although such estimates are useful

as a measure of cash flows into the Government, they

do not accurately reflect the true economic cost of these

provisions. For example, for a provision where activity

levels have changed, so that incoming tax receipts from

past deferrals are greater than deferred receipts from

new activity, the cash-basis tax expenditure estimate

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

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

deferral provision, a cash-based estimate can overstate

the real effect on receipts to the Government because

the newly deferred taxes will ultimately be received.

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

Present-Value Estimates

Discounted present-value estimates of revenue effects

are presented in Table 6–4 for certain provisions that

involve tax deferrals or other long-term revenue effects.

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

The present-value estimates represent the revenue

effects, net of future tax payments, that follow from

activities undertaken during calendar year 2001 that

cause the deferrals or other long-term revenue effects.

For instance, a pension contribution in 2001 would

cause a deferral of tax payments on wages in 2001

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

the 2001 pension contribution and accrued earnings will

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

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

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

direct loans and guarantees in a given year affect future cash flows.
6. TAX EXPENDITURES 99

Table 6–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES

(In millions of dollars)

Total from corporations and individuals

2001 2002 2003 2004 2005 2006 2007 2003–2007

National Defense

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,160 2,190 2,210 2,240 2,260 2,290 2,310 11,310

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 2,450 2,540 2,660 2,690 2,760 2,810 3,170 14,090

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 760 800 840 880 920 960 1,020 4,620

4 Extraterritorial income exclusion ............................................................................................................. 4,490 4,820 5,150 5,510 5,890 6,290 6,730 29,570

5 Inventory property sales source rules exception ................................................................................... 1,400 1,470 1,540 1,620 1,700 1,790 1,880 8,530

6 Deferral of income from controlled foreign corporations (normal tax method) .................................... 6,600 7,000 7,450 7,900 8,400 8,930 9,550 42,230

7 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,300 550 0 0 000 0

General science, space, and technology:

8 Expensing of research and experimentation expenditures (normal tax method) ................................. 2,020 1,780 2,380 2,880 3,400 3,910 4,160 16,730

9 Credit for increasing research activities ................................................................................................. 5,370 6,010 4,590 4,020 2,330 990 410 12,350

Energy:

10 Expensing of exploration and development costs, fuels ....................................................................... 50 60 70 90 90 100 100 450

11 Excess of percentage over cost depletion, fuels .................................................................................. 250 260 270 290 300 310 320 1,490

12 Alternative fuel production credit ............................................................................................................ 900 850 410 130 130 130 130 930

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

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

15 Exclusion of interest on energy facility bonds ....................................................................................... 90 90 100 120 130 140 150 640

16 Enhanced oil recovery credit .................................................................................................................. 310 360 440 530 640 760 910 3,280

17 New technology credit ............................................................................................................................ 60 80 100 100 100 90 90 480

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

19 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 50 50 50 20 –10 –50 –50 –40

20 Exclusion from income of conservation subsidies provided by public utilities ..................................... 70 70 70 70 70 70 60 340

Natural resources and environment:

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

22 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 250 260 270 290 300 300 310 1,470

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 400 420 440 480 530 580 630 2,660

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

25 Expensing of multiperiod timber growing costs ..................................................................................... 360 360 370 380 390 400 410 1,950

26 Tax incentives for preservation of historic structures ............................................................................ 180 200 210 220 230 240 250 1,150

Agriculture:

27 Expensing of certain capital outlays ...................................................................................................... 170 170 170 170 170 170 170 850

28 Expensing of certain multiperiod production costs ................................................................................ 120 130 130 130 120 120 120 620

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

30 Capital gains treatment of certain income ............................................................................................. 990 1,040 1,100 1,160 1,220 1,290 1,360 6,130

31 Income averaging for farmers ................................................................................................................ 70 70 70 70 80 80 80 380

32 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 10 50

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ..................................................................................................... 1,000 1,070 1,150 1,230 1,320 1,420 1,530 6,650

34 Excess bad debt reserves of financial institutions ............................................................................ 60 50 30 20 10 0 0 60

35 Exclusion of interest on life insurance savings ................................................................................. 16,290 17,710 19,250 20,940 22,780 24,790 26,930 114,690

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 220 230 250 260 280 290 300 1,380

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

Housing:

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 800 830 870 960 1,050 1,140 1,240 5,260

40 Exclusion of interest on rental housing bonds .................................................................................. 160 170 180 200 220 240 260 1,100

41 Deductibility of mortgage interest on owner-occupied homes .......................................................... 64,510 64,190 66,110 68,070 70,870 73,560 76,870 355,480

42 Deductibility of State and local property tax on owner-occupied homes ......................................... 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

43 Deferral of income from post 1987 installment sales ....................................................................... 1,040 1,050 1,080 1,100 1,120 1,140 1,160 5,600

44 Capital gains exclusion on home sales ............................................................................................. 19,090 19,670 20,260 20,860 21,490 22,140 22,800 107,550

45 Exception from passive loss rules for $25,000 of rental loss .......................................................... 4,800 4,400 4,070 3,780 3,530 3,290 3,090 17,760

46 Credit for low-income housing investments ....................................................................................... 3,220 3,330 3,460 3,630 3,810 3,980 4,130 19,010

47 Accelerated depreciation on rental housing (normal tax method) .................................................... 5,190 5,440 5,710 5,790 5,800 5,720 5,800 28,820

Commerce:

48 Cancellation of indebtedness ............................................................................................................. 30 30 30 40 40 40 40 190

49 Exceptions from imputed interest rules ............................................................................................. 80 80 80 80 80 80 80 400

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 67,800 61,810 60,200 56,990 56,180 50,670 49,880 273,920

51 Capital gains exclusion of small corporation stock ........................................................................... 70 100 130 160 210 250 300 1,050

52 Step-up basis of capital gains at death ............................................................................................ 26,540 27,610 28,710 29,860 31,050 32,300 33,590 155,510

53 Carryover basis of capital gains on gifts ........................................................................................... 530 600 680 760 900 1,080 1,130 4,550

54 Ordinary income treatment of loss from small business corporation stock sale ............................. 40 40 40 50 50 50 50 240

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 4,540 4,560 4,240 3,960 3,800 4,160 4,880 21,040
100 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Total from corporations and individuals

2001 2002 2003 2004 2005 2006 2007 2003–2007

56 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 37,860 37,130 36,480 36,790 37,430 38,520 40,930 190,150

57 Expensing of certain small investments (normal tax method) .......................................................... 1,670 1,430 1,420 1,390 1,360 1,480 1,720 7,370

58 Amortization of start-up costs (normal tax method) .......................................................................... 130 160 200 240 250 270 270 1,230

59 Graduated corporation income tax rate (normal tax method) .......................................................... 4,940 5,590 6,210 6,580 7,120 7,450 7,880 35,240

60 Exclusion of interest on small issue bonds ....................................................................................... 310 310 330 360 390 430 470 1,980

Transportation:

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

62 Exclusion of reimbursed employee parking expenses .......................................................................... 1,980 2,090 2,190 2,300 2,420 2,550 2,670 12,130

63 Exclusion for employer-provided transit passes .................................................................................... 220 280 360 410 470 540 600 2,380

Community and regional development:

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

65 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 630 640 680 750 820 890 980 4,120

66 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 60 70 70 70 330

67 Empowerment zones, Enterprise communities, and Renewal communities ........................................ 380 730 1,130 1,170 1,280 1,410 1,580 6,570

68 New markets tax credit ........................................................................................................................... 10 90 190 290 430 610 830 2,350

69 Expensing of environmental remediation costs ..................................................................................... 80 100 100 20 –20 –10 –10 80

Education, training, employment, and social services:

Education:

70 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,210 1,200 1,210 1,240 1,330 1,380 1,390 6,550

71 HOPE tax credit .................................................................................................................................. 4,130 4,110 3,520 2,880 2,930 2,730 2,900 14,960

72 Lifetime Learning tax credit ................................................................................................................ 2,370 2,290 2,360 3,140 2,980 2,740 2,960 14,180

73 Education Individual Retirement Accounts ........................................................................................ 30 50 80 130 220 330 470 1,230

74 Deductibility of student-loan interest .................................................................................................. 390 450 640 660 680 700 720 3,400

75 Deduction for higher education expenses ......................................................................................... 0 430 2,290 2,960 3,710 3,010 0 11,970

76 State prepaid tuition plans ................................................................................................................. 190 270 340 400 460 530 590 2,320

77 Exclusion of interest on student-loan bonds ..................................................................................... 230 230 240 260 290 310 350 1,450

78 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 540 550 580 640 700 760 830 3,510

79 Credit for holders of zone academy bonds ....................................................................................... 30 50 70 80 90 90 90 420

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

81 Parental personal exemption for students age 19 or over ............................................................... 1,010 1,070 1,120 1,170 1,230 1,280 1,340 6,140

82 Deductibility of charitable contributions (education) .......................................................................... 3,830 3,980 4,200 4,440 4,600 4,840 5,030 23,110

83 Exclusion of employer-provided educational assistance ................................................................... 260 410 500 530 560 590 620 2,800

Training, employment, and social services:

84 Work opportunity tax credit ................................................................................................................ 300 230 140 60 30 10 0 240

85 Welfare-to-work tax credit .................................................................................................................. 90 70 40 20 10 0 0 70

86 Employer provided child care exclusion ............................................................................................ 720 740 770 810 930 1,020 1,080 4,610

87 Employer-provided child care credit .................................................................................................. 0 40 90 130 150 150 160 680

88 Assistance for adopted foster children .............................................................................................. 190 220 250 260 270 280 290 1,350

89 Adoption credit and exclusion ............................................................................................................ 130 140 220 450 500 540 560 2,270

90 Exclusion of employee meals and lodging (other than military) ...................................................... 710 740 780 810 850 890 930 4,260

91 Child credit 2 ........................................................................................................................................ 19,840 19,760 19,680 19,550 20,550 21,530 21,240 102,550

92 Credit for child and dependent care expenses ................................................................................. 2,670 2,610 2,670 2,960 2,700 2,150 1,920 12,400

93 Credit for disabled access expenditures ........................................................................................... 50 50 50 50 60 60 60 280

94 Deductibility of charitable contributions, other than education and health ....................................... 30,150 30,810 32,080 33,830 35,190 36,890 38,290 176,280

95 Exclusion of certain foster care payments ........................................................................................ 500 510 520 530 540 570 610 2,770

96 Exclusion of parsonage allowances ................................................................................................... 350 370 400 420 450 470 490 2,230

Health:

97 Exclusion of employer contributions for medical insurance premiums and medical care ................... 82,800 90,910 99,260 106,940 115,380 124,050 134,960 580,590

98 Self-employed medical insurance premiums ......................................................................................... 1,520 1,730 2,420 3,570 3,870 4,170 4,430 18,460

99 Workers’ compensation insurance premiums ........................................................................................ 4,730 4,870 5,080 5,230 5,410 5,570 5,790 27,080

100 Medical Savings Accounts ...................................................................................................................... 20 20 20 20 20 20 20 100

101 Deductibility of medical expenses .......................................................................................................... 4,990 5,260 5,530 5,840 6,280 6,600 7,100 31,350

102 Exclusion of interest on hospital construction bonds ............................................................................ 1,100 1,130 1,190 1,310 1,440 1,570 1,700 7,210

103 Deductibility of charitable contributions (health) .................................................................................... 4,010 4,180 4,420 4,690 4,850 5,100 5,320 24,380

104 Tax credit for orphan drug research ...................................................................................................... 140 150 170 190 220 240 270 1,090

105 Special Blue Cross/Blue Shield deduction ............................................................................................. 270 300 340 310 300 270 300 1,520

Income security:

106 Exclusion of railroad retirement system benefits ................................................................................... 380 390 400 400 400 400 400 2,000

107 Exclusion of workers’ compensation benefits ........................................................................................ 5,560 5,810 6,070 6,320 6,600 6,900 7,200 33,090

108 Exclusion of public assistance benefits (normal tax method) ............................................................... 370 380 400 410 430 450 470 2,160

109 Exclusion of special benefits for disabled coal miners ......................................................................... 70 70 60 60 60 50 50 280

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

Net exclusion of pension contributions and earnings:

111 Employer plans ................................................................................................................................... 42,070 48,070 53,080 54,500 55,630 58,980 63,320 285,510

112 401(k) plans ........................................................................................................................................ 44,080 52,960 59,510 62,770 65,290 69,230 73,320 330,120
6. TAX EXPENDITURES 101

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

(In millions of dollars)

Total from corporations and individuals

2001 2002 2003 2004 2005 2006 2007 2003–2007

113 Individual Retirement Accounts .......................................................................................................... 18,680 18,090 18,660 19,050 18,930 19,230 18,330 94,200

114 Low and moderate income savers credit .......................................................................................... 0 550 1,960 1,940 1,900 1,800 1,280 8,880

115 Keogh plans ........................................................................................................................................ 6,160 6,520 6,770 7,040 7,250 7,490 7,730 36,280

Exclusion of other employee benefits:

116 Premiums on group term life insurance ............................................................................................ 1,750 1,780 1,800 1,830 1,860 1,890 1,920 9,300

117 Premiums on accident and disability insurance ................................................................................ 210 220 230 240 250 260 270 1,250

118 Small business retirement plan credit ............................................................................................... 0 20 50 90 120 130 150 540

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

120 Special ESOP rules ............................................................................................................................ 1,290 1,340 1,420 1,490 1,570 1,640 1,730 7,850

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

122 Additional deduction for the elderly ................................................................................................... 1,970 1,890 1,950 2,060 2,100 2,150 2,050 10,310

123 Tax credit for the elderly and disabled ............................................................................................. 30 30 30 30 30 30 30 150

124 Deductibility of casualty losses .......................................................................................................... 210 250 310 360 410 450 490 2,020

125 Earned income tax credit 3 ................................................................................................................. 4,940 4,370 4,800 4,930 5,100 5,180 5,390 25,400

Social Security:

Exclusion of social security benefits:

126 Social Security benefits for retired workers ....................................................................................... 17,830 18,000 18,180 18,560 18,850 19,720 20,890 96,200

127 Social Security benefits for disabled ................................................................................................. 2,690 2,930 3,240 3,630 4,020 4,470 5,020 20,380

128 Social Security benefits for dependents and survivors ..................................................................... 3,720 3,870 4,060 4,320 4,560 4,820 5,170 22,930

Veterans benefits and services:

129 Exclusion of veterans death benefits and disability compensation ...................................................... 3,150 3,190 3,300 3,490 3,680 3,870 4,080 18,420

130 Exclusion of veterans pensions .............................................................................................................. 70 80 80 80 90 90 100 440

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

132 Exclusion of interest on veterans housing bonds ................................................................................. 40 40 40 40 50 50 60 240

General purpose fiscal assistance:

133 Exclusion of interest on public purpose State and local bonds ........................................................... 23,100 23,680 24,270 24,880 25,500 26,140 26,800 127,590

134 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

135 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 2,190 2,240 2,240 2,240 2,200 1,300 0 7,980

Interest:

136 Deferral of interest on U.S. savings bonds ........................................................................................... 290 300 310 330 330 350 360 1,680

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 23,100 23,680 24,270 24,880 25,500 26,140 26,800 127,590

Energy facilities ................................................................................................................................... 90 90 100 120 130 140 150 640

Water, sewage, and hazardous waste disposal facilities ................................................................. 400 420 440 480 530 580 630 2,660

Small-issues ........................................................................................................................................ 310 310 330 360 390 430 470 1,980

Owner-occupied mortgage subsidies ................................................................................................. 800 830 870 960 1,050 1,140 1,240 5,260

Rental housing .................................................................................................................................... 160 170 180 200 220 240 260 1,100

Airports, docks, and similar facilities ................................................................................................. 630 640 680 750 820 890 980 4,120

Student loans ...................................................................................................................................... 230 230 240 260 290 310 350 1,450

Private nonprofit educational facilities ............................................................................................... 540 550 580 640 700 760 830 3,510

Hospital construction .......................................................................................................................... 1,100 1,130 1,190 1,310 1,440 1,570 1,700 7,210

Veterans’ housing ............................................................................................................................... 40 40 40 40 50 50 60 240

Credit for holders of zone academy bonds ........................................................................................... 30 50 70 80 90 90 90 420

1 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income tax

principles. For tax reasons, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions

define income under the general rule of U.S. income taxation. 2 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: 2001 $990; 2002 $1,020; 2003 $1,050; 2004 $1,080;

2005 $1,080; 2006 $1,100; and 2007 $1,120. 3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $980; 2002 $7,390; 2003 $7,390; 2004 $7,210;

2005 $6,950; 2006 $9,380; and 2007 $9,200. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $26,120; 2002 $28,280; 2003

$30,630; 2004 $31,080; 2005 $31,720; 2006 $33,130; and 2007 $34,090.

