315

19. TAX EXPENDITURES 

The Congressional Budget Act of 1974 (Public Law 

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

included in the budget. Tax expenditures are defined 

in the law as ‘‘revenue losses attributable to provisions 

of the Federal tax laws which allow a special exclusion, 

exemption, or deduction from gross income or which 

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

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

as alternatives to other policy instruments, such as 

spending or regulatory programs. Identification and 

measurement of tax expenditures depends importantly 

on the baseline tax system against which the actual 

tax system is compared. 

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

sizeable deferrals, deductions and exclusions are provided for employer contributions for medical insurance, 

pension contributions and earnings, capital gains, and 

payments of State and local individual income and 

property taxes. Reported tax expenditures under the 

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

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

Each tax expenditure estimate in this chapter was 

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

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

interactions among provisions. For that reason, this 

chapter does not present a grand total for the estimated 

tax expenditures. Moreover, past tax changes entailing 

broad elimination of tax expenditures were generally 

accompanied by changes in tax rates or other basic 

provisions, so that the net effects on Federal revenues 

were considerably (if not totally) offset. 

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

2004–2010 using three methods of accounting: revenue 

effects, outlay equivalents, and present values. The 

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

deferrals of tax payments into the future. 

The section of the chapter on performance measures 

and economic effects presents information related to 

assessment of the effect of tax expenditures on the 

achievement of program performance goals. This section 

is a complement to the Government-wide performance 

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

The 2004 and 2005 Budgets included a thorough review of important ambiguities in the tax expenditure 

concept. In particular, this review focused on defining 

tax expenditures relative to a comprehensive income 

tax baseline, defining tax expenditures relative to a 

broad-based consumption tax baseline, and defining 

negative tax expenditures, i.e., provisions of current law 

that over-tax certain items or activities. A similar review is presented in the Appendix again this year. 

TAX EXPENDITURES IN THE INCOME TAX 

Tax Expenditure Estimates 

All tax expenditure estimates presented here are 

based upon current tax law enacted as of December 

31, 2004. Expired or repealed provisions are not listed 

if their revenue effects result only from taxpayer activity occurring before fiscal year 2004. 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 2004–2010 are displayed according to the 

budget’s functional categories in Table 19–1. Descriptions of the specific tax expenditure provisions follow 

the tables of estimates and the discussion of general 

features of the tax expenditure concept. 

As in prior years, two baseline concepts, the normal 

tax baseline and the reference tax law baseline, are 

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

of the 1985 Budget, where the former is referred to 

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

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

However, items treated as tax expenditures under the 

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

are zero using the reference tax rules. The alternative 

baseline concepts are discussed in detail following the 

tables. 

Table 19–2 reports the respective portions of the total 

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

not imply that these categories of filers benefit from 

the special tax provisions in proportion to the respective 

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

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

capital, depending on economic forces. 

Table 19–3 ranks the major tax expenditures by the 

size of their 2006–2010 revenue effect. 

Interpreting Tax Expenditure Estimates 

The estimates shown for individual tax expenditures 

in Tables 19–1, 19–2, and 19–3 do not necessarily equal 

the increase in Federal revenues (or the change in the 

budget balance) that would result from repealing these 

special provisions, for the following reasons. 

Eliminating a tax expenditure may have incentive 

effects that alter economic behavior. These incentives 

can affect the resulting magnitudes of the activity or 

of other tax provisions or Government programs. For 

example, if capital gains were taxed at ordinary rates, 

capital gain realizations would be expected to decline, 

potentially resulting in a decline in tax receipts. Such 

behavioral effects are not reflected in the estimates. 

Tax expenditures are interdependent even without 

incentive effects. Repeal of a tax expenditure provision 

can increase or decrease the tax revenues associated 

with other provisions. For example, even if behavior 

does not change, repeal of an itemized deduction could 

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

brackets. Alternatively, repeal of an itemized deduction 

could lower the revenue cost from other deductions if 

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

repealed simultaneously, the increase in tax liability 

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

estimates reported in Table 19–1 are the totals of individual and corporate income tax revenue effects reported in Table 19–2 and do not reflect any possible 

interactions between individual and corporate income 

tax receipts. For this reason, the estimates in Table 

19–1 should be regarded as approximations. 

Present-Value Estimates 

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

Table 19–4. Cash-based estimates reflect the difference 

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

from prior years. Although such estimates are useful 

as a measure of cash flows into the Government, they 

do not accurately reflect the true economic cost of these 

provisions. For example, for a provision where activity 

levels have changed, so that incoming tax receipts from 

past deferrals are greater than deferred receipts from 

new activity, the cash-basis tax expenditure estimate 

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

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

deferral provision, a cash-based estimate can overstate 

the real effect on receipts to the Government because 

the newly deferred taxes will ultimately be received. 

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

Discounted present-value estimates of revenue effects 

are presented in Table 19–4 for certain provisions that 

involve tax deferrals or other long-term revenue effects. 

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

The present-value estimates represent the revenue 

effects, net of future tax payments, that follow from 

activities undertaken during calendar year 2004 which 

cause the deferrals or other long-term revenue effects. 

For instance, a pension contribution in 2004 would 

cause a deferral of tax payments on wages in 2004 

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

the 2004 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. 

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 19–5.
19. TAX EXPENDITURES 317

Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES 

(in millions of dollars) 

Total from corporations and individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10

National Defense 

1 Exclusion of benefits and allowances to armed forces personnel ........................................................... 2,460 2,490 2,520 2,540 2,560 2,590 2,620 12,830

International affairs: 

2 Exclusion of income earned abroad by U.S. citizens ............................................................................... 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570

3 Exclusion of certain allowances for Federal employees abroad .............................................................. 850 900 950 1,000 1,050 1,100 1,160 5,260

4 Extraterritorial income exclusion ................................................................................................................ 5,500 5,170 4,270 1,820 220 40 20 6,370

5 Inventory property sales source rules exception ....................................................................................... 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980

6 Deferral of income from controlled foreign corporations (normal tax method) ........................................ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740

7 Deferred taxes for financial firms on certain income earned overseas ................................................... 2,130 2,190 2,260 960 .............. .............. .............. 3,220

General science, space, and technology 

8 Expensing of research and experimentation expenditures (normal tax method) ..................................... –2,330 4,110 7,920 6,990 6,260 5,360 4,800 31,330

9 Credit for increasing research activities ..................................................................................................... 4,680 5,130 2,140 910 390 180 50 3,670

Energy 

10 Expensing of exploration and development costs, fuels ........................................................................... 260 400 370 280 240 190 140 1,220

11 Excess of percentage over cost depletion, fuels ...................................................................................... 1,320 1,280 1,350 1,420 1,470 1,510 1,550 7,300

12 Alternative fuel production credit ................................................................................................................ 1,040 1,040 1,040 1,040 420 .............. .............. 2,500

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 .............................................................................................. 70 70 80 80 100 70 60 390

15 Exclusion of interest on energy facility bonds ........................................................................................... 100 100 110 110 120 120 130 590

16 Enhanced oil recovery credit ...................................................................................................................... 330 340 340 350 360 370 390 1,810

17 New technology credit ................................................................................................................................ 330 470 620 700 800 820 690 3,630

18 Alcohol fuel credits 1 ................................................................................................................................... 30 30 30 30 40 40 40 180

19 Tax credit and deduction for clean-fuel burning vehicles ......................................................................... 70 70 50 –20 –70 –80 –60 –180

20 Exclusion of conservation subsidies provided by public utilities .............................................................. 100 100 100 100 90 90 90 470

Natural resources and environment 

21 Expensing of exploration and development costs, nonfuel minerals ....................................................... 230 230 250 250 250 270 270 1,290

22 Excess of percentage over cost depletion, nonfuel minerals ................................................................... .............. .............. .............. .............. .............. .............. 10 10

23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ................................ 500 530 570 600 630 650 680 3,130

24 Capital gains treatment of certain timber income ..................................................................................... 70 70 80 80 100 70 60 390

25 Expensing of multiperiod timber growing costs ......................................................................................... 340 350 370 380 400 410 430 1,990

26 Tax incentives for preservation of historic structures ............................................................................... 300 320 330 340 360 380 400 1,810

27 Expensing of capital costs with respect to complying with EPA sulfur regulations ................................ .............. 10 .............. 10 20 40 10 90

28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ............................................. .............. .............. .............. –10 –30 –40 –40 –120

Agriculture 

29 Expensing of certain capital outlays .......................................................................................................... 100 110 130 130 130 140 140 670

30 Expensing of certain multiperiod production costs .................................................................................... 50 60 70 70 80 80 80 380

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

32 Capital gains treatment of certain income ................................................................................................. 670 730 760 820 990 720 580 3,870

33 Income averaging for farmers .................................................................................................................... 40 40 40 40 40 40 40 200

34 Deferral of gain on sale of farm refiners ................................................................................................... 10 10 10 20 20 20 20 90

35 Bio-Diesel tax credit ................................................................................................................................... .............. 30 30 10 .............. .............. .............. 40

Commerce and housing 

Financial institutions and insurance: 

36 Exemption of credit union income ......................................................................................................... 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550

37 Excess bad debt reserves of financial institutions ................................................................................ –20 –20 –10 –10 –10 .............. .............. –30

38 Exclusion of interest on life insurance savings ..................................................................................... 20,830 22,750 24,070 26,180 28,770 30,980 33,610 143,610

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

40 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................ 180 190 210 220 230 250 260 1,170

41 Small life insurance company deduction ............................................................................................... 80 80 80 80 80 80 80 400

Housing: 

42 Exclusion of interest on owner-occupied mortgage subsidy bonds ..................................................... 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470

43 Exclusion of interest on rental housing bonds ...................................................................................... 360 390 410 420 460 470 480 2,240

44 Deductibility of mortgage interest on owner-occupied homes .............................................................. 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540

45 Deductibility of State and local property tax on owner-occupied homes ............................................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

46 Deferral of income from post 1987 installment sales ........................................................................... 1,100 1,120 1,140 1,160 1,190 1,200 1,320 6,010

47 Capital gains exclusion on home sales ................................................................................................. 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180

48 Exclusion of net imputed rental income on owner-occupied homes ................................................... 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206

49 Exception from passive loss rules for $25,000 of rental loss .............................................................. 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060

50 Credit for low-income housing investments .......................................................................................... 3,660 3,850 4,010 4,190 4,390 4,610 4,850 22,050

51 Accelerated depreciation on rental housing (normal tax method) ....................................................... 750 –156 –993 –1,846 –2,697 –3,961 –5,901 –15,398

Commerce: 

52 Cancellation of indebtedness ................................................................................................................. 30 30 30 40 40 40 40 190

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

54 Capital gains (except agriculture, timber, iron ore, and coal) .............................................................. 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190

55 Capital gains exclusion of small corporation stock ............................................................................... 160 210 250 300 350 390 430 1,720
318 ANALYTICAL PERSPECTIVES 

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

(in millions of dollars) 

Total from corporations and individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10

56 Step-up basis of capital gains at death ................................................................................................ 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420

57 Carryover basis of capital gains on gifts .............................................................................................. 210 240 290 290 310 430 850 2,170

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

59 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................... –3,250 –4,180 –4,790 –6,940 –10,360 –14,740 –21,240 –58,060

60 Accelerated depreciation of machinery and equipment (normal tax method) ..................................... 44,690 –11,000 –37,830 –30,920 –27,950 –26,190 –25,760 –148,650

61 Expensing of certain small investments (normal tax method) ............................................................. 1,520 4,820 1,650 –490 –30 140 230 1,500

62 Amortization of start-up costs (normal tax method) ............................................................................. 80 50 .............. –40 –90 –140 –170 –440

63 Graduated corporation income tax rate (normal tax method) .............................................................. 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630

64 Exclusion of interest on small issue bonds .......................................................................................... 450 490 510 540 580 590 610 2,830

65 Deduction for U.S. production activities ................................................................................................ .............. 3,270 5,420 8,750 11,230 11,670 15,860 52,930

66 Special rules for certain film and TV production .................................................................................. .............. 90 110 90 70 –40 –90 140

Transportation 

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

68 Exclusion of reimbursed employee parking expenses .............................................................................. 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150

69 Exclusion for employer-provided transit passes ........................................................................................ 410 480 550 630 710 790 880 3,560

70 Tax credit for certain expenditures for maintaining railroad tracks .......................................................... .............. 70 140 150 110 50 30 480

Community and regional development 

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

72 Exclusion of interest for airport, dock, and similar bonds ........................................................................ 850 930 980 1,030 1,100 1,130 1,170 5,410

73 Exemption of certain mutuals’ and cooperatives’ income ......................................................................... 60 60 60 70 70 70 70 340

74 Empowerment zones, Enterprise communities, and Renewal communities ............................................ 1,080 1,120 1,210 1,340 1,480 1,740 1,130 6,900

75 New markets tax credit .............................................................................................................................. 290 430 610 830 870 790 670 3,770

76 Expensing of environmental remediation costs ......................................................................................... 80 70 20 –10 –10 –20 –10 –30

77 Deferral of capital gains with respect of dispositions of transmission property ....................................... .............. –490 –620 –530 –230 100 360 –920

Education, training, employment, and social services 

Education: 

78 Exclusion of scholarship and fellowship income (normal tax method) ................................................ 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020

79 HOPE tax credit ..................................................................................................................................... 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890

80 Lifetime Learning tax credit ................................................................................................................... 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560

81 Education Individual Retirement Accounts ............................................................................................ 110 140 190 240 300 370 440 1,540

82 Deductibility of student-loan interest ...................................................................................................... 760 780 800 810 820 830 840 4,100

83 Deduction for higher education expenses ............................................................................................. 1,280 1,830 1,840 .............. .............. .............. .............. 1,840

84 State prepaid tuition plans ..................................................................................................................... 210 490 650 740 830 920 1,010 4,150

85 Exclusion of interest on student-loan bonds ......................................................................................... 290 310 340 350 370 380 390 1,830

86 Exclusion of interest on bonds for private nonprofit educational facilities ........................................... 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170

87 Credit for holders of zone academy bonds .......................................................................................... 90 110 130 130 140 140 140 680

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

89 Parental personal exemption for students age 19 or over ................................................................... 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370

90 Deductibility of charitable contributions (education) .............................................................................. 3,690 3,420 3,680 4,030 4,260 4,550 4,870 21,390

91 Exclusion of employer-provided educational assistance ....................................................................... 530 560 590 620 650 690 720 3,270

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

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

Training, employment, and social services: 

94 Work opportunity tax credit .................................................................................................................... 280 250 280 190 60 30 10 570

95 Welfare-to-work tax credit ...................................................................................................................... 60 60 80 60 20 10 .............. 170

96 Employer provided child care exclusion ................................................................................................ 600 620 810 930 970 1,010 1,060 4,780

97 Employer-provided child care credit ...................................................................................................... .............. 8 10 10 10 10 10 50

98 Assistance for adopted foster children .................................................................................................. 290 310 350 380 420 460 500 2,110

99 Adoption credit and exclusion ................................................................................................................ 450 500 540 560 570 580 600 2,850

100 Exclusion of employee meals and lodging (other than military) .......................................................... 810 850 890 930 970 1,010 1,060 4,860

101 Child credit 2 ........................................................................................................................................... 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030

102 Credit for child and dependent care expenses ..................................................................................... 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850

103 Credit for disabled access expenditures ............................................................................................... 30 40 40 40 40 50 50 220

104 Deductibility of charitable contributions, other than education and health .......................................... 27,370 29,670 32,550 34,500 36,790 39,410 42,210 185,460

105 Exclusion of certain foster care payments ............................................................................................ 440 440 440 450 450 460 470 2,270

106 Exclusion of parsonage allowances ...................................................................................................... 430 460 480 510 540 580 610 2,720

Health 

107 Exclusion of employer contributions for medical insurance premiums and medical care ....................... 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240

108 Self-employed medical insurance premiums ............................................................................................. 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400

109 Medical Savings Accounts/Health Savings Accounts ................................................................................ 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860

110 Deductibility of medical expenses .............................................................................................................. 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770

111 Exclusion of interest on hospital construction bonds ................................................................................ 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840

112 Deductibility of charitable contributions (health) ........................................................................................ 3,090 3,350 3,670 3,890 4,150 4,450 4,770 20,930

113 Tax credit for orphan drug research .......................................................................................................... 180 210 230 260 290 330 360 1,470

114 Special Blue Cross/Blue Shield deduction ................................................................................................ 400 390 360 390 340 370 430 1,890

115 Tax credit for health insurance purchased by certain displaced and retired individuals 3 ...................... 50 60 40 40 40 50 50 220
19. TAX EXPENDITURES 319

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

(in millions of dollars) 

Total from corporations and individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10

Income security 

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

117 Exclusion of workers’ compensation benefits ............................................................................................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590

118 Exclusion of public assistance benefits (normal tax method) ................................................................... 410 430 450 470 490 510 480 2,400

119 Exclusion of special benefits for disabled coal miners ............................................................................. 60 50 50 50 40 40 40 220

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

Net exclusion of pension contributions and earnings: 

121 Employer plans ....................................................................................................................................... 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030

122 401(k) plans ............................................................................................................................................ 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410

123 Individual Retirement Accounts ............................................................................................................. 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850

124 Low and moderate income savers credit .............................................................................................. 970 1,100 1,170 700 .............. .............. .............. 1,870

125 Keogh plans ............................................................................................................................................ 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670

Exclusion of other employee benefits: 

126 Premiums on group term life insurance ................................................................................................ 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750

127 Premiums on accident and disability insurance .................................................................................... 260 280 290 300 310 320 330 1,550

128 Small business retirement plan credit ........................................................................................................ 80 100 120 140 150 150 140 700

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

130 Special ESOP rules .................................................................................................................................... 1,920 2,060 2,220 2,400 2,580 2,780 3,000 12,980

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

132 Additional deduction for the elderly ........................................................................................................... 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680

133 Tax credit for the elderly and disabled ...................................................................................................... 20 20 20 20 10 10 10 70

134 Deductibility of casualty losses .................................................................................................................. 550 250 270 280 290 300 320 1,460

135 Earned income tax credit 4 ......................................................................................................................... 4,890 4,980 5,420 5,170 5,290 5,480 5,600 26,960