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

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

(In millions of dollars)

Corporations Individuals

2001 2002 2003 2004 2005 2006 2007 2003–

2007 2001 2002 2003 2004 2005 2006 2007 2003–2007

National Defense

1 Exclusion of benefits and allowances to armed forces personnel ............ ............ ............ ............ ............ ............ ............ .............. 2,160 2,190 2,210 2,240 2,260 2,290 2,310 11,310

International affairs:

2 Exclusion of income earned abroad

by U.S. citizens ........................... ............ ............ ............ ............ ............ ............ ............ .............. 2,450 2,540 2,660 2,690 2,760 2,810 3,170 14,090

3 Exclusion of certain allowances for

Federal employees abroad ......... ............ ............ ............ ............ ............ ............ ............ .............. 760 800 840 880 920 960 1,020 4,620

4 Extraterritorial income exclusion ..... 4,490 4,820 5,150 5,510 5,890 6,290 6,730 29,570 ............ ............ .............. .............. .............. .............. .............. ..............

5 Inventory property sales source

rules exception ............................ 1,400 1,470 1,540 1,620 1,700 1,790 1,880 8,530 ............ ............ .............. .............. .............. .............. .............. ..............

6 Deferral of income from controlled

foreign corporations (normal tax

method) ....................................... 6,600 7,000 7,450 7,900 8,400 8,930 9,550 42,230 ............ ............ .............. .............. .............. .............. .............. ..............

7 Deferred taxes for financial firms

on certain income earned overseas ............................................. 1,300 550 ............ ............ ............ ............ ............ 0 ............ ............ .............. .............. .............. .............. .............. ..............

General science, space, and technology:

8 Expensing of research and experimentation expenditures (normal

tax method) ................................. 1,980 1,750 2,330 2,820 3,330 3,830 4,080 16,390 40 30 50 60 70 80 80 340

9 Credit for increasing research activities .......................................... 5,310 5,950 4,540 3,980 2,310 990 410 12,240 60 60 50 40 20 .............. .............. 110

Energy:

10 Expensing of exploration and development costs, fuels ................ 40 50 60 70 70 80 80 360 10 10 10 20 20 20 20 90

11 Excess of percentage over cost

depletion, fuels ............................ 220 230 240 250 260 270 280 1,300 30 30 30 40 40 40 40 190

12 Alternative fuel production credit .... 860 810 390 120 120 120 120 870 40 40 20 10 10 10 10 60

13 Exception from passive loss limitation for working interests in oil

and gas properties ...................... ............ ............ ............ ............ ............ ............ ............ .............. 20 20 20 20 20 20 20 100

14 Capital gains treatment of royalties

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

15 Exclusion of interest on energy facility bonds .................................. 20 20 20 30 30 30 30 140 70 70 80 90 100 110 120 500

16 Enhanced oil recovery credit .......... 280 330 400 480 580 690 830 2,980 30 30 40 50 60 70 80 300

17 New technology credit .................... 60 80 100 100 100 90 90 480 ............ ............ .............. .............. .............. .............. .............. ..............

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

19 Tax credit and deduction for cleanfuel burning vehicles ................... 30 30 20 0 –20 –40 –40 –80 20 20 30 20 10 –10 –10 40

20 Exclusion from income of conservation subsidies provided by

public utilities .............................. ............ ............ ............ ............ ............ ............ ............ .............. 70 70 70 70 70 70 60 340

Natural resources and environment:

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

22 Excess of percentage over cost

depletion, nonfuel minerals ........ 240 250 260 270 280 280 290 1,380 10 10 10 20 20 20 20 90

23 Exclusion of interest on bonds for

water, sewage, and hazardous

waste facilities ............................. 100 110 110 110 110 120 120 570 300 310 330 370 420 460 510 2,090

24 Capital gains treatment of certain

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

25 Expensing of multiperiod timber

growing costs .............................. 240 240 250 260 260 270 280 1,320 120 120 120 120 130 130 130 630

26 Tax incentives for preservation of

historic structures ........................ 170 180 190 200 210 220 230 1,050 10 20 20 20 20 20 20 100

Agriculture:

27 Expensing of certain capital outlays 20 20 20 20 20 20 20 100 150 150 150 150 150 150 150 750

28 Expensing of certain multiperiod

production costs .......................... 10 20 20 20 20 20 20 100 110 110 110 110 100 100 100 520

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

30 Capital gains treatment of certain

income ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 990 1,040 1,100 1,160 1,220 1,290 1,360 6,130

31 Income averaging for farmers ........ ............ ............ ............ ............ ............ ............ ............ .............. 70 70 70 70 80 80 80 380

32 Deferral of gain on sale of farm refiners ........................................... 10 10 10 10 10 10 10 50 ............ ............ .............. .............. .............. .............. .............. ..............
6. TAX EXPENDITURES 103

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

(In millions of dollars)

Corporations Individuals

2001 2002 2003 2004 2005 2006 2007 2003– 2007 2001 2002 2003 2004 2005 2006 2007 2003– 2007

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ....................................... 1,000 1,070 1,150 1,230 1,320 1,420 1,530 6,650 ............ ............ .............. .............. .............. .............. .............. ..............

34 Excess bad debt reserves of financial institutions .................. 60 50 30 20 10 0 0 60 ............ ............ .............. .............. .............. .............. .............. ..............

35 Exclusion of interest on life insurance savings ..................... 1,650 1,770 1,890 2,020 2,160 2,280 2,490 10,840 14,640 15,940 17,360 18,920 20,620 22,510 24,440 103,850

36 Special alternative tax on small

property and casualty insurance companies ..................... 10 10 10 10 10 10 10 50 ............ ............ .............. .............. .............. .............. .............. ..............

37 Tax exemption of certain insurance companies owned by

tax-exempt organizations ....... 220 230 250 260 280 290 300 1,380 ............ ............ .............. .............. .............. .............. .............. ..............

38 Small life insurance company

deduction ................................ 100 100 100 100 100 100 100 500 ............ ............ .............. .............. .............. .............. .............. ..............

Housing:

39 Exclusion of interest on owneroccupied mortgage subsidy

bonds ...................................... 200 210 210 220 230 230 240 1,130 600 620 660 740 820 910 1,000 4,130

40 Exclusion of interest on rental

housing bonds ........................ 40 40 40 50 50 50 50 240 120 130 140 150 170 190 210 860

41 Deductibility of mortgage interest

on owner-occupied homes ..... ............ ............ ............ ............ ............ ............ ............ .............. 64,510 64,190 66,110 68,070 70,870 73,560 76,870 355,480

42 Deductibility of State and local

property tax on owner-occupied homes ............................. ............ ............ ............ ............ ............ ............ ............ .............. 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

43 Deferral of income from post

1987 installment sales ........... 270 270 280 290 290 300 300 1,460 770 780 800 810 830 840 860 4,140

44 Capital gains exclusion on home

sales ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 19,090 19,670 20,260 20,860 21,490 22,140 22,800 107,550

45 Exception from passive loss

rules for $25,000 of rental

loss ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,800 4,400 4,070 3,780 3,530 3,290 3,090 17,760

46 Credit for low-income housing

investments ............................. 2,420 2,500 2,600 2,730 2,860 2,990 3,100 14,280 800 830 860 900 950 990 1,030 4,730

47 Accelerated depreciation on

rental housing (normal tax

method) ................................... 390 410 440 450 460 470 480 2,300 4,800 5,030 5,270 5,340 5,340 5,250 5,320 26,520

Commerce:

48 Cancellation of indebtedness ..... ............ ............ ............ ............ ............ ............ ............ .............. 30 30 30 40 40 40 40 190

49 Exceptions from imputed interest

rules ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 80 80 80 80 80 80 80 400

50 Capital gains (except agriculture,

timber, iron ore, and coal)

(normal tax method) ............... ............ ............ ............ ............ ............ ............ ............ .............. 67,800 61,810 60,200 56,990 56,180 50,670 49,880 273,920

51 Capital gains exclusion of small

corporation stock .................... ............ ............ ............ ............ ............ ............ ............ .............. 70 100 130 160 210 250 300 1,050

52 Step-up basis of capital gains at

death ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 26,540 27,610 28,710 29,860 31,050 32,300 33,590 155,510

53 Carryover basis of capital gains

on gifts .................................... ............ ............ ............ ............ ............ ............ ............ .............. 530 600 680 760 900 1,080 1,130 4,550

54 Ordinary income treatment of

loss from small business corporation stock sale ................. ............ ............ ............ ............ ............ ............ ............ .............. 40 40 40 50 50 50 50 240

55 Accelerated depreciation of

buildings other than rental

housing (normal tax method) 2,690 2,620 2,450 2,180 1,990 2,050 2,310 10,980 1,850 1,940 1,790 1,780 1,810 2,110 2,570 10,060

56 Accelerated depreciation of machinery and equipment (normal tax method) ..................... 30,750 30,220 29,750 30,200 30,860 31,970 34,070 156,850 7,110 6,910 6,730 6,590 6,570 6,550 6,860 33,300

57 Expensing of certain small investments (normal tax method) ........................................... 530 470 460 460 450 490 570 2,430 1,140 960 960 930 910 990 1,150 4,940

58 Amortization of start-up costs

(normal tax method) ............... 90 110 140 160 170 180 180 830 40 50 60 80 80 90 90 400

59 Graduated corporation income

tax rate (normal tax method) 4,940 5,590 6,210 6,580 7,120 7,450 7,880 35,240 ............ ............ .............. .............. .............. .............. .............. ..............

60 Exclusion of interest on small

issue bonds ............................ 80 80 80 80 80 90 90 420 230 230 250 280 310 340 380 1,560

Transportation:

61 Deferral of tax on shipping companies .............................................. 20 20 20 20 20 20 20 100 ............ ............ .............. .............. .............. .............. .............. ..............
104 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Corporations Individuals

2001 2002 2003 2004 2005 2006 2007 2003– 2007 2001 2002 2003 2004 2005 2006 2007 2003– 2007

62 Exclusion of reimbursed employee

parking expenses ........................ ............ ............ ............ ............ ............ ............ ............ .............. 1,980 2,090 2,190 2,300 2,420 2,550 2,670 12,130

63 Exclusion for employer-provided

transit passes .............................. ............ ............ ............ ............ ............ ............ ............ .............. 220 280 360 410 470 540 600 2,380

Community and regional development:

64 Investment credit for rehabilitation

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

65 Exclusion of interest for airport,

dock, and similar bonds ............. 160 160 170 170 180 180 190 890 470 480 510 580 640 710 790 3,230

66 Exemption of certain mutuals’ and

cooperatives’ income .................. 60 60 60 60 70 70 70 330 ............ ............ .............. .............. .............. .............. .............. ..............

67 Empowerment zones, Enterprise

communities, and Renewal communities ....................................... 100 220 300 300 320 350 390 1,660 280 510 830 870 960 1,060 1,190 4,910

68 New markets tax credit ................... 0 20 50 70 110 150 210 590 10 70 140 220 320 460 620 1,760

69 Expensing of environmental remediation costs ................................ 70 80 80 20 –20 –10 –10 60 10 20 20 .............. .............. .............. .............. 20

Education, training, employment,

and social services:

Education:

70 Exclusion of scholarship and fellowship income (normal tax

method) ................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,210 1,200 1,210 1,240 1,330 1,380 1,390 6,550

71 HOPE tax credit .......................... ............ ............ ............ ............ ............ ............ ............ .............. 4,130 4,110 3,520 2,880 2,930 2,730 2,900 14,960

72 Lifetime Learning tax credit ........ ............ ............ ............ ............ ............ ............ ............ .............. 2,370 2,290 2,360 3,140 2,980 2,740 2,960 14,180

73 Education Individual Retirement

Accounts ................................. ............ ............ ............ ............ ............ ............ ............ .............. 30 50 80 130 220 330 470 1,230

74 Deductibility of student-loan interest ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 390 450 640 660 680 700 720 3,400

75 Deduction for higher education

expenses ................................ ............ ............ ............ ............ ............ ............ ............ .............. 0 430 2,290 2,960 3,710 3,010 0 11,970

76 State prepaid tuition plans ......... ............ ............ ............ ............ ............ ............ ............ .............. 190 270 340 400 460 530 590 2,320

77 Exclusion of interest on studentloan bonds .............................. 60 60 60 60 60 60 70 310 170 170 180 200 230 250 280 1,140

78 Exclusion of interest on bonds

for private nonprofit educational facilities ..................... 140 140 140 150 150 150 160 750 400 410 440 490 550 610 670 2,760

79 Credit for holders of zone academy bonds .............................. 30 50 70 80 90 90 90 420 ............ ............ .............. .............. .............. .............. .............. ..............