Social Security 

Exclusion of social security benefits 

136 Social Security benefits for retired workers .......................................................................................... 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120

137 Social Security benefits for disabled ..................................................................................................... 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680

138 Social Security benefits for dependents and survivors ........................................................................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880

Veterans benefits and services 

139 Exclusion of veterans death benefits and disability compensation .......................................................... 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850

140 Exclusion of veterans pensions ................................................................................................................. 110 120 120 120 120 130 140 630

141 Exclusion of GI bill benefits ....................................................................................................................... 130 150 160 170 180 190 200 900

142 Exclusion of interest on veterans housing bonds ..................................................................................... 50 50 50 60 60 60 60 290

General purpose fiscal assistance 

143 Exclusion of interest on public purpose State and local bonds ............................................................... 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840

144 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ..................... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

145 Tax credit for corporations receiving income from doing business in U.S. possessions ........................ 1,000 900 500 50 .............. .............. .............. 550

Interest 

146 Deferral of interest on U.S. savings bonds ............................................................................................... 50 50 50 50 60 70 70 300

Addendum: Aid to State and local governments 

Deductibility of: 

Property taxes on owner-occupied homes ............................................................................................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

Nonbusiness State and local taxes other than on owner-occupied homes ........................................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

Exclusion of interest on State and local bonds for: 

Public purposes ...................................................................................................................................... 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840

Energy facilities ...................................................................................................................................... 100 100 110 110 120 120 130 590

Water, sewage, and hazardous waste disposal facilities ..................................................................... 500 530 570 600 630 650 680 3,130

Small-issues ............................................................................................................................................ 450 490 510 540 580 590 610 2,830

Owner-occupied mortgage subsidies ..................................................................................................... 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470

Rental housing ........................................................................................................................................ 360 390 410 420 460 470 480 2,240

Airports, docks, and similar facilities ..................................................................................................... 850 930 980 1,030 1,100 1,130 1,170 5,410

Student loans .......................................................................................................................................... 290 310 340 350 370 380 390 1,830

Private nonprofit educational facilities ................................................................................................... 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170

Hospital construction .............................................................................................................................. 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840

Veterans’ housing ................................................................................................................................... 50 50 50 60 60 60 60 290

Credit for holders of zone academy bonds ............................................................................................... 90 110 130 130 140 140 140 680

1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 

$1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 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: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 

$12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million in 2010 projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 

$34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. 

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. 
320 ANALYTICAL PERSPECTIVES 

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

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

National Defense 

1 Exclusion of benefits and allowances to 

armed forces personnel ........................ ............ ............ ................ ................ ................ ................ ................ ................ 2,460 2,490 2,520 2,540 2,560 2,590 2,620 12,830

International affairs: 

2 Exclusion of income earned abroad by 

U.S. citizens .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570

3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ................ ................ ................ ................ ................ ................ 850 900 950 1000 1050 1100 1160 5,260

4 Extraterritorial income exclusion ............... 5,500 5,170 4,270 1,820 220 40 20 6,370 ................ ................ ................ ................ ................ ................ ................ ................

5 Inventory property sales source rules exception ................................................... 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980 ................ ................ ................ ................ ................ ................ ................ ................

6 Deferral of income from controlled foreign 

corporations (normal tax method) ........ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ................ ................ ................ ................ ................ ................ ................ ................

7 Deferred taxes for financial firms on certain income earned overseas ............... 2,130 2,190 2,260 960 ................ ................ ................ 3,220 ................ ................ ................ ................ ................ ................ ................ ................

General science, space, and technology 

8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... –2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 –50 100 150 140 120 110 100 620

9 Credit for increasing research activities ... 4,630 5,080 2,100 910 390 180 50 3,630 50 50 40 ................ ................ ................ ................ 40

Energy 

10 Expensing of exploration and development costs, fuels ................................... 230 350 320 240 210 160 120 1,050 30 50 50 40 30 30 20 170

11 Excess of percentage over cost depletion, 

fuels ....................................................... 1,210 1,180 1,240 1,310 1,350 1,390 1,430 6,720 110 100 110 110 120 120 120 580

12 Alternative fuel production credit .............. 1,000 1,000 1,000 1,000 400 ................ ................ 2,400 40 40 40 40 20 ................ ................ 100

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 ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 70 70 80 80 100 70 60 390

15 Exclusion of interest on energy facility 

bonds ..................................................... 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490

16 Enhanced oil recovery credit .................... 300 310 310 320 330 340 350 1,650 30 30 30 30 30 30 40 160

17 New technology credit ............................... 330 470 620 700 800 820 690 3,630 ................ ................ ................ ................ ................ ................ ................ ................

18 Alcohol fuel credits 1 .................................. 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50

19 Tax credit and deduction for clean-fuel 

burning vehicles .................................... 20 30 40 20 –10 –20 –10 20 50 40 10 –40 –60 –60 –50 –200

20 Exclusion of conservation subsidies provided by public utilities .......................... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 100 100 90 90 90 470

Natural resources and environment 

21 Expensing of exploration and development costs, nonfuel minerals ................ 210 210 230 230 230 250 250 1,190 20 20 20 20 20 20 20 100

22 Excess of percentage over cost depletion, 

nonfuel minerals .................................... ............ ............ ................ ................ ................ ................ 10 10 ................ ................ ................ ................ ................ ................ ................ ................

23 Exclusion of interest on bonds for water, 

sewage, and hazardous waste facilities 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530

24 Capital gains treatment of certain timber 

income ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 70 70 80 80 100 70 60 390

25 Expensing of multiperiod timber growing 

costs ...................................................... 230 240 250 260 280 290 300 1,380 110 110 120 120 120 120 130 610

26 Tax incentives for preservation of historic 

structures ............................................... 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440

27 Expensing of capital costs with respect to 

complying with EPA sulfur regulations ............ 10 ................ 10 20 40 10 90 ................ ................ ................ ................ ................ ................ ................ ................

28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....... ............ ............ ................ –10 –20 –30 –30 –90 ................ ................ ................ ................ –10 –10 –10 –30

Agriculture 

29 Expensing of certain capital outlays ......... 20 20 20 20 20 20 20 100 80 90 110 110 110 120 120 570

30 Expensing of certain multiperiod production costs ............................................... 10 10 10 10 10 10 10 50 40 50 60 60 70 70 70 330

31 Treatment of loans forgiven for solvent 

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

32 Capital gains treatment of certain income ............ ............ ................ ................ ................ ................ ................ ................ 670 730 760 820 990 720 580 3,870

33 Income averaging for farmers ................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 40 40 40 200

34 Deferral of gain on sale of farm refiners 10 10 10 20 20 20 20 90 ................ ................ ................ ................ ................ ................ ................ ................

35 Bio-Diesel tax credit .................................. ............ ............ ................ ................ ................ ................ ................ ................ ................ 30 30 10 ................ ................ ................ 40

Commerce and housing 

Financial institutions and insurance: 

36 Exemption of credit union income ........ 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550 ................ ................ ................ ................ ................ ................ ................ ................

37 Excess bad debt reserves of financial 

institutions ......................................... –20 –20 –10 –10 –10 ................ ................ –30 ................ ................ ................ ................ ................ ................ ................ ................

38 Exclusion of interest on life insurance 

savings .............................................. 2,010 2,180 2,270 2,570 2,880 3,070 3,330 14,120 18,820 20,570 21,800 23,610 25,890 27,910 30,280 129,490

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

40 Tax exemption of certain insurance 

companies owned by tax-exempt organizations ........................................ 180 190 210 220 230 250 260 1,170 ................ ................ ................ ................ ................ ................ ................ ................

41 Small life insurance company deduction ..................................................... 80 80 80 80 80 80 80 400 ................ ................ ................ ................ ................ ................ ................ ................

Housing: 
19. TAX EXPENDITURES 321

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

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

42 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240

43 Exclusion of interest on rental housing 

bonds ................................................. 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810

44 Deductibility of mortgage interest on 

owner-occupied homes ..................... ............ ............ ................ ................ ................ ................ ................ ................ 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540

45 Deductibility of State and local property 

tax on owner-occupied homes ......... ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

46 Deferral of income from post 1987 installment sales .................................. 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 1,000 4,470

47 Capital gains exclusion on home sales ............ ............ ................ ................ ................ ................ ................ ................ 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180

48 Exclusion of net imputed rental income 

on owner-occupied homes ............... ............ ............ ................ ................ ................ ................ ................ ................ 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206

49 Exception from passive loss rules for 

$25,000 of rental loss ....................... ............ ............ ................ ................ ................ ................ ................ ................ 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060

50 Credit for low-income housing investments ................................................. 2,930 3,080 3,210 3,350 3,510 3,690 3,880 17,640 730 770 800 840 880 920 970 4,410

51 Accelerated depreciation on rental 

housing (normal tax method) ........... –10 –50 –100 –140 –200 –280 –390 –1,100 760 –110 –900 –1,700 –2,500 –3,690 –5,510 –14,300

Commerce: 

52 Cancellation of indebtedness ................ ............ ............ ................ ................ ................ ................ ................ ................ 30 30 30 40 40 40 40 190