80 Exclusion of interest on savings

bonds redeemed to finance

educational expenses ............. ............ ............ ............ ............ ............ ............ ............ .............. 10 20 20 20 20 20 20 100

81 Parental personal exemption for

students age 19 or over ........ ............ ............ ............ ............ ............ ............ ............ .............. 1,010 1,070 1,120 1,170 1,230 1,280 1,340 6,140

82 Deductibility of charitable contributions (education) .............. 590 680 770 830 840 900 950 4,290 3,240 3,300 3,430 3,610 3,760 3,940 4,080 18,820

83 Exclusion of employer-provided

educational assistance ........... ............ ............ ............ ............ ............ ............ ............ .............. 260 410 500 530 560 590 620 2,800

Training, employment, and social

services:

84 Work opportunity tax credit ........ 260 190 120 50 20 10 0 200 40 40 20 10 10 0 0 40

85 Welfare-to-work tax credit .......... 80 60 30 20 10 0 0 60 10 10 10 0 0 0 0 10

86 Employer provided child care exclusion ..................................... ............ ............ ............ ............ ............ ............ ............ .............. 720 740 770 810 930 1,020 1,080 4,610

87 Employer-provided child care

credit ....................................... 0 40 90 130 150 150 160 680 ............ ............ .............. .............. .............. .............. .............. ..............

88 Assistance for adopted foster

children ................................... ............ ............ ............ ............ ............ ............ ............ .............. 190 220 250 260 270 280 290 1,350

89 Adoption credit and exclusion .... ............ ............ ............ ............ ............ ............ ............ .............. 130 140 220 450 500 540 560 2,270

90 Exclusion of employee meals

and lodging (other than military) ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 710 740 780 810 850 890 930 4,260

91 Child credit 2 ............................... ............ ............ ............ ............ ............ ............ ............ .............. 19,840 19,760 19,680 19,550 20,550 21,530 21,240 102,550

92 Credit for child and dependent

care expenses ........................ ............ ............ ............ ............ ............ ............ ............ .............. 2,670 2,610 2,670 2,960 2,700 2,150 1,920 12,400

93 Credit for disabled access expenditures ............................... 10 10 10 10 20 20 20 80 40 40 40 40 40 40 40 200

94 Deductibility of charitable contributions, other than education and health .................... 730 850 950 1,040 1,040 1,110 1,180 5,320 29,420 29,960 31,130 32,790 34,150 35,780 37,110 170,960

95 Exclusion of certain foster care

payments ................................ ............ ............ ............ ............ ............ ............ ............ .............. 500 510 520 530 540 570 610 2,770
6. TAX EXPENDITURES 105

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

(In millions of dollars)

Corporations Individuals

2001 2002 2003 2004 2005 2006 2007 2003– 2007 2001 2002 2003 2004 2005 2006 2007 2003– 2007

96 Exclusion of parsonage allowances ...................................... ............ ............ ............ ............ ............ ............ ............ .............. 350 370 400 420 450 470 490 2,230

Health:

97 Exclusion of employer contributions

for medical insurance premiums

and medical care ........................ ............ ............ ............ ............ ............ ............ ............ .............. 82,800 90,910 99,260 106,940 115,380 124,050 134,960 580,590

98 Self-employed medical insurance

premiums .................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,520 1,730 2,420 3,570 3,870 4,170 4,430 18,460

99 Workers’ compensation insurance

premiums .................................... ............ ............ ............ ............ ............ ............ ............ .............. 4,730 4,870 5,080 5,230 5,410 5,570 5,790 27,080

100 Medical Savings Accounts .............. ............ ............ ............ ............ ............ ............ ............ .............. 20 20 20 20 20 20 20 100

101 Deductibility of medical expenses .. ............ ............ ............ ............ ............ ............ ............ .............. 4,990 5,260 5,530 5,840 6,280 6,600 7,100 31,350

102 Exclusion of interest on hospital

construction bonds ...................... 280 290 290 300 310 320 320 1,540 820 840 900 1,010 1,130 1,250 1,380 5,670

103 Deductibility of charitable contributions (health) ............................... 710 820 920 1,010 1,010 1,080 1,150 5,170 3,300 3,360 3,500 3,680 3,840 4,020 4,170 19,210

104 Tax credit for orphan drug research ......................................... 140 150 170 190 220 240 270 1,090 ............ ............ .............. .............. .............. .............. .............. ..............

105 Special Blue Cross/Blue Shield deduction ......................................... 270 300 340 310 300 270 300 1,520 ............ ............ .............. .............. .............. .............. .............. ..............

Income security:

106 Exclusion of railroad retirement

system benefits ........................... ............ ............ ............ ............ ............ ............ ............ .............. 380 390 400 400 400 400 400 2,000

107 Exclusion of workers’ compensation

benefits ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 5,560 5,810 6,070 6,320 6,600 6,900 7,200 33,090

108 Exclusion of public assistance benefits (normal tax method) ........... ............ ............ ............ ............ ............ ............ ............ .............. 370 380 400 410 430 450 470 2,160

109 Exclusion of special benefits for

disabled coal miners ................... ............ ............ ............ ............ ............ ............ ............ .............. 70 70 60 60 60 50 50 280

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

Net exclusion of pension contributions and earnings:

111 Employer plans ........................... ............ ............ ............ ............ ............ ............ ............ .............. 42,070 48,070 53,080 54,500 55,630 58,980 63,320 285,510

112 401(k) plans ................................ ............ ............ ............ ............ ............ ............ ............ .............. 44,080 52,960 59,510 62,770 65,290 69,230 73,320 330,120

113 Individual Retirement Accounts .. ............ ............ ............ ............ ............ ............ ............ .............. 18,680 18,090 18,660 19,050 18,930 19,230 18,330 94,200

114 Low and moderate income savers credit ................................. ............ ............ ............ ............ ............ ............ ............ .............. 0 550 1,960 1,940 1,900 1,800 1,280 8,880

115 Keogh plans ................................ ............ ............ ............ ............ ............ ............ ............ .............. 6,160 6,520 6,770 7,040 7,250 7,490 7,730 36,280

Exclusion of other employee benefits:

116 Premiums on group term life insurance ................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,750 1,780 1,800 1,830 1,860 1,890 1,920 9,300

117 Premiums on accident and disability insurance ...................... ............ ............ ............ ............ ............ ............ ............ .............. 210 220 230 240 250 260 270 1,250

118 Small business retirement plan

credit ........................................... 0 10 30 50 70 80 90 320 0 10 20 40 50 50 60 220

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

120 Special ESOP rules ........................ 980 1,020 1,080 1,140 1,200 1,260 1,330 6,010 310 320 340 350 370 380 400 1,840

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

122 Additional deduction for the elderly ............ ............ ............ ............ ............ ............ ............ .............. 1,970 1,890 1,950 2,060 2,100 2,150 2,050 10,310

123 Tax credit for the elderly and disabled ........................................... ............ ............ ............ ............ ............ ............ ............ .............. 30 30 30 30 30 30 30 150

124 Deductibility of casualty losses ...... ............ ............ ............ ............ ............ ............ ............ .............. 210 250 310 360 410 450 490 2,020

125 Earned income tax credit 3 ............. ............ ............ ............ ............ ............ ............ ............ .............. 4,940 4,370 4,800 4,930 5,100 5,180 5,390 25,400

Social Security:

Exclusion of social security benefits:

126 Social Security benefits for retired workers ........................... ............ ............ ............ ............ ............ ............ ............ .............. 17,830 18,000 18,180 18,560 18,850 19,720 20,890 96,200

127 Social Security benefits for disabled ....................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,690 2,930 3,240 3,630 4,020 4,470 5,020 20,380

128 Social Security benefits for dependents and survivors .......... ............ ............ ............ ............ ............ ............ ............ .............. 3,720 3,870 4,060 4,320 4,560 4,820 5,170 22,930

Veterans benefits and services:

129 Exclusion of veterans death benefits and disability compensation ............ ............ ............ ............ ............ ............ ............ .............. 3,150 3,190 3,300 3,490 3,680 3,870 4,080 18,420

130 Exclusion of veterans pensions ...... ............ ............ ............ ............ ............ ............ ............ .............. 70 80 80 80 90 90 100 440

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

132 Exclusion of interest on veterans

housing bonds ............................ 10 10 10 10 10 10 10 50 30 30 30 30 40 40 50 190
106 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Corporations Individuals

2001 2002 2003 2004 2005 2006 2007 2003–

2007 2001 2002 2003 2004 2005 2006 2007 2003–2007

General purpose fiscal assistance:

133 Exclusion of interest on public purpose State and local bonds ....... 5,860 6,010 6,160 6,310 6,470 6,630 6,800 32,370 17,240 17,670 18,110 18,570 19,030 19,510 20,000 95,220

134 Deductibility of nonbusiness state

and local taxes other than on

owner-occupied homes ............... ............ ............ ............ ............ ............ ............ ............ .............. 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

135 Tax credit for corporations receiving income from doing business

in U.S. possessions .................... 2,190 2,240 2,240 2,240 2,200 1,300 0 7,980 ............ ............ .............. .............. .............. .............. .............. ..............

Interest:

136 Deferral of interest on U.S. savings

bonds .......................................... ............ ............ ............ ............ ............ ............ ............ .............. 290 300 310 330 330 350 360 1,680

Addendum: Aid to State and local

governments:

Deductibility of:

Property taxes on owner-occupied homes ............................. ............ ............ ............ ............ ............ ............ ............ .............. 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

Nonbusiness State and local

taxes other than on owner-occupied homes ......................... ............ ............ ............ ............ ............ ............ ............ .............. 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

Exclusion of interest on State and

local bonds for:

Public purposes .......................... 5,860 6,010 6,160 6,310 6,470 6,630 6,800 32,370 17,240 17,670 18,110 18,570 19,030 19,510 20,000 95,220

Energy facilities ........................... 20 20 20 30 30 30 30 140 70 70 80 90 100 110 120 500

Water, sewage, and hazardous

waste disposal facilities .......... 100 110 110 110 110 120 120 570 300 310 330 370 420 460 510 2,090

Small-issues ................................ 80 80 80 80 80 90 90 420 230 230 250 280 310 340 380 1,560

Owner-occupied mortgage subsidies ....................................... 200 210 210 220 230 230 240 1,130 600 620 660 740 820 910 1,000 4,130

Rental housing ............................ 40 40 40 50 50 50 50 240 120 130 140 150 170 190 210 860

Airports, docks, and similar facilities ...................................... 160 160 170 170 180 180 190 890 470 480 510 580 640 710 790 3,230

Student loans .............................. 60 60 60 60 60 60 70 310 170 170 180 200 230 250 280 1,140

Private nonprofit educational facilities ...................................... 140 140 140 150 150 150 160 750 400 410 440 490 550 610 670 2,760

Hospital construction .................. 280 290 290 300 310 320 320 1,540 820 840 900 1,010 1,130 1,250 1,380 5,670

Veterans’ housing ....................... 10 10 10 10 10 10 10 50 30 30 30 30 40 40 50 190

Credit for holders of zone academy

bonds .......................................... 30 50 70 80 90 90 90 420 ............ ............ .............. .............. .............. .............. .............. ..............

1 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income

tax principles. For tax reasons, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions define income under the general rule of U.S. income taxation. 2 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: 2001 $990; 2002 $1,020; 2003 $1,050; 2004

$1,080; 2005 $1,080; 2006 $1,100; and 2007 $1,120. 3 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $980; 2002 $7,390; 2003 $7,390; 2004

$7,210; 2005 $6,950; 2006 $9,380; and 2007 $9,200. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $26,120; 2002 $28,280; 2003

$30,630; 2004 $31,080; 2005 $31,720; 2006 $33,130; and 2007 $34,090.

Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.
6. TAX EXPENDITURES 107

Table 6–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2003 PROJECTED REVENUE EFFECT

(In millions of dollars)

Provision 2003 2003–2007

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 99,260 580,590

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 66,110 355,480

Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... 60,200 273,920

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 59,510 330,120

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 53,080 285,510

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 48,150 204,860

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... 36,480 190,150

Deductibility of charitable contributions, other than education and health ......................................................................... 32,080 176,280

Step-up basis of capital gains at death .............................................................................................................................. 28,710 155,510

Exclusion of interest on public purpose State and local bonds ......................................................................................... 24,270 127,590

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 23,580 97,830

Capital gains exclusion on home sales ............................................................................................................................... 20,260 107,550

Child credit ............................................................................................................................................................................ 19,680 102,550

Exclusion of interest on life insurance savings ................................................................................................................... 19,250 114,690

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 18,660 94,200

Exclusion of Social Security benefits for retired workers ................................................................................................... 18,180 96,200

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,450 42,230

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 6,770 36,280

Graduated corporation income tax rate (normal tax method) ............................................................................................ 6,210 35,240

Exclusion of workers’ compensation benefits ...................................................................................................................... 6,070 33,090

Accelerated depreciation on rental housing (normal tax method) ...................................................................................... 5,710 28,820

Deductibility of medical expenses ........................................................................................................................................ 5,530 31,350

Extraterritorial income exclusion .......................................................................................................................................... 5,150 29,570

Workers’ compensation insurance premiums ...................................................................................................................... 5,080 27,080

Earned income tax credit ..................................................................................................................................................... 4,800 25,400

Credit for increasing research activities .............................................................................................................................. 4,590 12,350

Deductibility of charitable contributions (health) .................................................................................................................. 4,420 24,380

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... 4,240 21,040

Deductibility of charitable contributions (education) ............................................................................................................ 4,200 23,110

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,070 17,760

Exclusion of Social Security benefits for dependents and survivors ................................................................................. 4,060 22,930

HOPE tax credit ................................................................................................................................................................... 3,520 14,960

Credit for low-income housing investments ......................................................................................................................... 3,460 19,010

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,300 18,420

Exclusion of Social Security benefits for disabled .............................................................................................................. 3,240 20,380

Credit for child and dependent care expenses ................................................................................................................... 2,670 12,400

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,660 14,090

Self-employed medical insurance premiums ....................................................................................................................... 2,420 18,460

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 2,380 16,730

Lifetime Learning tax credit .................................................................................................................................................. 2,360 14,180

Deduction for higher education expenses ........................................................................................................................... 2,290 11,970

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 2,240 7,980

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,210 11,310

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,190 12,130

Net exclusion of pension contributions and earnings: Low and moderate income savers credit ..................................... 1,960 8,880

Additional deduction for the elderly ..................................................................................................................................... 1,950 10,310

Net exclusion of pension contributions and earnings: Premiums on group term life insurance ....................................... 1,800 9,300

Inventory property sales source rules exception ................................................................................................................. 1,540 8,530

Special ESOP rules .............................................................................................................................................................. 1,420 7,850

Expensing of certain small investments (normal tax method) ............................................................................................ 1,420 7,370

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,210 6,550

Exclusion of interest on hospital construction bonds .......................................................................................................... 1,190 7,210

Exemption of credit union income ....................................................................................................................................... 1,150 6,650

Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,130 6,570

Parental personal exemption for students age 19 or over ................................................................................................. 1,120 6,140

Capital gains treatment of certain income ........................................................................................................................... 1,100 6,130

Deferral of income from post 1987 installment sales ......................................................................................................... 1,080 5,600

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 870 5,260

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 840 4,620

Exclusion of employee meals and lodging (other than military) ........................................................................................ 780 4,260

Employer provided child care exclusion .............................................................................................................................. 770 4,610

Carryover basis of capital gains on gifts ............................................................................................................................. 680 4,550

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 680 4,120

Deductibility of student-loan interest .................................................................................................................................... 640 3,400

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 580 3,510

Exclusion of certain foster care payments .......................................................................................................................... 520 2,770

Exclusion of employer-provided educational assistance ..................................................................................................... 500 2,800

Enhanced oil recovery credit ............................................................................................................................................... 440 3,280

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 440 2,660
108 ANALYTICAL PERSPECTIVES

Table 6–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2003 PROJECTED REVENUE EFFECT—Continued

(In millions of dollars)

Provision 2003 2003–2007

Alternative fuel production credit ......................................................................................................................................... 410 930

Exclusion of parsonage allowances ..................................................................................................................................... 400 2,230

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 400 2,160

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

Expensing of multiperiod timber growing costs ................................................................................................................... 370 1,950

Exclusion for employer-provided transit passes .................................................................................................................. 360 2,380

State prepaid tuition plans ................................................................................................................................................... 340 2,320

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 340 1,520

Exclusion of interest on small issue bonds ......................................................................................................................... 330 1,980

Deductibility of casualty losses ............................................................................................................................................ 310 2,020

Deferral of interest on U.S. savings bonds ......................................................................................................................... 310 1,680

Excess of percentage over cost depletion, fuels ................................................................................................................ 270 1,490

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. 270 1,470

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 250 1,380

Assistance for adopted foster children ................................................................................................................................ 250 1,350

Exclusion of interest on student-loan bonds ....................................................................................................................... 240 1,450

Net exclusion of pension contributions and earnings: Premiums on accident and disability insurance .......................... 230 1,250

Adoption credit and exclusion .............................................................................................................................................. 220 2,270

Tax incentives for preservation of historic structures ......................................................................................................... 210 1,150

Amortization of start-up costs (normal tax method) ............................................................................................................ 200 1,230

New markets tax credit ........................................................................................................................................................ 190 2,350

Exclusion of interest on rental housing bonds .................................................................................................................... 180 1,100

Tax credit for orphan drug research .................................................................................................................................... 170 1,090

Expensing of certain capital outlays .................................................................................................................................... 170 850

Work opportunity tax credit .................................................................................................................................................. 140 240

Capital gains exclusion of small corporation stock ............................................................................................................. 130 1,050

Expensing of certain multiperiod production costs .............................................................................................................. 130 620

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

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

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

Exclusion of interest on energy facility bonds .................................................................................................................... 100 640

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

New technology credit .......................................................................................................................................................... 100 480

Expensing of environmental remediation costs ................................................................................................................... 100 80

Employer-provided child care credit .................................................................................................................................... 90 590

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

Education Individual Retirement Accounts .......................................................................................................................... 80 1,230

Exclusion of veterans pensions ........................................................................................................................................... 80 440

Exceptions from imputed interest rules ............................................................................................................................... 80 400

Expensing of exploration and development costs, fuels .................................................................................................... 70 450

Credit for holders of zone academy bonds ......................................................................................................................... 70 420

Income averaging for farmers .............................................................................................................................................. 70 380

Exclusion from income of conservation subsidies provided by public utilities ................................................................... 70 340

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 330

Exclusion of special benefits for disabled coal miners ....................................................................................................... 60 280

Small business retirement plan credit ................................................................................................................................. 50 540

Credit for disabled access expenditures ............................................................................................................................. 50 280

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 50 –40

Ordinary income treatment of loss from small business corporation stock sale ............................................................... 40 240

Exclusion of interest on veterans housing bonds ............................................................................................................... 40 240

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

Welfare-to-work tax credit .................................................................................................................................................... 40 70

Cancellation of indebtedness ............................................................................................................................................... 30 190

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

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

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

Tax credit for the elderly and disabled ............................................................................................................................... 30 150

Excess bad debt reserves of financial institutions .............................................................................................................. 30 60

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

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

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

Medical Savings Accounts ................................................................................................................................................... 20 100

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

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

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 50

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

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 0 0
6. TAX EXPENDITURES 109

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

CALENDAR YEAR 2001

(In millions of dollars)

Provision

Present

Value of

Revenue

Loss

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 6,760

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 1,170

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 1,700

4 Expensing of exploration and development costs - fuels .................................................................................... 130

5 Expensing of exploration and development costs - nonfuels .............................................................................. 0

6 Expensing of multiperiod timber growing costs ................................................................................................... 220

7 Expensing of certain multiperiod production costs - agriculture ......................................................................... 230

8 Expensing of certain capital outlays - agriculture ................................................................................................ 260

9 Deferral of income on life insurance and annuity contracts ................................................................................ 22,920

10 Accelerated depreciation of rental housing (normal tax method) ....................................................................... 4,750

11 Accelerated depreciation of buildings other than rental housing (normal tax method) ...................................... 540

12 Accelerated depreciation of machinery and equipment (normal tax method) .................................................... 31,210

13 Expensing of certain small investments (normal tax method) ............................................................................ 990

14 Amortization of start-up costs (normal tax method) ............................................................................................. 20

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

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

17 Credit for low-income housing investments ......................................................................................................... 2,850

18 Deferral for state prepaid tuition plans ................................................................................................................. 190

19 Exclusion of pension contributions - employer plans .......................................................................................... 97,290

20 Exclusion of 401(k) contributions .......................................................................................................................... 69,980

21 Exclusion of IRA contributions and earnings ....................................................................................................... 6,090

22 Exclusion of contributions and earnings for Keogh plans ................................................................................... 9,780

23 Exclusion of interest on public-purpose bonds .................................................................................................... 20,730

24 Exclusion of interest on non-public purpose bonds ............................................................................................. 5,560

25 Deferral of interest on U.S. savings bonds .......................................................................................................... 330

Outlay Equivalents

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

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

The outlay-equivalent measure allows the cost of a tax

expenditure to be compared with a direct Federal outlay

on a more even footing. Outlay equivalents are reported

in Table 6–5.

Table 6–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX

(In millions of dollars)

Outlay Equivalents

2001 2002 2003 2004 2005 2006 2007 2003–2007

National Defense

1 Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,510 2,540 2,570 2,600 2,620 2,650 2,680 13,120

International affairs:

2 Exclusion of income earned abroad by U.S. citizens ........................................................................... 3,270 3,380 3,540 3,570 3,670 3,720 4,210 18,710

3 Exclusion of certain allowances for Federal employees abroad .......................................................... 1,020 1,060 1,130 1,170 1,230 1,270 1,350 6,150

4 Extraterritorial income exclusion ............................................................................................................. 6,910 7,410 7,930 8,470 9,060 9,680 10,350 45,490

5 Inventory property sales source rules exception ................................................................................... 2,150 2,260 2,370 2,490 2,620 2,750 2,890 13,120

6 Deferral of income from controlled foreign corporations (normal tax method) .................................... 6,600 7,000 7,450 7,900 8,400 8,930 9,550 42,230

7 Deferred taxes for financial firms on certain income earned overseas ................................................ 1,300 550 .............. .............. .............. .............. .............. 0

General science, space, and technology:

8 Expensing of research and experimentation expenditures (normal tax method) ................................. 2,020 1,780 2,380 2,880 3,400 3,910 4,160 16,730

9 Credit for increasing research activities ................................................................................................. 8,270 9,240 7,060 6,190 3,580 1,530 640 18,990

Energy:

10 Expensing of exploration and development costs, fuels ....................................................................... 80 80 100 120 120 130 130 600

11 Excess of percentage over cost depletion, fuels .................................................................................. 290 300 310 320 340 340 360 1,670

12 Alternative fuel production credit ............................................................................................................ 1,210 1,130 540 170 170 170 170 1,220

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

14 Capital gains treatment of royalties on coal .......................................................................................... 130 140 150 150 160 170 180 810

15 Exclusion of interest on energy facility bonds ....................................................................................... 130 130 150 170 180 200 210 1,170

16 Enhanced oil recovery credit .................................................................................................................. 370 440 530 640 770 920 1,110 3,970

17 New technology credit ............................................................................................................................ 90 130 150 150 150 150 150 750

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

19 Tax credit and deduction for clean-fuel burning vehicles ..................................................................... 70 70 70 30 -20 -60 -60 -40

20 Exclusion from income of conservation subsidies provided by public utilities ..................................... 90 90 90 90 90 90 90 450
110 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Outlay Equivalents

2001 2002 2003 2004 2005 2006 2007 2003–2007

Natural resources and environment:

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

22 Excess of percentage over cost depletion, nonfuel minerals ............................................................... 340 360 370 380 380 400 410 1,940

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ............................ 570 600 630 690 760 840 910 3,830

24 Capital gains treatment of certain timber income ................................................................................. 130 140 150 150 160 170 180 810

25 Expensing of multiperiod timber growing costs ..................................................................................... 460 470 480 500 510 520 540 2,550

26 Tax incentives for preservation of historic structures ............................................................................ 190 200 210 220 230 240 250 1,150

Agriculture:

27 Expensing of certain capital outlays ...................................................................................................... 210 210 210 210 210 210 210 1,050

28 Expensing of certain multiperiod production costs ................................................................................ 150 160 160 150 150 140 140 740

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

30 Capital gains treatment of certain income ............................................................................................. 1,320 1,380 1,460 1,550 1,630 1,720 1,810 8,170

31 Income averaging for farmers ................................................................................................................ 80 90 90 90 90 100 100 470

32 Deferral of gain on sale of farm refiners ............................................................................................... 10 10 10 10 10 10 10 50

Commerce and housing:

Financial institutions and insurance:

33 Exemption of credit union income ..................................................................................................... 1,330 1,430 1,530 1,640 1,770 1,890 2,030 8,860

34 Excess bad debt reserves of financial institutions ............................................................................ 80 70 40 30 10 0 0 80

35 Exclusion of interest on life insurance savings ................................................................................. 16,290 17,710 19,250 20,940 22,780 24,790 26,930 114,690

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

37 Tax exemption of certain insurance companies owned by tax-exempt organizations .................... 300 310 340 350 380 390 410 1,870

38 Small life insurance company deduction ........................................................................................... 130 130 130 130 130 130 130 650

Housing:

39 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................. 1,150 1,190 1,250 1,380 1,510 1,640 1,780 7,560

40 Exclusion of interest on rental housing bonds .................................................................................. 230 250 260 290 320 350 370 1,590

41 Deductibility of mortgage interest on owner-occupied homes .......................................................... 64,510 64,190 66,110 68,070 70,870 73,560 76,870 355,480

42 Deductibility of State and local property tax on owner-occupied homes ......................................... 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

43 Deferral of income from post 1987 installment sales ....................................................................... 1,020 1,040 1,060 1,080 1,100 1,120 1,140 5,500

44 Capital gains exclusion on home sales ............................................................................................. 23,870 24,580 25,320 26,080 26,860 27,670 28,500 134,430

45 Exception from passive loss rules for $25,000 of rental loss .......................................................... 4,800 4,400 4,070 3,780 3,530 3,290 3,090 17,760

46 Credit for low-income housing investments ....................................................................................... 4,360 4,510 4,700 4,930 5,170 5,400 5,610 25,810

47 Accelerated depreciation on rental housing (normal tax method) .................................................... 5,190 5,440 5,710 5,790 5,800 5,720 5,800 28,820

Commerce:

48 Cancellation of indebtedness ............................................................................................................. 30 30 30 40 40 40 40 190

49 Exceptions from imputed interest rules ............................................................................................. 80 80 80 80 80 80 80 400

50 Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) ........................ 90,400 82,420 80,260 75,980 74,910 67,560 66,510 365,220

51 Capital gains exclusion of small corporation stock ........................................................................... 90 130 170 220 270 340 400 1,400

52 Step-up basis of capital gains at death ............................................................................................ 35,390 36,810 38,280 39,810 41,400 43,060 44,780 207,330

53 Carryover basis of capital gains on gifts ........................................................................................... 530 600 680 760 900 1,080 1,130 4,550

54 Ordinary income treatment of loss from small business corporation stock sale ............................. 50 50 50 60 60 60 60 290

55 Accelerated depreciation of buildings other than rental housing (normal tax method) ................... 4,540 4,560 4,240 3,960 3,800 4,160 4,880 21,040

56 Accelerated depreciation of machinery and equipment (normal tax method) ................................. 37,860 37,130 36,480 36,790 37,430 38,520 40,930 190,150

57 Expensing of certain small investments (normal tax method) .......................................................... 1,670 1,430 1,420 1,390 1,360 1,480 1,720 7,370

58 Amortization of start-up costs (normal tax method) .......................................................................... 130 160 200 240 250 270 270 1,230

59 Graduated corporation income tax rate (normal tax method) .......................................................... 7,590 8,590 9,560 10,130 10,950 11,460 12,130 54,230

60 Exclusion of interest on small issue bonds ....................................................................................... 440 440 470 520 560 610 670 2,830

Transportation:

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

62 Exclusion of reimbursed employee parking expenses .......................................................................... 2,560 2,690 2,830 2,970 3,130 3,280 3,450 15,660

63 Exclusion for employer-provided transit passes .................................................................................... 310 390 500 570 660 750 840 3,320

Community and regional development:

64 Investment credit for rehabilitation of structures (other than historic) .................................................. 20 30 30 30 30 30 30 150

65 Exclusion of interest for airport, dock, and similar bonds ..................................................................... 900 920 980 1,080 1,180 1,280 1,400 5,920

66 Exemption of certain mutuals’ and cooperatives’ income ..................................................................... 60 60 60 60 70 70 70 330

67 Empowerment zones and enterprise communities ................................................................................ 380 730 1,120 1,170 1,280 1,410 1,580 6,560

68 New markets tax credit ........................................................................................................................... 20 90 190 300 420 610 830 2,350

69 Expensing of environmental remediation costs ..................................................................................... 110 120 130 40 -20 -20 -20 110

Education, training, employment, and social services:

Education:

70 Exclusion of scholarship and fellowship income (normal tax method) ............................................ 1,330 1,320 1,330 1,360 1,460 1,520 1,530 7,200

71 HOPE tax credit .................................................................................................................................. 5,300 5,270 4,510 3,690 3,760 3,500 3,720 19,180

72 Lifetime Learning tax credit ................................................................................................................ 3,030 2,940 3,030 4,020 3,830 3,520 3,800 18,200

73 Education Individual Retirement Accounts ........................................................................................ 40 60 90 150 260 390 550 1,440

74 Deductibility of student-loan interest .................................................................................................. 460 540 760 790 810 840 850 4,050

75 Deduction for higher education expenses ......................................................................................... 0 560 2,940 3,790 4,760 3,860 0 15,350

76 State prepaid tuition plans ................................................................................................................. 250 340 430 510 590 680 760 2,970