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

54 Capital gains (except agriculture, timber, iron ore, and coal) .................... ............ ............ ................ ................ ................ ................ ................ ................ 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190

55 Capital gains exclusion of small corporation stock ................................... ............ ............ ................ ................ ................ ................ ................ ................ 160 210 250 300 350 390 430 1,720

56 Step-up basis of capital gains at death ............ ............ ................ ................ ................ ................ ................ ................ 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420

57 Carryover basis of capital gains on 

gifts .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 210 240 290 290 310 430 850 2,170

58 Ordinary income treatment of loss from 

small business corporation stock 

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

59 Accelerated depreciation of buildings 

other than rental housing (normal 

tax method) ....................................... –2,980 –3,850 –4,340 –6,170 –9,220 –12,620 –17,320 –49,670 –280 –330 –450 –760 –1,140 –2,110 –3,930 –8,390

60 Accelerated depreciation of machinery 

and equipment (normal tax method) 37,080 –8,780 –32,880 –26,480 –23,310 –21,260 –20,290 –124,220 7,610 –2,220 –4,950 –4,440 –4,640 –4,930 –5,470 –24,430

61 Expensing of certain small investments 

(normal tax method) ......................... 680 1,780 680 –390 –140 –30 –10 110 840 3,040 970 –100 110 170 240 1,390

62 Amortization of start-up costs (normal 

tax method) ....................................... 70 40 ................ –40 –80 –120 –150 –390 10 10 ................ ................ –10 –20 –20 –50

63 Graduated corporation income tax rate 

(normal tax method) ......................... 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630 ................ ................ ................ ................ ................ ................ ................ ................

64 Exclusion of interest on small issue 

bonds ................................................. 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300

65 Deduction for U.S. production activities ............ 2,560 4,330 7,110 9,130 9,470 12,860 42,900 ................ 710 1,090 1,640 2,100 2,200 3,000 10,030

66 Special rules for certain film and TV 

production .......................................... ............ 70 90 70 60 –30 –70 120 ................ 20 20 20 10 –10 –20 20

Transportation 

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

68 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150

69 Exclusion for employer-provided transit 

passes ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 410 480 550 630 710 790 880 3,560

70 Tax credit for certain expenditures for 

maintaining railroad tracks .................... ............ 70 140 150 110 50 30 480 ................ ................ ................ ................ ................ ................ ................ ................

Community and regional development 

71 Investment credit for rehabilitation of 

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

72 Exclusion of interest for airport, dock, and 

similar bonds ......................................... 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380

73 Exemption of certain mutuals’ and cooperatives’ income ................................ 60 60 60 70 70 70 70 340 ................ ................ ................ ................ ................ ................ ................ ................

74 Empowerment zones, Enterprise communities, and Renewal communities ......... 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270

75 New markets tax credit ............................. 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820

76 Expensing of environmental remediation 

costs ...................................................... 70 60 20 –10 –10 –20 –10 –30 10 10 ................ ................ ................ ................ ................ ................

77 Deferral of capital gains with respect of 

dispositions of transmission property ... ............ –490 –620 –530 –230 100 360 –920 ................ ................ ................ ................ ................ ................ ................ ................

Education, training, employment, and social services 

Education: 

78 Exclusion of scholarship and fellowship 

income (normal tax method) ............ ............ ............ ................ ................ ................ ................ ................ ................ 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020

79 HOPE tax credit .................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890

80 Lifetime Learning tax credit .................. ............ ............ ................ ................ ................ ................ ................ ................ 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560

81 Education Individual Retirement Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 110 140 190 240 300 370 440 1,540

82 Deductibility of student-loan interest .... ............ ............ ................ ................ ................ ................ ................ ................ 760 780 800 810 820 830 840 4,100

83 Deduction for higher education expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,280 1,830 1,840 ................ ................ ................ ................ 1,840

84 State prepaid tuition plans .................... ............ ............ ................ ................ ................ ................ ................ ................ 210 490 650 740 830 920 1,010 4,150

85 Exclusion of interest on student-loan 

bonds ................................................. 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480
322 ANALYTICAL PERSPECTIVES 

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

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

86 Exclusion of interest on bonds for private nonprofit educational facilities .. 210 210 220 230 230 240 250 1,170 760 840 900 950 1020 1050 1080 5,000

87 Credit for holders of zone academy 

bonds ................................................. 90 110 130 130 140 140 140 680 ................ ................ ................ ................ ................ ................ ................ ................

88 Exclusion of interest on savings bonds 

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

89 Parental personal exemption for students age 19 or over ....................... ............ ............ ................ ................ ................ ................ ................ ................ 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370

90 Deductibility of charitable contributions 

(education) ........................................ 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 4,170 18,260

91 Exclusion of employer-provided educational assistance ........................... ............ ............ ................ ................ ................ ................ ................ ................ 530 560 590 620 650 690 720 3,270

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

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

Training, employment, and social services: 

94 Work opportunity tax credit ................... 240 210 240 160 50 30 10 490 40 40 40 30 10 ................ ................ 80

95 Welfare-to-work tax credit ..................... 50 50 70 50 20 10 ................ 150 10 10 10 10 ................ ................ ................ 20

96 Employer provided child care exclusion ............ ............ ................ ................ ................ ................ ................ ................ 600 620 810 930 970 1010 1060 4,780

97 Employer-provided child care credit ..... ............ 8 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ................

98 Assistance for adopted foster children ............ ............ ................ ................ ................ ................ ................ ................ 290 310 350 380 420 460 500 2,110

99 Adoption credit and exclusion .............. ............ ............ ................ ................ ................ ................ ................ ................ 450 500 540 560 570 580 600 2,850

100 Exclusion of employee meals and 

lodging (other than military) ............. ............ ............ ................ ................ ................ ................ ................ ................ 810 850 890 930 970 1,010 1,060 4,860

101 Child credit 2 .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030

102 Credit for child and dependent care 

expenses ........................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850

103 Credit for disabled access expenditures .................................................. 10 10 10 10 10 20 20 70 20 30 30 30 30 30 30 150

104 Deductibility of charitable contributions, 

other than education and health ...... 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 40,640 178,310

105 Exclusion of certain foster care payments ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 440 440 440 450 450 460 470 2,270

106 Exclusion of parsonage allowances ..... ............ ............ ................ ................ ................ ................ ................ ................ 430 460 480 510 540 580 610 2,720

Health 

107 Exclusion of employer contributions for 

medical insurance premiums and medical care ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240

108 Self-employed medical insurance premiums .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400

109 Medical Savings Accounts/Health Savings 

Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860

110 Deductibility of medical expenses ............. ............ ............ ................ ................ ................ ................ ................ ................ 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770

111 Exclusion of interest on hospital construction bonds .............................................. 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580

112 Deductibility of charitable contributions 

(health) ................................................... 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,570 20,030

113 Tax credit for orphan drug research ........ 180 210 230 260 290 330 360 1,470 ................ ................ ................ ................ ................ ................ ................ ................

114 Special Blue Cross/Blue Shield deduction 400 390 360 390 340 370 430 1,890 ................ ................ ................ ................ ................ ................ ................ ................

115 Tax credit for health insurance purchased 

by certain displaced and retired individuals 3 ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 60 40 40 40 50 50 220

Income security 

116 Exclusion of railroad retirement system 

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

117 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590

118 Exclusion of public assistance benefits 

(normal tax method) .............................. ............ ............ ................ ................ ................ ................ ................ ................ 410 430 450 470 490 510 480 2,400

119 Exclusion of special benefits for disabled 

coal miners ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 60 50 50 50 40 40 40 220

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

Net exclusion of pension contributions 

and earnings: 

121 Employer plans ..................................... ............ ............ ................ ................ ................ ................ ................ ................ 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030

122 401(k) plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410

123 Individual Retirement Accounts ............ ............ ............ ................ ................ ................ ................ ................ ................ 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850

124 Low and moderate income savers 

credit .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 970 1,100 1,170 700 ................ ................ ................ 1,870

125 Keogh plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670

Exclusion of other employee benefits: 

126 Premiums on group term life insurance ............ ............ ................ ................ ................ ................ ................ ................ 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750

127 Premiums on accident and disability insurance .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 260 280 290 300 310 320 330 1,550

128 Small business retirement plan credit ...... 40 50 60 70 80 80 70 360 40 50 60 70 70 70 70 340

129 Income of trusts to finance supplementary 

unemployment benefits ......................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100

130 Special ESOP rules ................................... 1600 1720 1870 2030 2190 2390 2610 11,090 320 340 350 370 390 390 390 1,890

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

132 Additional deduction for the elderly .......... ............ ............ ................ ................ ................ ................ ................ ................ 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680

133 Tax credit for the elderly and disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 10 10 10 70

134 Deductibility of casualty losses ................. ............ ............ ................ ................ ................ ................ ................ ................ 550 250 270 280 290 300 320 1,460

135 Earned income tax credit 4 ........................ ............ ............ ................ ................ ................ ................ ................ ................ 4,893 4,983 5,423 5,168 5,287 5,480 5,597 26,955
19. TAX EXPENDITURES 323

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

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

Social Security 

Exclusion of social security benefits 

136 Social Security benefits for retired 

workers .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120

137 Social Security benefits for disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680

138 Social Security benefits for dependents 

and survivors .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880

Veterans benefits and services 

139 Exclusion of veterans death benefits and 

disability compensation ......................... ............ ............ ................ ................ ................ ................ ................ ................ 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850

140 Exclusion of veterans pensions ................ ............ ............ ................ ................ ................ ................ ................ ................ 110 120 120 120 120 130 140 630

141 Exclusion of GI bill benefits ...................... ............ ............ ................ ................ ................ ................ ................ ................ 130 150 160 170 180 190 200 900

142 Exclusion of interest on veterans housing 

bonds ..................................................... 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240

General purpose fiscal assistance 

143 Exclusion of interest on public purpose 

State and local bonds ........................... 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890

144 Deductibility of nonbusiness state and 

local taxes other than on owner-occupied homes ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

145 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 1,000 900 500 50 ................ ................ ................ 550 ................ ................ ................ ................ ................ ................ ................ ................