77 Exclusion of interest on student-loan bonds ..................................................................................... 330 330 340 370 410 440 510 2,070

78 Exclusion of interest on bonds for private nonprofit educational facilities ....................................... 770 780 830 920 1,010 1,090 1,190 5,040
6. TAX EXPENDITURES 111

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

(In millions of dollars)

Outlay Equivalents

2001 2002 2003 2004 2005 2006 2007 2003–2007

79 Credit for holders of zone academy bonds ....................................................................................... 40 70 100 120 120 120 120 580

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

81 Parental personal exemption for students age 19 or over ............................................................... 1,120 1,180 1,250 1,300 1,360 1,420 1,480 6,810

82 Deductibility of charitable contributions (education) .......................................................................... 5,420 5,610 5,910 6,260 6,460 6,800 7,070 32,500

83 Exclusion of employer-provided educational assistance ................................................................... 320 510 620 660 690 730 770 3,470

Training, employment, and social services:

84 Work opportunity tax credit ................................................................................................................ 300 230 140 60 30 10 0 240

85 Welfare-to-work tax credit .................................................................................................................. 90 70 40 20 10 0 0 70

86 Exclusion of employer provided child care ........................................................................................ 950 990 1,020 1,080 1,240 1,360 1,450 6,150

87 Employer-provided child care ............................................................................................................. 0 60 120 170 190 210 220 790

88 Assistance for adopted foster children .............................................................................................. 220 250 280 290 300 310 320 1,500

89 Adoption credit and exclusion ............................................................................................................ 160 180 280 570 640 690 710 2,890

90 Exclusion of employee meals and lodging (other than military) ...................................................... 870 910 950 990 1,030 1,080 1,130 5,180

91 Child credit 2 ........................................................................................................................................ 26,460 26,350 26,240 26,070 27,400 28,700 28,320 136,730

92 Credit for child and dependent care expenses ................................................................................. 3,560 3,480 3,560 3,950 3,600 2,860 2,550 16,520

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

94 Deductibility of charitable contributions, other than education and health ....................................... 42,130 42,750 44,450 46,820 48,580 50,980 52,760 243,590

95 Exclusion of certain foster care payments ........................................................................................ 580 590 600 610 630 660 700 3,200

96 Exclusion of parsonage allowances ................................................................................................... 400 420 460 480 510 540 560 2,550

Health:

97 Exclusion of employer contributions for medical insurance premiums and medical care ................... 106,750 117,750 128,760 138,400 149,240 160,370 173,450 750,220

98 Self-employed medical insurance premiums ......................................................................................... 1,900 2,140 3,000 4,420 4,790 5,160 5,470 22,840

99 Workers’ compensation insurance premiums ........................................................................................ 5,900 6,070 6,330 6,510 6,730 6,920 7,190 33,680

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

101 Deductibility of medical expenses .......................................................................................................... 4,990 5,260 5,530 5,840 6,280 6,600 7,100 31,350

102 Exclusion of interest on hospital construction bonds ............................................................................ 1,580 1,620 1,700 1,880 2,070 2,250 2,440 10,340

103 Deductibility of charitable contributions (health) .................................................................................... 5,710 5,920 6,250 6,630 6,830 7,210 7,490 34,410

104 Tax credit for orphan drug research ...................................................................................................... 200 230 260 290 320 360 400 1,630

105 Special Blue Cross/Blue Shield deduction ............................................................................................. 340 380 430 390 380 340 380 1,920

Income security:

106 Exclusion of railroad retirement system benefits ................................................................................... 380 390 400 400 400 400 400 2,000

107 Exclusion of workers’ compensation benefits ........................................................................................ 5,560 5,810 6,070 6,320 6,600 6,900 7,200 33,090

108 Exclusion of public assistance benefits (normal tax method) ............................................................... 370 380 400 410 430 450 470 2,160

109 Exclusion of special benefits for disabled coal miners ......................................................................... 70 70 60 60 60 50 50 280

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

Net exclusion of pension contributions and earnings:

111 Employer plans ................................................................................................................................... 52,590 59,350 65,130 66,460 67,840 71,930 77,220 348,580

112 401(k) plans ........................................................................................................................................ 55,100 65,380 73,020 76,550 79,620 84,430 89,410 403,030

113 Individual Retirement Accounts .......................................................................................................... 23,980 24,250 25,280 25,590 25,630 25,890 25,450 127,840

114 Low and moderate income savers credit .......................................................................................... 0 660 2,330 2,290 2,240 2,120 1,500 10,480

115 Keogh plans ........................................................................................................................................ 7,880 8,330 8,620 8,930 9,150 9,410 9,680 45,790

Exclusion of other employee benefits:

116 Premiums on group term life insurance ............................................................................................ 2,330 2,370 2,400 2,440 2,480 2,520 2,560 12,400

117 Premiums on accident and disability insurance ................................................................................ 280 290 310 320 330 350 360 1,670

118 Small business retirement plan credit ............................................................................................... 0 30 70 120 160 180 200 730

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

120 Special ESOP rules ............................................................................................................................ 1,710 1,780 1,880 1,980 2,080 2,180 2,300 10,420

121 Additional deduction for the blind ...................................................................................................... 50 50 50 50 50 50 50 250

122 Additional deduction for the elderly ................................................................................................... 2,390 2,280 2,360 2,490 2,550 2,600 2,480 12,480

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

124 Deductibility of casualty losses .......................................................................................................... 230 280 340 390 450 500 490 2,170

125 Earned income tax credit 3 ................................................................................................................. 5,480 4,850 5,330 5,480 5,670 5,750 5,990 28,220

Social Security:

Exclusion of social security benefits:

126 Social Security benefits for retired workers ....................................................................................... 17,830 18,000 18,180 18,560 18,850 19,720 20,890 96,200

127 Social Security benefits for disabled ................................................................................................. 2,690 2,930 3,240 3,630 4,020 4,470 5,020 20,380

128 Social Security benefits for dependents and survivors ..................................................................... 3,720 3,870 4,060 4,320 4,560 4,820 5,170 22,930

Veterans benefits and services:

129 Exclusion of veterans death benefits and disability compensation ...................................................... 3,150 3,190 3,300 3,490 3,680 3,870 4,080 18,420

130 Exclusion of veterans pensions .............................................................................................................. 70 80 80 80 90 90 100 440

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

132 Exclusion of interest on veterans housing bonds ................................................................................. 50 50 50 50 70 70 80 320

General purpose fiscal assistance:

133 Exclusion of interest on public purpose State and local bonds ........................................................... 33,100 33,930 34,780 35,660 36,540 37,460 38,410 182,850

134 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ................. 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

135 Tax credit for corporations receiving income from doing business in U.S. possessions .................... 3,130 3,190 3,190 3,190 3,140 1,860 0 11,380

Interest:

136 Deferral of interest on U.S. savings bonds ........................................................................................... 290 300 310 330 330 350 360 1,680
112 ANALYTICAL PERSPECTIVES

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

(In millions of dollars)

Outlay Equivalents

2001 2002 2003 2004 2005 2006 2007 2003–2007

Addendum: Aid to State and local governments:

Deductibility of:

Property taxes on owner-occupied homes ........................................................................................ 22,410 22,680 23,580 23,210 20,330 16,300 14,410 97,830

Nonbusiness State and local taxes other than on owner-occupied homes ..................................... 45,520 46,160 48,150 47,730 43,270 34,820 30,890 204,860

Exclusion of interest on State and local bonds for:

Public purposes .................................................................................................................................. 33,100 33,930 34,780 35,660 36,540 37,460 38,410 182,850

Energy facilities ................................................................................................................................... 130 130 150 170 180 200 210 1,170

Water, sewage, and hazardous waste disposal facilities ................................................................. 570 600 630 690 760 840 910 3,830

Small-issues ........................................................................................................................................ 440 440 470 520 560 610 670 2,830

Owner-occupied mortgage subsidies ................................................................................................. 1,150 1,190 1,250 1,380 1,510 1,640 1,780 7,560

Rental housing .................................................................................................................................... 230 250 260 290 320 350 370 1,590

Airports, docks, and similar facilities ................................................................................................. 900 920 980 1,080 1,180 1,280 1,400 5,920

Student loans ...................................................................................................................................... 330 330 340 370 410 440 510 2,070

Private nonprofit educational facilities ............................................................................................... 770 780 830 920 1,010 1,090 1,190 5,040

Hospital construction .......................................................................................................................... 1,580 1,620 1,700 1,880 2,070 2,250 2,440 10,340

Veterans’ housing ............................................................................................................................... 50 50 50 50 70 70 80 320

Credit for holders of zone academy bonds ........................................................................................... 40 70 100 120 120 120 120 580

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: 2001 $990; 2002 $1,020; 2003 $1,050; 2004 $1,080;

2005 $1,080; 2006 $1,100; and 2007 $1,120. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $980; 2002 $7,390; 2003 $7,390; 2004 $7,210;

2005 $6,950; 2006 $9,380; and 2007 $9,200. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2001 $26,120; 2002 $28,280; 2003

$30,630; 2004 $31,080; 2005 $31,720; 2006 $33,130 and 2007 $34,090.

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

Tax Expenditure Baselines

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

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

law. As noted previously, deciding whether provisions

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

in prior years, this year’s tax expenditure estimates

are presented using two baselines: the normal tax baseline, which is used by the Joint Committee on Taxation,

and the reference tax law baseline, which has been

reported by the Administration since 1983.

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

sum of consumption and the change in net wealth in

a given period of time. The normal tax baseline allows

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

is not limited to a particular structure of tax rates,

or by a specific definition of the taxpaying unit.

The reference tax law baseline is also patterned on

a comprehensive income tax, but it is closer to existing

law. Tax expenditures under the reference law baseline

are generally tax expenditures under the normal tax

baseline, but the reverse is not always true.

Both the normal and reference tax baselines allow

several major departures from a pure comprehensive

income tax. For example:

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

own produce) is regarded as a tax expenditure.

Both accrued and imputed income would be taxed

under a comprehensive income tax.

• 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;
6. TAX EXPENDITURES 113

2Gross income does, however, include transfer paymnents 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 interst, does not actively perform managerial or other participatory functions.

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

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

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

may be limited under the alternative minimum tax.

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

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

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

ore royalties and the sale of timber and certain

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

part of the baseline rate structure under both the

reference and normal tax methods.

Income subject to the tax. Income subject to tax

is defined as gross income less the costs of earning

that income. The Federal income tax defines gross

income to include: (1) consideration received in

the exchange of goods and services, including labor

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

of gross or net income earned and/or reported by

another entity (such as a partnership). Under the

reference tax rules, therefore, gross income does

not include gifts—defined as receipts of money or

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

thought of as gifts from the Government. 2 The

normal tax baseline also excludes gifts between

individuals from gross income. Under the normal

tax baseline, however, all cash transfer payments

from the Government to private individuals are

counted in gross income, and exemptions of such

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

deductible in determining taxable income under

both the reference and normal tax baselines. 3

Capital recovery. Under the reference tax law

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

the depreciation allowance for machinery and

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

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

tax baseline for real property is computed using

40-year straight-line depreciation.

Treatment of foreign income. Both the normal and

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

income taxes that would otherwise be due), which

prevents double taxation of income earned abroad.

Under the normal tax method, however, controlled

foreign corporations (CFCs) are not regarded as

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

under this method. In contrast, except for tax

haven activities, the reference law baseline follows

current law in treating CFCs as separate taxable

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

until distributed to U.S. taxpayers. Under this

baseline, deferral of tax on CFC income is not

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

income.

In addition to these areas of difference, the Joint

Committee on Taxation considers a somewhat broader

set of tax expenditures under its normal tax baseline

than is considered here.

Performance Measures and the Economic

Effects of Tax Expenditures

The Government Performance and Results Act of

1993 (GPRA) directs Federal agencies to develop annual

and strategic plans for their programs and activities.

These plans set out performance objectives to be

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

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

Executive branch to undertake a series of analyses to

assess the effect of specific tax expenditures on the

achievement of agencies’ performance objectives.

The Executive Branch is continuing to focus on the

availability of data needed to assess the effects of the

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

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

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

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

panel sample was drawn from tax returns filed in 2000

for tax year 1999. The sample will capture the changing

demographic and economic circumstances of individuals

and the effects of changes in tax law over an extended

period of time. Data from the sample will therefore

permit more extensive, and better, analyses of many

tax provisions than can be performed using only annual

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

panel sample will enhance our ability to analyze the

effect of tax expenditures designed to increase savings.

Other efforts by OMB, Treasury, and other agencies

to improve data available for the analysis of savings

tax expenditures will continue over the next several

years.

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.

Because there is an existing public administrative and

private compliance structure for the tax system, the
114 ANALYTICAL PERSPECTIVES

incremental administrative and compliance costs for a

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

some tax expenditures actually simplify the tax system,

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

gains on home sales). Tax expenditures also implicitly

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

have different economic effects. Finally, a variety of

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

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

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

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

be flexible and can have very different economic effects.

Tax expenditures also have limitations. In many

cases they add to the complexity of the tax system,

which raises both administrative and compliance costs.

For example, targeting personal exemptions and credits

can complicate filing and decisionmaking. The income

tax system may have little or no contact with persons

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

information on certain characteristics of individuals

used in some spending programs, such as wealth. These

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

Tax expenditures also generally do not enable the same

degree of agency discretion as an outlay program. For

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

with tax expenditures. Finally, tax expenditures may

not receive the same level of scrutiny afforded to other

programs.

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

such as equipping and providing the armed forces or

administering the system of justice. Outlay programs

may also be specifically designed to meet the needs

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

programs may also receive more year-to-year oversight

and fine tuning, through the legislative and executive

budget process. In addition, many different types of

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

governments, the private sector, or individuals in the

form of grants or contracts—provide flexibility for policy

design. On the other hand, certain outlay programs—

such as direct government service provision—may rely

less directly on economic incentives and private-market

provision than tax incentives, which may reduce the

relative efficiency of spending programs for some goals.

Spending programs also require resources to be raised

via taxes, user charges, or government borrowing,

which can impose further costs by diverting resources

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

Regulations have more direct and immediate effects

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

private sector. Regulations can also be fine-tuned more

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

largely upon voluntary compliance, rather than detailed

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

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

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

this feature can also promote full compliance where

(as in certain safety-related cases) policymakers believe

that trade-offs with economic considerations are not of

paramount importance. Also, regulations generally do

not directly affect Federal outlays or receipts. Thus,

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

that goes well beyond the analysis required for outlays

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

lack of formal analysis.

Some policy objectives are achieved using multiple

approaches. For example, minimum wage legislation,

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

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

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

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

saving for retirement or investing in certain sectors);

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

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

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

Also, many tax expenditures, including those cited

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

accelerated depreciation may encourage investment. In

addition, the economic effects of particular provisions

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

incomes may have positive or negative effects on tax

neutrality).

Performance measurement is generally concerned

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

expenditures, the principal input is usually the revenue

effect. Outputs are quantitative or qualitative measures

of goods and services, or changes in income and investment, directly produced by these inputs. Outcomes, in
6. TAX EXPENDITURES 115

turn, represent the changes in the economy, society,

or environment that are the ultimate goals of programs.

Thus, for a provision that reduces taxes on certain

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

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

inequity or unintended consequence in the tax code,

an important performance measure might be how they

change effective tax rates (the discounted present-value

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

distortions caused by taxes). Effects on the incomes of

members of particular groups may be an important

measure for certain provisions.

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

groups of tax expenditures. The discussion is intended

to be illustrative and not all encompassing. However,

it is premised on the assumption that the data needed

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

major challenge, and data constraints may limit the

assessment of the effectiveness of many provisions. In

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

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

tax preferences for military benefits reflect, among

other things, the view that benefits such as housing,

subsistence, and moving expenses are intrinsic aspects

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

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

associated with foreign earnings is targeted to benefit

U.S. Government civilian personnel working abroad by

offsetting the living costs that can be higher than those

in the United States. These tax expenditures should

be considered together with direct agency budget costs

in making programmatic decisions.

International affairs.—Tax expenditures are also

aimed at goals such as tax neutrality. These include

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

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

General science, space and technology; energy;

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

tax expenditures reduces the cost of investment, both

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

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

incentives by measuring their effects on the cost of

capital (the interest rate which investments must yield

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

of these provisions on the amounts of corresponding

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

some cases, such as research, there is evidence that

the investment can provide significant positive

externalities—that is, economic benefits that are not

reflected in the market transactions between private

parties. It could be useful to quantify these externalities

and compare them with the size of tax expenditures.

Measures could also indicate the effects on production

from these investments—such as numbers or values

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

extent to which the preferences increase production (as

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

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

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

scientific, and other information (such as the effects

of increased domestic fuel production on imports from

various regions, or the effects of various energy sources

on the environment).

Housing investment also benefits from tax expenditures. The mortgage interest deduction on personal residences is a tax expenditure because the value of owneroccupied housing services is not included in a taxpayer’s

taxable income. Taxpayers also may exclude up to

$500,000 of the capital gains from the sale of personal

residences. Measures of the effectiveness of these provisions could include their effects on increasing the extent

of home ownership and the quality of housing. 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 for home sales. Deductibility of State

and local property taxes assists with making housing

more affordable as well as easing the cost of providing

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

be evaluated for their effects on making such housing

more available and affordable. These provisions should

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

Transportation.—Employer-provided parking is a

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

taxation. The tax expenditure estimates reflect the cost
116 ANALYTICAL PERSPECTIVES

of parking that is leased by employers for employees;

an estimate is not currently available for the value

of parking owned by employers and provided to their

employees. The exclusion for employer-provided transit

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

could be compared with alternative transportation policies.

Community and regional development.—A series

of tax expenditures is intended to promote community

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

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

activity in disadvantaged areas. These provisions can

be compared with grants and other policies designed

to spur economic development.

Education, training, employment, and social

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

costs of raising children, and to promote a variety of

charitable activities. The education incentives can be

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

child credits are intended to adjust the tax system for

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

compared to other Federal tax and spending policies,

including related features of the tax system, such as

personal exemptions (which are not defined as a tax

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

tax reduction.

Health.—Individuals also benefit from favorable

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

and pooling of risks. The effects of insurance coverage

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

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

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

Income security, Social Security, and veterans

benefits and services.—Major tax expenditures in the

income security function benefit retirement savings,

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

might be evaluated in terms of their effects on boosting

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

as well as public savings or deficits). Interactions with

other programs, including Social Security, also may

merit analysis. As in the case of employer-provided

health insurance, analysis of employer-provided pension

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

Other provisions principally affect the incomes of

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

in contrast, should be evaluated for its effects on labor

force participation as well as the income it provides

lower-income workers.

General purpose fiscal assistance and interest.—

The tax-exemption for public purpose State and local

bonds reduces the costs of borrowing for a variety of

purposes (borrowing for non-public purposes is reflected

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

primarily relates to personal income taxes (property tax

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

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

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

bonds benefits savers who invest in these instruments.

The extent of these benefits and any effects on Federal

borrowing costs could be evaluated.

The above illustrative discussion, although broad, is

nevertheless incomplete, omitting important details

both for the provisions mentioned and the many that

are not explicitly cited. Developing a framework that

is sufficiently comprehensive, accurate, and flexible to

reflect the objectives and effects of the wide range of

tax expenditures will be a significant challenge. OMB,

Treasury, and other agencies will work together, as

appropriate, to address this challenge. As indicated

above, over the next few years the Executive Branch’s

focus will be on the availability of the data needed

to assess the effects of the tax expenditures designed

to increase savings.

Descriptions of Income Tax Provisions

Descriptions of the individual and corporate income

tax expenditures reported upon in this chapter follow.

These descriptions relate to current law as of December

31, 2001, and do not reflect proposals made elsewhere

in the Budget.

National Defense

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

amounts of pay related to combat service, are excluded

from income subject to tax.

International Affairs

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

abroad, worked in the private sector, and satisfied a

foreign residency requirement in 2001 may exclude up

to $78,000 in foreign earned income from U.S. taxes.
6. TAX EXPENDITURES 117

5The determination of whether a provision is a tax expenditure is made on the basis

of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under

general U.S. income tax principles. For that reason, the tax expenditure extimates include,

for example, estimtes related to the exclusion of extraterritorial income, as well as other

exclusions, notwithstanding that such exclusions define income under the general rule of

U.S. income taxation.

The exclusion increases to $80,000 in 2002 (and thereafter). In addition, if these taxpayers receive a specific

allowance for foreign housing from their employers,

they may also exclude the value of that allowance. If

they do not receive a specific allowance for housing

expenses, they may deduct against their U.S. taxes that

portion of such expenses that exceeds one-sixth the salary of a civil servant at grade GS–14, step 1 ($67,765

in 2001).

3. Exclusion of certain allowances for Federal

employees abroad.—U.S. Federal civilian employees

and Peace Corps members who work outside the continental United States are allowed to exclude from U.S.

taxable income certain special allowances they receive

to compensate them for the relatively high costs associated with living overseas. The allowances supplement

wage income and cover expenses like rent, education,

and the cost of travel to and from the United States.

4. Extraterritorial income exclusion5.—For purposes of calculating U.S. tax liability, a taxpayer may

exclude from gross income the qualifying foreign trade

income attributable to foreign trading gross receipts.

The exclusion generally applies to income from the sale

or lease of qualifying foreign trade property and certain

types of services income. The FSC Repeal and

Extraterritorial Income Exclusion Act of 2000 created

the extraterritorial income exclusion to replace the foreign sales corporation provisions, which the Act repealed. The exclusion is generally available for transactions entered into after September 30, 2000.

5. Sales source rule exceptions.—The worldwide

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

and a credit for foreign taxes paid is allowed. The

amount of foreign taxes that can be credited is limited

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

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

exporters to use more foreign tax credits by allowing

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

of earnings was based on actual economic activity.

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

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

The income becomes taxable only when the controlling

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

tax method, the currently attributable foreign source

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

distributed. Thus, the normal tax method considers the

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

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

income earned through December 31, 2001 can be deferred.

General Science, Space, and Technology

8. Expensing R&E expenditures.—Research and

experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue

for several years. It is often difficult, however, to identify whether a specific R&E project is successful and,

if successful, what its expected life will be. Under the

normal tax method, the expensing of R&E expenditures

is viewed as a tax expenditure. The baseline assumed

for the normal tax method is that all R&E expenditures

are successful and have an expected life of five years.

9. R&E credit.—The research and experimentation

(R&E) credit is 20 percent of qualified research expenditures in excess of a base amount. The base amount

is generally determined by multiplying a ‘‘fixed-base

percentage’’ by the average amount of the company’s

gross receipts for the prior four years. The taxpayer’s

fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through

1988. Taxpayers may also elect an alternative credit

regime. Under the alternative credit regime the taxpayer is assigned a three-tiered fixed-base percentage

that is lower than the fixed-base percentage that would

otherwise apply, and the credit rate is reduced (the

rates range from 2.65 percent to 3.75 percent). A 20-

percent credit with a separate threshold is provided

for a taxpayer’s payments to universities for basic research. The credit applies to research conducted before

July 1, 2004 and extends to research conducted in Puerto Rico and the U.S. possessions.

Energy

10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of

unsalvageable materials used in constructing wells)

may be expensed rather than amortized over the productive life of the property. Integrated oil companies

may deduct only 70 percent of such costs and must

amortize the remaining 30 percent over five years. The

same rule applies to the exploration and development

costs of surface stripping and the construction of shafts

and tunnels for other fuel minerals.

11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed

to take percentage depletion deductions rather than

cost depletion on limited quantities of output. Under

cost depletion, outlays are deducted over the productive

life of the property based on the fraction of the resource

extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent

for oil, gas and oil shale; and 10 percent for coal. The

deduction is limited to 50 percent of net income from

the property, except for oil and gas where the deduction

can be 100 percent of net property income. Production
118 ANALYTICAL PERSPECTIVES

from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit

on output and no limitation with respect to qualified

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

investment.

12. Alternative fuel production credit.—A nontaxable credit of $3 per oil-equivalent barrel of production (in 1979 dollars) is provided for several forms of

alternative fuels. The credit is generally available if

the price of oil stays below $29.50 (in 1979 dollars).

The credit generally expires on December 31, 2002.

13. Oil and gas exception to passive loss limitation.—Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations.

As a result, the working interest-holder, who manages

on behalf of himself and all other owners the development of wells and incurs all the costs of their operation,

may aggregate negative taxable income from such interests with his income from all other sources.

14. Capital gains treatment of royalties on

coal.—Sales of certain coal under royalty contracts can

be treated as capital gains rather than ordinary income.

15. Energy facility bonds.—Interest earned on

State and local bonds used to finance construction of

certain energy facilities is tax-exempt. These bonds are

generally subject to the State private-activity bond annual volume cap.

16. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for

tertiary oil recovery on U.S. projects. Qualifying costs

include tertiary injectant expenses, intangible drilling

and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property.

17. New technology credits.—A credit of 10 percent

is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from

renewable resources such as wind, biomass, and poultry

waste facilities. The renewable resources credit applies

only to electricity produced by a facility placed in service on or before December 31, 2001.

18. Alcohol fuel credits.—An income tax credit is

provided for ethanol that is derived from renewable

sources and used as fuel. The credit equals 53 cents

per gallon in 2001 and 2002; 52 cents per gallon in

2003 and 2004; and 51 cents per gallon in 2005, 2006,

and 2007. To the extent that ethanol is mixed with

taxable motor fuel to create gasohol, taxpayers may

claim an exemption of the Federal excise tax rather

than the income tax credit. In addition, small ethanol

producers are eligible for a separate 10 cents per gallon

credit.

19. Credit and deduction for clean-fuel vehicles

and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles

and owners of clean-fuel refueling property may deduct

part of their expenditures. The credit and deduction

are phased out from 2002 through 2005.

20. Exclusion of utility conservation subsidies.—

Non-business customers can exclude from gross income

subsidies received from public utilities for expenditures

on energy conservation measures.

Natural Resources and Environment

21. Exploration and development costs.—Certain

capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than

depreciated over the life of the asset.

22. Percentage depletion.—Most nonfuel mineral

extractors may use percentage depletion rather than

cost depletion, with percentage depletion rates ranging

from 22 percent for sulfur to 5 percent for sand and

gravel.

23. Sewage, water, solid and hazardous waste

facility bonds.—Interest earned on State and local

bonds used to finance the construction of sewage, water,

or hazardous waste facilities is tax-exempt. These bonds

are generally subject to the State private-activity bond

annual volume cap.

24. Capital gains treatment of certain timber.—

Certain timber sold under a royalty contract can be

treated as a capital gain rather than ordinary income.

25. Expensing multiperiod timber growing

costs.—Most of the production costs of growing timber

may be expensed rather than capitalized and deducted

when the timber is sold. In most other industries, these

costs are capitalized under the uniform capitalization

rules.

26. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20-

percent investment credit, but the depreciable basis

must be reduced by the full amount of the credit taken.

Agriculture

27. Expensing certain capital outlays.—Farmers,

except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for

feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though

these expenditures are for inventories held beyond the

end of the year, or for capital improvements that would

otherwise be capitalized.

28. Expensing multiperiod livestock and crop

production costs.—The production of livestock and

crops with a production period of less than two years

is exempt from the uniform cost capitalization rules.

Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale

with a production period of two years or more may

elect not to capitalize costs. If they do, they must apply

straight-line depreciation to all depreciable property

they use in farming.

29. Loans forgiven solvent farmers.—Farmers are

forgiven the tax liability on certain forgiven debt. Normally, a debtor must include the amount of loan forgiveness as income or reduce his recoverable basis in
6. TAX EXPENDITURES 119

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.

30. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops,

can be treated as capital gains rather than ordinary

income.

31. Income averaging for farmers.—Taxpayers can

lower their tax liability by averaging, over the prior

three-year period, their taxable income from farming.

32. Deferral of gain on sales of farm refiners.—

A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement

property.

Commerce and Housing

This category includes a number of tax expenditure

provisions that also affect economic activity in other

functional categories. For example, provisions related

to investment, such as accelerated depreciation, could

be classified under the energy, natural resources and

environment, agriculture, or transportation categories.

33. Credit union income.—The earnings of credit

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

34. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings

banks, and savings and loan associations may deduct

additions to bad debt reserves in excess of actually

experienced losses.

35. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided

for investment income within qualified life insurance

and annuity contracts. Investment income earned on

qualified life insurance contracts held until death is

permanently exempt from income tax. Investment income distributed prior to the death of the insured is

tax-deferred, if not tax-exempt. Investment income

earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits

from tax deferral without annual contribution or income

limits generally applicable to other tax-favored retirement income plans.

36. Small property and casualty insurance companies.—Insurance companies that have annual net

premium incomes of less than $350,000 are exempt

from tax; those with $350,000 to $2.1 million of net

premium incomes may elect to pay tax only on the

income earned by their investment portfolio.

37. Insurance companies owned by exempt organizations.—Generally, the income generated by life

and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations

conducted by such exempt organizations as fraternal

societies and voluntary employee benefit associations,

however, are exempt from tax.

38. Small life insurance company deduction.—

Small life insurance companies (gross assets of less

than $500 million) can deduct 60 percent of the first

$3 million of otherwise taxable income. The deduction

phases out for otherwise taxable income between $3

million and $15 million.

39. Mortgage housing bonds.—Interest earned on

State and local bonds used to finance homes purchased

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds

that can be issued to finance these and other private

activity is limited. The combined volume cap for private

activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial

development bonds is $62.50 per capita ($187.5 million

minimum) per State in 2001, and $75 per capita ($225

million minimum) in 2002. The Community Renewal

Tax Relief Act of 2000 accelerated the scheduled increase in the state volume cap and indexed the cap

for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax

credits for a specified percentage of interest on qualified

mortgages. The total amount of MCCs issued by a State

cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds.