Interest 

146 Deferral of interest on U.S. savings 

bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 60 70 70 300

Addendum: Aid to State and local governments 

Deductibility of: 

Property taxes on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

Nonbusiness State and local taxes 

other than on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

Exclusion of interest on State and local 

bonds for: 

Public purposes ..................................... 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890

Energy facilities ..................................... 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490

Water, sewage, and hazardous waste 

disposal facilities ............................... 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530

Small-issues .......................................... 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300

Owner-occupied mortgage subsidies ... 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240

Rental housing ...................................... 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810

Airports, docks, and similar facilities .... 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380

Student loans ........................................ 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480

Private nonprofit educational facilities .. 210 210 220 230 230 240 250 1,170 760 840 900 950 1,020 1,050 1,080 5,000

Hospital construction ............................. 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580

Veterans’ housing ................................. 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240

Credit for holders of zone academy 

bonds ..................................................... 90 110 130 130 140 140 140 680 ................ ................ ................ ................ ................ ................ ................ ................

1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 

2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 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: 2004 $8,857; 2005 $13,516; 2006 $13,180; 

2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and 

$150 million in 2010 projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 

$34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. 

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. 
324 ANALYTICAL PERSPECTIVES 

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS 

(in millions of dollars) 

Provision 2006 2006–10

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690 760,240

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030 445,540

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140 283,410

Capital gains exclusion on home sales ............................................................................................................................... 36,270 247,180

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050 241,030

Deductibility of charitable contributions, other than education and health ......................................................................... 32,550 185,460

Exclusion of net imputed rental income on owner-occupied homes .................................................................................. 29,720 185,206

Step-up basis of capital gains at death .............................................................................................................................. 28,760 164,420

Child credit ............................................................................................................................................................................ 32,810 164,030

Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .............................................. 34,620 163,240

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370 144,190

Exclusion of interest on life insurance savings ................................................................................................................... 24,070 143,610

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610 136,840

Social Security benefits for retired workers ......................................................................................................................... 19,770 106,120

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830 68,140

Net exclusion of pension contributions and earnings: Keough plans ................................................................................ 9,980 58,670

Deductibility of medical expenses ........................................................................................................................................ 9,140 54,770

Deduction for U.S. production activities .............................................................................................................................. 5,420 52,930

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440 42,740

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310 32,850

Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940 31,590

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920 31,330

Earned income tax credit ..................................................................................................................................................... 5,423 26,955

Self-employed medical insurance premiums ....................................................................................................................... 4,330 26,400

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750 22,060

Credit for low-income housing investments ......................................................................................................................... 4,010 22,050

Social Security benefits for disabled ................................................................................................................................... 3,870 21,680

Deductibility of charitable contributions (education) ............................................................................................................ 3,680 21,390

Deductibility of charitable contributions (health) .................................................................................................................. 3,670 20,930

Exclusion of veterans death benefits and disability compensation .................................................................................... 3,750 20,850

Social Security benefits for dependents and survivors ....................................................................................................... 3,990 19,880

Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,730 19,630

HOPE tax credit ................................................................................................................................................................... 3,220 16,890

Medical Savings Accounts / Health Savings Accounts ...................................................................................................... 1,830 15,860

Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,810 15,570

Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,730 15,150

Special ESOP rules .............................................................................................................................................................. 2,220 12,980

Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,520 12,830

Exclusion of interest on hospital construction bonds .......................................................................................................... 2,160 11,840

Lifetime Learning tax credit .................................................................................................................................................. 2,080 11,560

Inventory property sales source rules exception ................................................................................................................. 1,770 10,980

Premiums on group term life insurance .............................................................................................................................. 2,110 10,750

Credit for child and dependent care expenses ................................................................................................................... 2,810 9,850

Additional deduction for the elderly ..................................................................................................................................... 1,960 9,680

Parental personal exemption for students age 19 or over ................................................................................................. 2,110 8,370

Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,460 8,020

Exemption of credit union income ....................................................................................................................................... 1,390 7,550

Excess of percentage over cost depletion, fuels ................................................................................................................ 1,350 7,300

Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,210 6,900

Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 1,180 6,470

Extraterritorial income exclusion .......................................................................................................................................... 4,270 6,370

Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 1,120 6,170

Deferral of income from post 1987 installment sales ......................................................................................................... 1,140 6,010

Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 980 5,410

Exclusion of certain allowances for Federal employees abroad ........................................................................................ 950 5,260

Exclusion of employee meals and lodging (other than military) ........................................................................................ 890 4,860

Employer provided child care exclusion .............................................................................................................................. 810 4,780

State prepaid tuition plans ................................................................................................................................................... 650 4,150

Deductibility of student-loan interest .................................................................................................................................... 800 4,100

Capital gains treatment of certain income ........................................................................................................................... 760 3,870

New markets tax credit ........................................................................................................................................................ 610 3,770

Credit for increasing research activities .............................................................................................................................. 2,140 3,670

New technology credit .......................................................................................................................................................... 620 3,630

Exclusion for employer-provided transit passes .................................................................................................................. 550 3,560

Exclusion of employer-provided educational assistance ..................................................................................................... 590 3,270

Deferred taxes for financial firms on certain income earned overseas ............................................................................. 2,260 3,220

Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 570 3,130

Adoption credit and exclusion .............................................................................................................................................. 540 2,850

Exclusion of interest on small issue bonds ......................................................................................................................... 510 2,830
19. TAX EXPENDITURES 325

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS—

Continued

(in millions of dollars) 

Provision 2006 2006–10

Exclusion of parsonage allowances ..................................................................................................................................... 480 2,720

Alternative fuel production credit ......................................................................................................................................... 1,040 2,500

Exclusion of public assistance benefits (normal tax method) ............................................................................................ 450 2,400

Exclusion of certain foster care payments .......................................................................................................................... 440 2,270

Exclusion of interest on rental housing bonds .................................................................................................................... 410 2,240

Carryover basis of capital gains on gifts ............................................................................................................................. 290 2,170

Assistance for adopted foster children ................................................................................................................................ 350 2,110

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

Expensing of multiperiod timber growing costs ................................................................................................................... 370 1,990

Special Blue Cross/Blue Shield deduction .......................................................................................................................... 360 1,890

Low and moderate income savers credit ............................................................................................................................ 1,170 1,870

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

Exclusion of interest on student-loan bonds ....................................................................................................................... 340 1,830

Tax incentives for preservation of historic structures ......................................................................................................... 330 1,810

Enhanced oil recovery credit ............................................................................................................................................... 340 1,810

Capital gains exclusion of small corporation stock ............................................................................................................. 250 1,720

Premiums on accident and disability insurance .................................................................................................................. 290 1,550

Education Individual Retirement Accounts .......................................................................................................................... 190 1,540

Expensing of certain small investments (normal tax method) ............................................................................................ 1,650 1,500

Tax credit for orphan drug research .................................................................................................................................... 230 1,470

Deductibility of casualty losses ............................................................................................................................................ 270 1,460

Expensing of exploration and development costs, nonfuel minerals ................................................................................. 250 1,290

Expensing of exploration and development costs, fuels .................................................................................................... 370 1,220

Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 210 1,170

Exclusion of GI bill benefits ................................................................................................................................................. 160 900

Small business retirement plan credit ................................................................................................................................. 120 700

Credit for holders of zone academy bonds ......................................................................................................................... 130 680

Expensing of certain capital outlays .................................................................................................................................... 130 670

Exclusion of veterans pensions ........................................................................................................................................... 120 630

Exclusion of interest on energy facility bonds .................................................................................................................... 110 590

Work opportunity tax credit .................................................................................................................................................. 280 570

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

Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 500 550

Tax credit for certain expenditures for maintaining railroad tracks .................................................................................... 140 480

Exclusion of conservation subsidies provided by public utilities ........................................................................................ 100 470

Small life insurance company deduction ............................................................................................................................. 80 400

Capital gains treatment of royalties on coal ....................................................................................................................... 80 390

Capital gains treatment of certain timber income ............................................................................................................... 80 390

Expensing of certain multiperiod production costs .............................................................................................................. 70 380

Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 340

Deferral of interest on U.S. savings bonds ......................................................................................................................... 50 300

Exclusion of interest on veterans housing bonds ............................................................................................................... 50 290

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

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

Tax credit for health insurance purchased by certain displaced and retired individuals .................................................. 40 220

Exclusion of special benefits for disabled coal miners ....................................................................................................... 50 220

Credit for disabled access expenditures ............................................................................................................................. 40 220

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

Income averaging for farmers .............................................................................................................................................. 40 200

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

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

Alcohol fuel credits ............................................................................................................................................................... 30 180

Welfare-to-work tax credit .................................................................................................................................................... 80 170

Special deduction for teacher expenses ............................................................................................................................. 150 150

Special rules for certain film and TV production ................................................................................................................ 110 140

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

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

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

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

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

Expensing of capital costs with respect to complying with EPA sulfur regulations .......................................................... ............................ 90

Deferral of gain on sale of farm refiners ............................................................................................................................. 10 90

Tax credit for the elderly and disabled ............................................................................................................................... 20 70

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

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

Employer-provided child care credit .................................................................................................................................... 10 50

Bio-Diesel tax credit ............................................................................................................................................................. 30 40
326 ANALYTICAL PERSPECTIVES 

Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS—

Continued

(in millions of dollars) 

Provision 2006 2006–10

Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. ............................ 10

Expensing of environmental remediation costs ................................................................................................................... 20 –30

Excess bad debt reserves of financial institutions .............................................................................................................. –10 –30

Exclusion of gain or loss on sale or exchange of certain brownfield sites ....................................................................... ............................ –120

Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 50 –180

Amortization of start-up costs (normal tax method) ............................................................................................................ ............................ –440

Deferral of capital gains with respect of dispositions of transmission property ................................................................ –620 –920

Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... –4,786 –58,061

Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... –37,830 –148,650

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

CALENDAR YEAR 2004

(in millions of dollars) 

Provision

2004

Present Value

of Revenue 

Loss 

1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 6,360

2 Deferred taxes for financial firms on income earned overseas .......................................................................... 2,160

3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 2,220

4 Expensing of exploration and development costs—fuels .................................................................................... 160

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

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

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

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

9 Deferral of income on life insurance and annuity contracts ................................................................................ 25,020

10 Accelerated depreciation on rental housing ......................................................................................................... 5,210

11 Accelerated depreciation of buildings other than rental ...................................................................................... 543

12 Accelerated depreciation of machinery and equipment ....................................................................................... 39,380

13 Expensing of certain small investments (normal tax method) ............................................................................ 670

14 Amortization of start-up costs (normal tax method) ............................................................................................. 50

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

16 Credit for holders of zone academy bonds ......................................................................................................... 200

17 Credit for low-income housing investments ......................................................................................................... 3,870

18 Deferral for State prepaid tuition plans ................................................................................................................ 1,310

19 Exclusion of pension contributions—employer plans ........................................................................................... 85,040

20 Exclusion of 401(k) contributions .......................................................................................................................... 82,400

21 Exclusion of IRA contributions and earnings ....................................................................................................... 3,460

22 Exclusion of contributions and earnings for Keogh plans ................................................................................... 3,000

23 Exclusion of interest on public-purpose bonds .................................................................................................... 14,650

24 Exclusion of interest on non-public purpose bonds ............................................................................................. 5,680

25 Deferral of interest on U.S. savings bonds .......................................................................................................... 230

26 Expensing of capital costs with respect to complying with EPA sulfur regulations ........................................... ........................
19. TAX EXPENDITURES 327

Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES 

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

National Defense 

1 Exclusion of benefits and allowances to 

armed forces personnel ........................ ............ ............ ................ ................ ................ ................ ................ ................ 2,860 2,880 2,920 2,950 2,980 3,010 3,040 14,900

International affairs 

2 Exclusion of income earned abroad by 

U.S. citizens .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,530 3,640 3,700 3,880 4,100 4,320 4,560 20,560

3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ................ ................ ................ ................ ................ ................ 1,100 1,150 1,210 1,280 1,350 1,410 1,490 6,740

4 Extraterritorial income exclusion ............... 8,470 7,950 6,570 2,800 330 50 30 9,780 ................ ................ ................ ................ ................ ................ ................ ................

5 Inventory property sales solurce rules exception ................................................... 2,310 2,490 2,720 3,000 3,390 3,740 4,050 16,900 ................ ................ ................ ................ ................ ................ ................ ................

6 Deferral of income from controlled foreign 

corporations (normal tax method) ........ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ................ ................ ................ ................ ................ ................ ................ ................

7 Deferred taxes for financial firms on certain income earned overseas ............... 2,130 2,190 2,260 960 ................ ................ ................ 3,220 ................ ................ ................ ................ ................ ................ ................ ................

General science, space, and technology 

8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... –2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 –50 100 150 140 120 110 100 620

9 Credit for increasing research activities ... 7,120 7,820 3,230 1,400 590 270 70 5,560 80 80 60 ................ ................ ................ ................ 60

Energy 

10 Expensing of exploration and development costs, fuels ................................... 230 350 330 250 210 180 140 1,110 40 70 60 50 40 30 30 210

11 Excess of percentage over cost depletion, 

fuels ....................................................... 1,570 1,570 1,690 1,760 1,820 1,880 1,910 9,060 140 140 150 150 170 170 180 820

12 Alternative fuel production credit .............. 1,330 1,330 1,330 1,330 530 ................ ................ 3,190 70 70 70 70 30 ................ ................ 170

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 ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 140 100 90 550

15 Exclusion of interest on energy facility 

bonds ..................................................... 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700

16 Enhanced oil recovery credit .................... 400 410 420 430 440 450 460 2,200 10 10 10 10 10 10 10 50

17 New technology credit ............................... 470 680 880 1,000 1,130 1,160 970 5,140 ................ ................ ................ ................ ................ ................ ................ ................

18 Alcohol fuel credits 1 .................................. 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50

19 Tax credit and deduction for clean-fuel 

burning vehicles .................................... 30 40 50 30 –10 –30 –10 30 70 50 10 –50 –80 –80 –70 –270

20 Exclusion of utility conservation subsidies ............ ............ ................ ................ ................ ................ ................ ................ 130 130 130 130 130 120 120 630

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 .................................... 280 280 300 300 320 320 340 1,580 20 20 30 30 30 30 30 150

23 Exclusion of interest on bonds for water, 

sewage, and hazardous waste facilities 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680

24 Capital gains treatment of certain timber 

income ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 140 100 90 550

25 Expensing of multiperiod timber growing 

costs ...................................................... 310 320 330 350 370 380 400 1,830 140 140 140 150 150 150 150 740

26 Tax incentives for preservation of historic 

structures ............................................... 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440

27 Expensing of capital costs with respect to 

complying with EPA sulfur regulations ............ 20 ................ 10 30 70 10 120 ................ ................ ................ ................ ................ ................ ................ ................

28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....... ............ ............ ................ –10 –20 –30 –50 –110 ................ ................ ................ ................ –10 –10 –20 –40

Agriculture 

29 Expensing of certain capital outlays ......... 20 30 30 30 30 30 30 150 100 110 130 130 130 140 140 670

30 Expensing of certain multiperiod production costs ............................................... 10 10 20 20 20 20 20 100 50 60 70 70 80 80 80 380

31 Treatment of loans forgiven for solvent 

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

32 Capital gains treatment of certain income ............ ............ ................ ................ ................ ................ ................ ................ 960 1,040 1,090 1,170 1,410 1,030 830 5,530

33 Income averaging for farmers ................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 50 50 50 230

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

35 Bio-Diesel tax credit .................................. ............ ............ ................ ................ ................ ................ ................ ................ ................ 40 40 10 ................ ................ ................ 50

Commerce and housing 

Financial institutions and insurance: 

36 Exemption of credit union income ........ 1,620 1,690 1,760 1,840 1,920 2,000 2,080 9,600 ................ ................ ................ ................ ................ ................ ................ ................

37 Bad debt reserves of financial institutions ................................................... –30 –30 –10 –10 –10 ................ ................ –30 ................ ................ ................ ................ ................ ................ ................ ................

38 Exclusion of interest on life insurance 

savings .............................................. 2,280 2,450 2,520 2,840 3,180 3,380 3,660 15,580 21,380 23,090 24,260 26,130 28,560 30,690 33,310 142,950

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

40 Tax exemption of certain insurance 

companies owned by tax-exempt organizations ........................................ 270 290 320 330 350 380 400 1,780 ................ ................ ................ ................ ................ ................ ................ ................