40. Rental housing bonds.—Interest earned on

State and local government bonds used to finance multifamily rental housing projects is tax-exempt. At least

20 percent (15 percent in targeted areas) of the units

must be reserved for families whose income does not

exceed 50 percent of the area’s median income; or 40

percent for families with incomes of no more than 60

percent of the area median income. Other tax-exempt

bonds for multifamily rental projects are generally

issued with the requirement that all tenants must be

low or moderate income families. Rental housing bonds

are subject to the volume cap discussed in the mortgage

housing bond section above.

41. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on

their primary and secondary residences as itemized

nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the

owner’s basis in the residence and, for debt incurred

after October 13, 1987, it is limited to no more than

$1 million. Interest on up to $100,000 of other debt

secured by a lien on a principal or second residence

is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions

on personal residences are tax expenditures because

the value of owner-occupied housing services is not included in a taxpayer’s taxable income.

42. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their

primary and secondary residences even though they are
120 ANALYTICAL PERSPECTIVES

not required to report the value of owner-occupied housing services as gross income.

43. Installment sales.—Dealers in real and personal

property (i.e., sellers who regularly hold property for

sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment.

Nondealers (i.e., sellers of real property used in their

business) are required to pay interest on deferred taxes

attributable to their total installment obligations in excess of $5 million. Only properties with sales prices

exceeding $150,000 are includable in the total. The payment of a market rate of interest eliminates the benefit

of the tax deferral. The tax exemption for nondealers

with total installment obligations of less than $5 million

is, therefore, a tax expenditure.

44. Capital gains exclusion on home sales.—A

homeowner can exclude from tax up to $500,000

($250,000 for singles) of the capital gains from the sale

of a principal residence. The exclusion may not be used

more than once every two years.

45. Passive loss real estate exemption.—In general, passive losses may not offset income from other

sources. Losses up to $25,000 attributable to certain

rental real estate activity, however, are exempt from

this rule.

46. Low-income housing credit.—Taxpayers who

invest in certain low-income housing are eligible for

a tax credit. The credit rate is set so that the present

value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other

Federal benefits (such as tax-exempt bond financing),

or (2) substantially rehabilitated existing housing. The

credit is allowed in equal amounts over 10 years. State

agencies determine who receives the credit; States are

limited in the amount of credit they may authorize

annually. The Community Renewal Tax Relief Act of

2000 increased the per-resident limit to $1.50 in 2001

and to $1.75 in 2002 and indexed the limit for inflation,

beginning in 2003. The Act also created a $2 million

minimum annual cap for small States beginning in

2002; the cap is indexed for inflation, beginning in

2003.

47. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of

the reference law rules, and thus do not give rise to

tax expenditures under the reference method. Under

the normal tax method, however, 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.

48. Cancellation of indebtedness.—Individuals are

not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not

reported as current income, however, the basis of the

underlying property must be reduced by the amount

canceled.

49. Imputed interest rules.—Holders (issuers) of

debt instruments are generally required to report interest earned (paid) in the period it accrues, not when

paid. In addition, the amount of interest accrued is

determined by the actual price paid, not by the stated

principal and interest stipulated in the instrument. In

general, any debt associated with the sale of property

worth less than $250,000 is excepted from the general

interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but

is under normal law. Exceptions above $250,000 are

a tax expenditure under reference law; these exceptions

include the following: (1) sales of personal residences

worth more than $250,000, and (2) sales of farms and

small businesses worth between $250,000 and $1 million.

50. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held

for more than 1 year are taxed at a lower rate than

ordinary income. The lower rate on capital gains is

considered a tax expenditure under the normal tax

method but not under the reference law method.

For most assets held for more than 1 year, the top

capital gains tax rate is 20 percent. For assets acquired

after December 31, 2000, the top capital gains tax rate

for assets held for more than 5 years is 18 percent.

On January 1, 2001, taxpayers may mark-to-market

existing assets to start the 5-year holding period. Losses

from the mark-to-market are not recognized.

For assets held for more than 1 year by taxpayers

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

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

the top capital gains tax rate for assets held by these

taxpayers for more than 5 years is 8 percent.

51. Capital gains exclusion for small business

stock.—An exclusion of 50 percent is provided for capital gains from qualified small business stock held by

individuals for more than 5 years. A qualified small

business is a corporation whose gross assets do not

exceed $50 million as of the date of issuance of the

stock.

52. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are

not subject to capital gains taxes. The cost basis of

the appreciated assets is adjusted upward to the market value at the owner’s date of death. After repeal

of the estate tax under EGTRRA for 2010, the basis

for property acquired from a decedent will be the lesser

of fair market value or the decedent’s basis. Certain

types of additions to basis will be allowed so that assets

in most estates that are not currently subject to estate

tax will not be subject to capital gains tax in the hands

of the heirs.

53. Carryover basis of capital gains on gifts.—

When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the

transferred property was first acquired) carries-over to

the donee. The carryover of the donor’s basis allows

a continued deferral of unrealized capital gains. Even

though the estate tax is repealed for 2010 under

EGTRRA, the gift tax is retained with a lifetime exemption of $1 million.
6. TAX EXPENDITURES 121

54. Ordinary income treatment of losses from

sale of small business corporate stock shares.—

Up to $100,000 in losses from the sale of small business

corporate stock (capitalization less than $1 million) may

be treated as ordinary losses. Such losses would, thus,

not be subject to the $3,000 annual capital loss writeoff limit.

55. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus

do not give rise to tax expenditures under reference

law. Under normal law, however, a 40-year life for nonrental-housing buildings is the norm. Thus, the 39-year

depreciation period for property placed in service after

February 25, 1993, the 31.5-year depreciation period

for property placed in service from 1987 to February

25, 1993, and the pre-1987 depreciation periods create

a tax expenditure.

56. Accelerated depreciation of machinery and

equipment.—The tax depreciation allowance provisions

are part of the reference law rules, and thus do not

give rise to tax expenditures under reference law.

Under the normal tax baseline, this tax depreciation

allowance is measured relative to straight-line depreciation using Asset Depreciation Range (ADR) lives. Statutory depreciation of machinery and equipment is accelerated relative to this baseline, thereby creating a tax

expenditure under the normal tax rules.

57. Expensing of certain small investments.—In

2001, qualifying investments in tangible property up

to $24,000 can be expensed rather than depreciated

over time. The expensing limit increases to $25,000

in 2003. To the extent that qualifying investment during the year exceeds $200,000, the amount eligible for

expensing is decreased. In 2001, the amount expensed

is completely phased out when qualifying investments

exceed $224,000.

58. Business start-up costs.—When taxpayers enter

into a new business, certain start-up expenses, such

as the cost of legal services, are normally incurred.

Taxpayers may elect to amortize these outlays over 60

months even though they are similar to other payments

made for nondepreciable intangible assets that are not

recoverable until the business is sold. The normal tax

method treats this amortization as a tax expenditure;

the reference tax method does not.

59. Graduated corporation income tax rate

schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000

of taxable income, 25 percent on the next $25,000, and

34 percent on the next $9.925 million. Compared with

a flat 34-percent rate, the lower rates provide an

$11,750 reduction in tax liability for corporations with

taxable income of $75,000. This benefit is recaptured

for corporations with taxable incomes exceeding

$100,000 by a 5-percent additional tax on corporate

incomes in excess of $100,000 but less than $335,000.

The corporate tax rate is 35 percent on income over

$10 million. Compared with a flat 35-percent tax rate,

the 34-percent rate provides a $100,000 reduction in

tax liability for corporations with taxable incomes of

$10 million. This benefit is recaptured for corporations

with taxable incomes exceeding $15 million by a 3-

percent additional tax on income over $15 million but

less than $18.33 million. Because the corporate rate

schedule is part of reference tax law, it is not considered a tax expenditure under the reference method.

A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower

rates is considered a tax expenditure under this concept.

60. Small issue industrial development bonds.—

Interest earned on small issue industrial development

bonds (IDBs) issued by State and local governments

to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must

be depreciated, however, using the straight-line method.

The annual volume of small issue IDBs is subject to

the unified volume cap discussed in the mortgage housing bond section above.

Transportation

61. Deferral of tax on U.S. shipping companies.—

Certain companies that operate U.S. flag vessels can

defer income taxes on that portion of their income used

for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment

of loans to finance these investments. Once indefinite,

the deferral has been limited to 25 years since January

1, 1987.

62. Exclusion of employee parking expenses.—

Employee parking expenses that are paid for by the

employer or that are received in lieu of wages are excludable from the income of the employee. In 2001,

the maximum amount of the parking exclusion is $180

(indexed) per month. The tax expenditure estimate does

not include parking at facilities owned by the employer.

63. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in

lieu of wages to defray an employee’s commuting costs

are excludable from the employee’s income. In 2001,

the maximum amount of the exclusion is $65 (indexed)

per month. In 2002, the maximum amount of the exclusion increases to $100 (indexed) per month.

Community and Regional Development

64. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation

of buildings that are used for business or productive

activities and that were erected before 1936 for other

than residential purposes. The taxpayer’s recoverable

basis must be reduced by the amount of the credit.

65. Airport, dock, and similar facility bonds.—

Interest earned on State and local bonds issued to finance high-speed rail facilities and government-owned

airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to

a volume cap.
122 ANALYTICAL PERSPECTIVES

66. Exemption of income of mutuals and cooperatives.—The incomes of mutual and cooperative telephone and electric companies are exempt from tax if

at least 85 percent of their revenues are derived from

patron service charges.

67. Empowerment zones, enterprise communities,

and renewal communities.—Qualifying businesses in

designated economically depressed areas can receive tax

benefits such as an employer wage credit, increased

expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain

capital gains incentives. In addition, certain first-time

buyers of a principal residence in the District of Columbia can receive a tax credit on homes purchased on

or before December 31, 2003, and investors in certain

D.C. property can receive a capital gains break. The

Community Renewal Tax Relief Act of 2000 created

the renewal communities tax benefits, which begin on

January 1, 2002 and expire on December 31, 2009.

The Act also created additional empowerment zones,

increased the tax benefits for empowerment zones, and

extended the expiration date of (1) empowerment zones

from December 31, 2004 to December 31, 2009, and

(2) the D.C. home-buyer credit from December 31, 2001

to December 31, 2003.

68. New markets tax credit.—Taxpayers who invest

in a community development entity (CDE) after December 31, 2000 are eligible for a tax credit. The total

equity investment available for the credit across all

CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and

2003, $2.0 billion in 2004 and 2005, and $3.5 billion

in 2006 and 2007. The amount of the credit equals

(1) 5 percent in the year of purchase and the following

2 years, and (2) 6 percent in the following 4 years.

A CDE is any domestic firm whose primary mission

is to serve or provide investment capital for low-income

communities/individuals; a CDE must be accountable

to residents of low-income communities. The Community Renewal Tax Relief Act of 2000 created the new

markets tax credit.

69. Expensing of environmental remediation

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

costs, rather than capitalize the costs, even though the

expenses will generally increase the value of the property significantly or appreciably prolong the life of the

property. The expensing only applies to clean-up costs

incurred on or before December 31, 2003. The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2001 to December 31,

2003. The Act also expanded the number of qualified

sites.

Education, Training, Employment, and Social

Services

70. Scholarship and fellowship income.—Scholarships and fellowships are excluded from taxable income

to the extent they pay for tuition and course-related

expenses of the grantee. Similarly, tuition reductions

for employees of educational institutions and their families are not included in taxable income. From an economic point of view, scholarships and fellowships are

either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus,

under the reference law method, this exclusion is not

a tax expenditure because this method does not include

either gifts or price reductions in a taxpayer’s gross

income. The exclusion, however, is considered a tax expenditure under the normal tax method, which includes

gift-like transfers of government funds in gross income

(many scholarships are derived directly or indirectly

from government funding).

71. HOPE tax credit.—The non-refundable HOPE

tax credit allows a credit for 100 percent of an eligible

student’s first $1,000 of tuition and fees and 50 percent

of the next $1,000 of tuition and fees. The credit only

covers tuition and fees paid during the first two years

of a student’s post-secondary education. The credit is

phased out ratably for taxpayers with modified AGI

between $80,000 and $100,000 ($40,000 and $50,000

for singles) (indexed beginning in 2002).

72. Lifetime learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for

20 percent of an eligible student’s tuition and fees. For

tuition and fees paid before January 1, 2003, the maximum credit per return is $1,000. For tuition and fees

paid after December 31, 2002, the maximum credit per

return is $2,000. The credit is phased out ratably for

taxpayers with modified AGI between $80,000 and

$100,000 ($40,000 and $50,000 for singles) (indexed beginning in 2002). The credit applies to both undergraduate and graduate students.

73. Deduction for higher education expenses.—

EGTRRA provides a new above-the-line deduction for

qualified higher education expenses. The maximum annual deduction is $3,000 beginning in 2002 for taxpayers with adjusted gross income up to $130,000 on

a joint return ($65,000 for singles). The maximum deduction increases to $4,000 in 2004. Taxpayers with

adjusted gross income up to $160,000 on a joint return

($80,000 for singles) may deduct up to $2,000 beginning

in 2004. No deduction is allowed for expenses paid after

December 31, 2005.

74. Education Individual Retirement Accounts.—

Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is

not taxed when earned, and investment income from

an education IRA is tax-exempt when withdrawn to

pay for a student’s tuition and fees. The maximum contribution to an education IRA in 2001 is $500 per beneficiary. In 2001, 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). EGTRRA increases the maximum contribution to

$2,000 and the phase-out range for joint filers to

$190,000 through $220,000 of modified AGI, double the

range of singles. EGTRRA also allows elementary and

secondary school expenses to be paid tax-free from such

accounts.
6. TAX EXPENDITURES 123

75. Student-loan interest.—Taxpayers may claim

an above-the-line deduction of up to $2,500 on interest

paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. In 2001, 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). EGTRRA increased the income thresholds

for the phase down to $100,000 and $130,000 ($50,000

and $65,000 for singles) (indexed) and repealed the five

year rule for interest payments made after December

21, 2001.

76. State prepaid tuition plans.—Some States

have adopted prepaid tuition plans and prepaid room

and board plans, which allow persons to pay in advance

for college expenses for designated beneficiaries. In

2001 taxes on the earnings from these plans are paid

by the beneficiaries and are deferred until tuition is

actually paid. Beginning in 2002, investment income

is not taxed when earned, and is tax-exempt when

withdrawn to pay for qualified expenses. These changes

were the result of EGTRRA.

77. Student-loan bonds.—Interest earned on State

and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds

that each State may issue annually is limited.

78. Bonds for private nonprofit educational institutions.—Interest earned on State and local government bonds issued to finance the construction of facilities used by private nonprofit educational institutions

is not taxed.

79. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds

receive a non-refundable tax credit (at a rate set by

the Treasury Department) rather than interest. The

credit is included in gross income. Proceeds from zone

academy bonds may only be used to renovate, but not

construct, qualifying schools and for certain other

school purposes. The total amount of zone academy

bonds that may be issued is limited to $1.6 billion—

$400 million in each year from 1998 to 2001.

80. U.S. savings bonds for education.—Interest

earned on U.S. savings bonds issued after December

31, 1989 is tax-exempt if the bonds are transferred

to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers

with AGI between $83,650 and $113,650 ($55,750 and

$70,750 for singles) in 2001.

81. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent

children age 19 or over who (1) receive parental support

payments of $1,000 or more per year, (2) are full-time

students, and (3) do not claim a personal exemption

on their own tax returns.

82. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the assets’ current value without being taxed on

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent

of adjusted gross income; a corporation’s total charitable

contributions generally may not exceed 10 percent of

pre-tax income.

83. Employer-provided educational assistance.—

Employer-provided educational assistance is excluded

from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. EGTRRA permanently extended this exclusion and extended the exclusion to also include graduate education (beginning in 2002).

84. Work opportunity tax credit.—Employers can

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2001

and who are certified as members of various targeted

groups. The amount of the credit that can be claimed

is 25 percent for employment of less than 400 hours

and 40 percent for employment of 400 hours or more.

The maximum credit per employee is $2,400 and can

only be claimed on the first year of wages an individual

earns from an employer. Employers must reduce their

deduction for wages paid by the amount of the credit

claimed.

85. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible

wages paid to qualified long-term family assistance recipients during the first two years of employment. The

credit is 35 percent of the first $10,000 of wages in

the first year of employment and 50 percent of the

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The

credit applies to wages paid to employees who are hired

on or before December 31, 2001.

86. Employer-provided child care exclusion.—

Employer-provided child care is excluded from an employee’s gross income even though the employer’s costs

for the child care are a deductible business expense.

87. Employer-provided child care credit.—Employers can deduct expenses for supporting child care

or child care resource and referral services. EGTRRA

provides a tax credit to employers for qualified expenses

beginning in 2002. The credit is equal to 25 percent

of qualified expenses for employee child care and 10

percent of qualified expenses for child care resource

and referral services. Employer deductions for such expenses are reduced by the amount of the credit. The

maximum total credit is limited to $150,000 per taxable

year.

88. Assistance for adopted foster children.—Taxpayers who adopt eligible children from the public foster care system can receive monthly payments for the

children’s significant and varied needs and a reimbursement of up to $2,000 for nonrecurring adoption expenses. These payments are excluded from gross income.

89. Adoption credit and exclusion.—Taxpayers can

receive a nonrefundable tax credit for qualified adoption

expenses. The maximum credit is $5,000 per child

($6,000 for special needs adoptions) for 2001. The credit

is phased-out ratably for taxpayers with modified AGI
124 ANALYTICAL PERSPECTIVES

between $75,000 and $115,000 in 2001. EGTRRA increased the maximum credit for non-special needs children to $10,000, set a flat credit amount of $10,000

for special needs children, and increased the start point

of the phase-out to $150,000 beginning in 2002. The

credit amounts and the phase-out thresholds are indexed for inflation beginning in 2003. Unused credits

may be carried forward and used during the five subsequent years. Taxpayers may also exclude qualified

adoption expenses from income, subject to the same

maximum amounts and phase-out as the credit. The

same expenses cannot qualify for tax benefits under

both programs; however, a taxpayer may use the benefits of the exclusion and the tax credit for different

expenses. Stepchild adoptions are not eligible for either

benefit. Both the credit and the exclusion were made

permanent by EGTRRA.

90. Employer-provided meals and lodging.—Employer-provided meals and lodging are excluded from

an employee’s gross income even though the employer’s

costs for these items are a deductible business expense.

91. Child credit.—Taxpayers with children under

age 17 can qualify for a $600 refundable per child credit. The maximum credit is increased to $700 in 2005,

$800 in 2009, and $1,000 in 2010. The credit is phased

out for taxpayers at the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 for singles).

92. Child and dependent care expenses.—Married

couples with child and dependent care expenses may

claim a tax credit when one spouse works full time

and the other works at least part time or goes to school.

The credit may also be claimed by single parents and

by divorced or separated parents who have custody of

children. Expenditures up to a maximum $2,400 for

one dependent and $4,800 for two or more dependents

are eligible for the credit. EGTRRA increased the maximum expenditure limit to $3,000 for one dependent

and $6,000 for two or more dependents beginning in

2003. The credit is equal to 30 percent of qualified

expenditures (35 percent beginning in 2003) for taxpayers with incomes of $10,000 or less ($15,000 or less

beginning in 2003). The credit is reduced to a minimum

of 20 percent by one percentage point for each $2,000

of income in excess of $10,000 ($15,000 beginning in

2003).

93. Disabled access expenditure credit.—Small

businesses (less than $1 million in gross receipts or

fewer than 31 full-time employees) can claim a 50-percent credit for expenditures in excess of $250 to remove

access barriers for disabled persons. The credit is limited to $5,000.

94. Charitable contributions, other than education and health.—Taxpayers may deduct contributions to charitable, religious, and certain other nonprofit organizations. Taxpayers who donate capital assets to charitable organizations can deduct the assets’

current value without being taxed on any appreciation

in value. An individual’s total charitable contribution

generally may not exceed 50 percent of adjusted gross

income; a corporation’s total charitable contributions

generally may not exceed 10 percent of pre-tax income.

95. Foster care payments.—Foster parents provide

a home and care for children who are wards of the

State, under contract with the State. Compensation received for this service is excluded from the gross incomes of foster parents; the expenses they incur are

nondeductible.

96. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income.

Health

97. Employer-paid medical insurance and expenses.—Employer-paid health insurance premiums

and other medical expenses (including long-term care)

are deducted as a business expense by employers, but

they are not included in employee gross income. The

self-employed also may deduct part of their family

health insurance premiums.

98. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums.

Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 2001, 70 percent in

2002, and 100 percent in 2003 and thereafter.

99. Workers compensation insurance premiums.—Workers compensation insurance premiums

are paid by employers and deducted as a business expense, but the premiums are not included in employee

gross income.

100. Medical savings accounts.—Some employees

may deduct annual contributions to a medical savings

account (MSA); employer contributions to MSAs (except

those made through cafeteria plans) for qualified employees are also excluded from income. An employee

may contribute to an MSA in a given year only if the

employer does not contribute to the MSA in that year.

MSAs are only available to self-employed individuals

or employees covered under an employer-sponsored high

deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the

deductible under the high deductible plan for family

coverage (65 percent for individual coverage). Earnings

from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No

new MSAs may be established after December 31, 2002.

The Community Renewal Tax Relief Act of 2000 extended the expiration date from December 31, 2000

to December 31, 2002.

101. Medical care expenses.—Personal expenditures for medical care (including the costs of prescription drugs) exceeding 7.5 percent of the taxpayer’s adjusted gross income are deductible.

102. Hospital construction bonds.—Interest earned

on State and local government debt issued to finance
6. TAX EXPENDITURES 125

hospital construction is excluded from income subject

to tax.

103. Charitable contributions to health institutions.—Individuals and corporations may deduct contributions to nonprofit health institutions. Tax expenditures resulting from the deductibility of contributions

to other charitable institutions are listed under the education, training, employment, and social services function.

104. Orphan drugs.—Drug firms can claim a tax

credit of 50 percent of the costs for clinical testing required by the Food and Drug Administration for drugs

that treat rare physical conditions or rare diseases.

105. Blue Cross and Blue Shield.—Blue Cross and

Blue Shield health insurance providers in existence on

August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that

substantially reduce (or even eliminate) their tax liabilities.

Income Security

106. 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.

107. Workers’ compensation benefits.—Workers

compensation provides payments to disabled workers.

These benefits, although income to the recipients, are

not subject to the income tax.

108. 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.

109. 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.

110. Military disability pensions.—Most of the

military pension income received by current disabled

retired veterans is excluded from their income subject

to tax.

111. 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.

112. 401(k) plans.—Individual taxpayers can make

tax-preferred contributions to certain types of employerprovided 401(k) plans (and 401(k)-type plans like 403(b)

plans and the Federal government’s Thrift Savings

Plan). In 2001, an employee could exclude up to $10,500

(indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k) plan. EGTRRA increases the exclusion amount to $11,000 in 2002,

$12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and

$15,000 in 2006 (indexed thereafter). The tax on the

investment income earned by 401(k)-type plans is deferred until withdrawn.

EGTRRA also allows employees to make after-tax

contributions to 401(k) and 401(k)-type plans beginning

in 2002. These contributions are not excluded from AGI,

but the investment income of such after-tax contributions is not taxed when earned or withdrawn.

113. Individual Retirement Accounts.—Individual

taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs,

non-deductible IRAs, and Roth IRAs. In 2001, employees can make annual contributions to an IRA up to

$2,000 (or 100 percent of compensation, if less). The

annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. EGTRRA increases the IRA contribution

limit to $3,000 in 2002, $4,000 in 2005, and $5,000

in 2008 (indexed thereafter) and allows taxpayers over

age 50 to make additional ‘‘catch-up’’ contributions of

$1,000 (by 2006).

Taxpayers whose AGI is below $53,000 ($33,000 for

non-joint filers) in 2001 can claim a deduction for IRA

contributions. In 2001, the IRA deduction is phased

out for taxpayers with AGI between $53,000 and

$63,000 ($33,000 and $43,000 for non-joint). The phaseout range increases annually until it reaches $80,000

to $100,000 in 2007 ($50,000 to $60,000 in 2005 for

non-joint filers). Taxpayers whose AGI is above the

phase-out range can also claim a deduction for their

IRA contributions depending on whether they (or their

spouse) are an active participant in an employer-provided retirement plan. The tax on the investment income earned by 401(k) plans, non-deductible IRAs, and

deductible IRAs is deferred until the money is withdrawn.

Taxpayers with incomes below $150,000 ($90,000 for

nonjoint filers) can make contributions to Roth IRAs.

The maximum contribution to a Roth IRA is phased

out for taxpayers with AGI between $150,000 and

$160,000 ($95,000 and $110,000 for singles). Investment

income of a Roth IRA is not taxed when earned nor

when withdrawn. Withdrawals from a Roth IRA are

penalty free if: (1) the Roth IRA was opened at least

5 years before the withdrawal, and (2) the taxpayer

either (a) is at least 59–1/2, (b) dies, (c) is disabled,

or (d) purchases a first-time house.

Taxpayers can contribute to a non-deductible IRA regardless of their income and whether they are an active

participant in an employer-provided retirement plan.

The tax on investment income earned by non-deductible

IRAs is deferred until the money is withdrawn.

114. Low and moderate income savers’ credit.—

EGTRRA provides an additional incentive for lowerincome taxpayers to save through a nonrefundable credit of up to 50 percent on IRA contributions. This credit

is in addition to any deduction or exclusion. The credit

is completely phased out by $50,000 for joint filers and

$25,000 for single filers. This temporary credit is in

effect from 2002 through 2006.
126 ANALYTICAL PERSPECTIVES

115. 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 $35,000 in 2001. Total plan contributions are limited to 15 percent of a firm’s total wages.

EGTRRA increases the percent of pay limit to 100 percent of the income of the self-employed by 2005 and

increases the dollar limit on contributions to $40,000

beginning in 2002. EGTRRA also increased the plan

limit to 25 percent of a firm’s total wages and excluded

employee contributions from this limit beginning in

2002. The tax on the investment income earned by

Keogh plans is deferred until withdrawn.

116. 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.

117. Small business retirement plan credit.—

EGTRRA provides businesses with 100 or fewer employees a credit for 50 percent of the qualified startup costs

associated with a new qualified retirement plan. The

credit is limited to $500 annually and may only be

claimed for expenses incurred during the first three

years from the start of the qualified plan. Qualified

startup expenses include expenses related to the establishment and administration of the plan, and the retirement-related education of employees. The credit applies

to costs incurred beginning in 2002.

118. 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.

119. Employer-provided supplementary unemployment benefits.—Employers may establish trusts

to pay supplemental unemployment benefits to employees separated from employment. Interest payments to

such trusts are exempt from taxation.

120. 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.

121. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,100

standard deduction if single, or $900 if married.

122. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,100 standard deduction if single, or $900 if

married.

123. 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.

124. 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.

125. Earned income tax credit (EITC).—The EITC

may be claimed by low income workers. For a family

with one qualifying child, the credit is 34 percent of

the first $7,140 of earned income in 2001. The credit

is 40 percent of the first $10,020 of income for a family

with two or more qualifying children. The credit is

phased out beginning when the taxpayer’s income exceeds $13,090 at the rate of 15.98 percent (21.06 percent if two or more qualifying children are present).

It is completely phased out when the taxpayer’s modified adjusted gross income reaches $28,281 ($32,121 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 2001,

the credit is 7.65 percent of the first $4,760 of earned

income. When the taxpayer’s income exceeds $5,950,

the credit is phased out at the rate of 7.65 percent.

It is completely phased out at $10,710 of modified adjusted gross income.

For workers with or without children, the income

levels at which the credit begins to phase-out and the

maximum amounts of income on which the credit can

be taken are adjusted for inflation. For married taxpayers filing a joint return, EGTRRA increases the base

amount for the phase-out by $1,000 in 2002 through

2004, $2,000 in 2005 through 2007, and $3,000 in 2008

(indexed thereafter). Earned income tax credits in excess of tax liabilities owed through the individual income tax system are refundable to individuals. This

portion of the credit is shown as an outlay, while the
6. TAX EXPENDITURES 127

amount that offsets tax liabilities is shown as a tax

expenditure.

Social Security

126. 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.

127. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund,

for disability and for dependents and survivors, are excluded from a beneficiary’s gross incomes.

128. Social Security benefits for dependents and

survivors.—Benefit payments from the Social Security

Trust Fund for dependents and survivors are excluded

from a beneficiary’s gross income.

Veterans Benefits and Services

129. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded

from taxable income.

130. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income.

131. G.I. Bill benefits.—G.I. Bill benefits paid by

the Veterans Administration are excluded from gross

income.

132. 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

133. Public purpose State and local bonds.—Interest earned on State and local government bonds

issued to finance public-purpose construction (e.g.,

schools, roads, sewers), equipment acquisition, and

other public purposes is tax-exempt. Interest on bonds

issued by Indian tribal governments for essential governmental purposes is also tax-exempt.

134. 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.

135. Business income earned in U.S. possessions.—U.S. corporations operating in a U.S. possession

(e.g., Puerto Rico) can claim a credit against some or

all of their U.S. tax liability on possession business

income. The credit expires December 31, 2005.

Interest

136. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until

the bonds are redeemed.