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

Housing: 

42 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590
328 ANALYTICAL PERSPECTIVES 

Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

43 Exclusion of interest on rental housing 

bonds ................................................. 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620

44 Deductibility of mortgage interest on 

owner-occupied homes ..................... ............ ............ ................ ................ ................ ................ ................ ................ 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540

45 Deductibility of State and local property 

tax on owner-occupied homes ......... ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

46 Deferral of income from post 1987 installment sales .................................. 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 890 4,360

47 Capital gains exclusion on home sales ............ ............ ................ ................ ................ ................ ................ ................ 34,980 38,630 42,670 47,120 52,050 68,320 89,950 300,110

48 Exclusion of net imputed rental income ............ ............ ................ ................ ................ ................ ................ ................ 32,790 38,130 39,630 44,280 49,150 54,170 59,710 246,940

49 Exception from passive loss rules for 

$25,000 of rental loss ....................... ............ ............ ................ ................ ................ ................ ................ ................ 5,030 4,900 4,750 4,580 4,410 4,240 4,240 22,220

50 Credit for low-income housing investments ................................................. 3,910 4,110 4,290 4,470 4,680 4,920 5,170 23,530 1,050 1,100 1,150 1,200 1,250 1,320 1,380 6,300

51 Accelerated depreciation on rental 

housing (normal tax method) ........... –8 –46 –98 –143 –197 –275 –389 –1,102 758 –110 –895 –1,703 –2,500 –3,686 –5,512 –14,296

Commerce: 

52 Cancellation of indebtedness ................ ............ ............ ................ ................ ................ ................ ................ ................ 30 30 30 40 40 40 40 190

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

54 Capital gains (except agriculture, timber, iron ore, and coal) .................... ............ ............ ................ ................ ................ ................ ................ ................ 35,930 38,860 40,530 43,500 52,620 38,430 30,900 205,980

55 Capital gains exclusion of small corporation stock ................................... ............ ............ ................ ................ ................ ................ ................ ................ 220 270 340 400 460 530 610 2,340

56 Step-up basis of capital gains at death ............ ............ ................ ................ ................ ................ ................ ................ 32,260 34,860 38,340 42,180 46,390 47,410 44,910 219,230

57 Carryover basis of capital gains on 

gifts .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 250 280 340 350 370 530 1,060 2,650

58 Ordinary income treatment of loss from 

small business corporation stock 

sale .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 60 60 60 60 60 60 60 300

59 Accelerated depreciation of buildings 

other than rental housing (normal 

tax method) ....................................... –2,980 –3,850 –4,340 –6,170 –9,220 –12,620 –17,320 –49,670 –280 –330 –450 –760 –1,140 –2,110 –3,930 –8,390

60 Accelerated depreciation of machinery 

and equipment (normal tax method) 37,080 –8,780 –32,880 –26,480 –23,310 –21,260 –20,290 –124,230 7,610 –2,220 –4,950 –4,440 –4,640 –4,930 –5,470 –24,430

61 Expensing of certain small investments 

(normal tax method) ......................... 680 1,780 680 –390 –140 –30 –10 120 840 3,040 970 –100 110 170 240 1,400

62 Amortization of start-up costs (normal 

tax method) ....................................... 70 40 ................ –40 –80 –120 –150 –390 10 10 ................ ................ –10 –20 –20 –50

63 Graduated corporation income tax rate 

(normal tax method) ......................... 3,760 4,910 5,730 5,880 6,030 6,180 6,360 30,180 ................ ................ ................ ................ ................ ................ ................ ................

64 Exclusion of interest on small issue 

bonds ................................................. 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330

65 Deduction for U.S. production activities ............ 3,420 5,780 9,480 12,170 12,620 17,150 57,200 ................ 950 1,460 2,180 2,800 2,940 4,000 13,380

66 Special rules for certain film and TV 

production .......................................... ............ 70 90 70 60 –30 –70 120 ................ 20 20 20 10 –10 –20 20

Transportation 

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

68 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,190 3,350 3,530 3,710 3,900 4,100 4,300 19,540

69 Exclusion for employer-provided transit 

passes ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 510 600 690 790 890 980 1,100 4,450

70 Tax credit for certain expenditures for 

maintaining railroad tracks .................... ............ 100 190 200 140 70 30 630 ................ ................ ................ ................ ................ ................ ................ ................

Community and regional development 

71 Investment credit for rehabilitation of 

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

72 Exclusion of interest for airport, dock, and 

similar bonds ......................................... 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340

73 Exemption of certain mutuals’ and cooperatives’ income ................................ 70 70 70 80 80 80 80 390 ................ ................ ................ ................ ................ ................ ................ ................

74 Empowerment zones, Enterprise communities and Renewal communities .......... 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270

75 New markets tax credit ............................. 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820

76 Expensing of environmental remediation 

costs ...................................................... 90 80 20 –20 –20 –20 –20 –60 20 20 ................ ................ ................ ................ ................ ................

77 Deferral of capital gains with respect of 

dispositions of transmission property ... ............ –490 –620 –530 –230 100 360 –920 ................ ................ ................ ................ ................ ................ ................ ................

Education, training, employment, and social services 

Education: 

78 Exclusion of scholarship and fellowship 

income (normal tax method) ............ ............ ............ ................ ................ ................ ................ ................ ................ 1,450 1,540 1,610 1,680 1,760 1,840 1,930 8,820

79 HOPE tax credit .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,260 4,380 4,130 4,260 4,300 4,380 4,590 21,660

80 Lifetime Learning tax credit .................. ............ ............ ................ ................ ................ ................ ................ ................ 2,800 2,730 2,660 2,960 3,000 3,050 3,150 14,820

81 Education Individual Retirement Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 130 180 240 310 390 470 570 1,980

82 Deductibility of student-loan interest .... ............ ............ ................ ................ ................ ................ ................ ................ 900 930 960 970 980 990 1,000 4,900

83 Deduction for higher education expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,640 2,340 2,360 ................ ................ ................ ................ 2,360

84 State prepaid tuition plans .................... ............ ............ ................ ................ ................ ................ ................ ................ 270 620 830 950 1,070 1,180 1,300 5,330

85 Exclusion of interest on student-loan 

bonds ................................................. 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140

86 Exclusion of interest on bonds for private nonprofit educational facilities .. 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240

87 Credit for holders of zone academy 

bonds ................................................. 130 160 180 190 200 200 190 960 ................ ................ ................ ................ ................ ................ ................ ................
19. TAX EXPENDITURES 329

Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

88 Exclusion of interest on savings bonds 

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

89 Parental personal exemption for students age 19 or over ....................... ............ ............ ................ ................ ................ ................ ................ ................ 3,550 2,960 2,340 2,040 1,800 1,600 1,480 9,260

90 Deductibility of charitable contributions 

(education) ........................................ 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 3,890 17,980

91 Exclusion of employer-provided educational assistance ........................... ............ ............ ................ ................ ................ ................ ................ ................ 650 690 730 770 810 850 890 4,050

92 Special deduction for teacher expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 190 200 180 ................ ................ ................ ................ 180

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

Training, employment, and social services: 

94 Work opportunity tax credit ................... 240 210 240 160 50 30 10 490 40 40 40 30 10 ................ ................ 80

95 Welfare-to-work tax credit ..................... 50 50 70 50 20 10 ................ 150 10 10 10 10 ................ ................ ................ 20

96 Exclusion of employer provided child 

care ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 800 830 1,080 1,240 1,290 1,350 1,410 6,370

97 Employer-provided child care ............... 6 11 13 15 17 18 20 83 ................ ................ ................ ................ ................ ................ ................ ................

98 Assistance for adopted foster children ............ ............ ................ ................ ................ ................ ................ ................ 330 350 390 430 470 520 570 2,380

99 Adoption credit and exclusion .............. ............ ............ ................ ................ ................ ................ ................ ................ 570 640 690 710 730 750 760 3,640

100 Exclusion of employee meals and 

lodging (other than military) ............. ............ ............ ................ ................ ................ ................ ................ ................ 990 1,030 1,080 1,130 1,180 1,230 1,290 5,910

101 Child credit 2 .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 25,950 39,010 32,280 31,960 31,450 31,450 31,450 158,590

102 Credit for child and dependent care 

expenses ........................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,990 4,190 3,750 2,530 2,400 2,280 2,170 13,130

103 Credit for disabled access expenditures .................................................. 20 20 20 20 20 20 20 100 30 30 40 40 40 40 40 200

104 Deductibility of charitable contributions, 

other than education and health ...... 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 37,910 175,580

105 Exclusion of certain foster care payments ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 510 510 510 510 520 530 540 2,610

106 Exclusion of parsonage allowances ..... ............ ............ ................ ................ ................ ................ ................ ................ 520 550 590 630 660 710 750 3,340

Health 

107 Exclusion of employer contributions for 

medical insurance premiums and medical care ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 126,660 139,650 158,980 177,050 195,850 214,730 228,090 974,700

108 Self-employed medical insurance premiums .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,730 5,480 6,110 6,700 7,360 7,990 33,640

109 Medical Savings Accounts Health Savings 

Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 520 1,040 1,670 2,450 3,150 3,540 3,520 14,330

110 Deductibility of medical expenses ............. ............ ............ ................ ................ ................ ................ ................ ................ 7,930 9,280 9,880 10,780 12,050 12,910 13,750 59,370

111 Exclusion of interest on hospital construction bonds .............................................. 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880

112 Deductibility of charitable contributions 

(health) ................................................... 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,260 19,720

113 Tax credit for orphan drug research ........ 280 310 350 390 430 480 540 2,190 ................ ................ ................ ................ ................ ................ ................ ................

114 Special Blue Cross/Blue Shield deduction 570 560 510 560 490 530 610 2,700 ................ ................ ................ ................ ................ ................ ................ ................

115 Tax credit for health insurance purchased 

by certain displaced and retired individuals 3 ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 60 40 40 50 50 50 230

Income security 

116 Exclusion of railroad retirement system 

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

117 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590

118 Exclusion of public assistance benefits 

(normal tax method) .............................. ............ ............ ................ ................ ................ ................ ................ ................ 410 430 450 470 490 510 480 2,400

119 Exclusion of special benefits for disabled 

coal miners ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 60 50 50 50 40 40 40 220

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

Net exclusion of pension contributions 

and earnings: 

121 Employer plans ..................................... ............ ............ ................ ................ ................ ................ ................ ................ 57,280 61,380 62,260 64,110 57,960 55,260 54,350 293,940

122 401(k) plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 58,210 55,940 58,710 63,170 68,460 74,300 80,980 345,620

123 Individual Retirement Accounts ............ ............ ............ ................ ................ ................ ................ ................ ................ 8,470 9,300 9,140 9,120 8,730 8,340 7,790 43,120

124 Low and moderate income savers 

credit .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 1,150 1,310 1,380 830 ................ ................ ................ 2,210

125 Keogh plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 11,170 11,800 12,500 13,290 14,490 15,780 17,200 73,260

Exclusion of other employee benefits: 

126 Premiums on group term life insurance ............ ............ ................ ................ ................ ................ ................ ................ 2,660 2,690 2,700 2,700 2,750 2,790 2,830 13,770

127 Premiums on accident and disability insurance .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 350 370 390 400 410 430 440 2,070

128 Small business retirement plan credit ...... 60 70 90 100 110 110 100 510 50 70 80 100 100 100 100 480

129 Income of trusts to finance supplementary 

unemployment benefits ......................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100

130 Special ESOP rules ................................... 2,550 2,740 2,970 3,210 3,460 3,750 4,070 17,460 510 540 550 590 620 610 610 2,980

131 Additional deduction for the blind ............. ............ ............ ................ ................ ................ ................ ................ ................ 40 40 50 40 50 50 50 240

132 Additional deduction for the elderly .......... ............ ............ ................ ................ ................ ................ ................ ................ 2,060 2,190 2,370 2,350 2,290 2,330 2,360 11,700

133 Tax credit for the elderly and disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 10 10 80

134 Deductibility of casualty losses ................. ............ ............ ................ ................ ................ ................ ................ ................ 610 270 290 280 290 300 320 1,480

135 Earned income tax credit 4 ........................ ............ ............ ................ ................ ................ ................ ................ ................ 5,437 5,536 6,026 5,742 5,874 6,089 5,868 29,599

Social Security 

Exclusion of social security benefits: 
330 ANALYTICAL PERSPECTIVES 

Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued

(in millions of dollars) 

Corporations Individuals 

2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10

136 Social Security benefits for retired 

workers .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120

137 Social Security benefits for disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680

138 Social Security benefits for dependents 

and survivors .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880

Veterans benefits and services 

139 Exclusion of veterans death benefits and 

disability compensation ......................... ............ ............ ................ ................ ................ ................ ................ ................ 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850

140 Exclusion of veterans pensions ................ ............ ............ ................ ................ ................ ................ ................ ................ 110 120 120 120 120 130 140 630

141 Exclusion of GI bill benefits ...................... ............ ............ ................ ................ ................ ................ ................ ................ 130 150 160 170 180 190 200 900

142 Exclusion of interest on veterans housing 

bonds ..................................................... 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340

General purpose fiscal assistance 

143 Exclusion of interest on public purpose 

State and local bonds ........................... 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570

144 Deductibility of nonbusiness state and 

local taxes other than on owner-occupied homes ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

145 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 1,430 1,290 720 70 ................ ................ ................ 790 ................ ................ ................ ................ ................ ................ ................ ................

Interest 

146 Deferral of interest on U.S. savings 

bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 60 70 70 300

Addendum: Aid to State and local governments: 

Deductibility of: 

Property taxes on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140

Nonbusiness State and local taxes 

other than on owner-occupied 

homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240

Exclusion of interest on State and local 

bonds for: 

Public purposes ..................................... 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570

Energy facilities ..................................... 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700

Water, sewage, and hazardous waste 

disposal facilities ............................... 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680

Small-issues .......................................... 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330

Owner-occupied mortgage subsidies ... 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590

Rental housing ...................................... 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620

Airports, docks, and similar facilities .... 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340

Student loans ........................................ 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140

Private nonprofit educational facilities .. 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240

Hospital construction ............................. 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880

Veterans’ housing ................................. 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340

Credit for holders of zone academy 

bonds ..................................................... 130 160 180 190 200 200 190 960 ................ ................ ................ ................ ................ ................ ................ ................

1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 

$1,490; 2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 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: 2004 $8,857; 2005 $13,516; 2006 $13,180; 

2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and 

$150 million projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 

$34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. 

Tax Expenditure Baselines 

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

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

law. As noted previously, deciding whether provisions 

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

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

tax baseline and the reference tax law baseline. An 

exception is provided for the lower tax rate on dividends 

and capital gains on corporate shares as discussed 

below. 

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

sum of consumption and the change in net wealth in 

a given period of time. The normal tax baseline allows 

personal exemptions, a standard deduction, and 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. 

In the case of income taxes, the reference tax law 

baseline is also patterned on a comprehensive income 

tax, but it is closer to existing law. Tax expenditures 

under the reference law baseline are generally tax expenditures under the normal tax baseline, but the reverse is not always true. 

Both the normal and reference tax baselines allow 

several major departures from a pure comprehensive 

income tax. For example, under the normal and reference tax baselines: 
19. TAX EXPENDITURES 331

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

such as Social Security benefits. 

2 In the case of individuals who hold ‘‘passive’’ equity interests in businesses, however, 

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

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

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

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

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

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

may be limited under the alternative minimum tax. 

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

own produce) is regarded as a tax expenditure. 

Both accrued and imputed income would be taxed 

under a comprehensive income tax. 

• A comprehensive income tax would generally not 

exclude from the tax base amounts for personal 

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

• There generally is a separate corporate income 

tax. 

• Tax rates are allowed to vary with marital status. 

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

would adjust the cost basis of capital assets and 

debt for changes in the price level during the time 

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

account of inflation in measuring depreciation, 

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

penalty), and failure to take account of inflation 

in measuring interest costs would be regarded as 

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

Although the reference law and normal tax baselines 

are generally similar, areas of difference include:

Tax rates. The separate schedules applying to the 

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

below the maximum statutory rate do not give 

rise to a tax expenditure. The normal tax baseline 

is similar, except that, by convention, it specifies 

the current maximum rate as the baseline for the 

corporate income tax. The lower tax rates applied 

to the first $10 million of corporate income are 

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

as part of the baseline rate structure under both 

the reference and normal tax methods.

Income subject to the tax. Income subject to tax 

is defined as gross income less the costs of earning 

that income. The Federal income tax defines gross 

income to include: (1) consideration received in 

the exchange of goods and services, including labor 

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

of gross or net income earned and/or reported by 

another entity (such as a partnership). Under the 

reference tax rules, therefore, gross income does 

not include gifts defined as receipts of money or 

property that are not consideration in an exchange 

or most transfer payments, which can be thought 

of as gifts from the Government. 1 The normal 

tax baseline also excludes gifts between individuals from gross income. Under the normal tax 

baseline, however, all cash transfer payments 

from the Government to private individuals are 

counted in gross income, and exemptions of such 

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

deductible in determining taxable income under 

both the reference and normal tax baselines. 2

Capital recovery. Under the reference tax law 

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

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

The latter represents a change in the calculation 

of the tax expenditure under normal law first 

made in the 2004 Budget. The Appendix provides 

further details on the new methodology and how 

it differs from the prior methodology.

Treatment of foreign income. Both the normal and 

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

income taxes that would otherwise be due), which 

prevents double taxation of income earned abroad. 

Under the normal tax method, however, controlled 

foreign corporations (CFCs) are not regarded as 

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

under this method. In contrast, except for tax 

haven activities, the reference law baseline follows 

current law in treating CFCs as separate taxable 

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

until distributed to U.S. taxpayers. Under this 

baseline, deferral of tax on CFC income is not 

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

income.

In addition to these areas of difference, the Joint 

Committee on Taxation considers a somewhat broader 

set of tax expenditures under its normal tax baseline 

than is considered here. 

Double Taxation of Corporate Profits 

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

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

and capital gains on corporate equity have not been 

considered tax preferences since the 2005 Budget. Thus, 

the difference between ordinary tax rates and the lower 

tax rates on dividends, introduced by the Jobs and 

Growth Tax Relief Reconciliation Act of 2003 

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

Similarly, the lower capital gains tax rates applied to 

gains realized from the disposition of corporate equity 

do not give rise to a tax expenditure as well. As a 
332 ANALYTICAL PERSPECTIVES 

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

Results Act of 1993’’ (Report 103–58, 1993). 4 Although this section focuses upon tax expenditures under the income tax, tax expenditures also arise under the unified transfer, payroll, and excise tax systems. Such provisions 

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

for certain types of consumption deemed meritorious. 

consequence, tax expenditure estimates for the lower 

tax rates on capital, step-up in basis, and the inside 

build-up on pension assets, 401k plans, IRAs, among 

others, are limited to capital gains from sources other 

than corporate equity. The Appendix provides a greater 

discussion of alternative baselines. 

Performance Measures and the Economic 

Effects of Tax Expenditures 

The Government Performance and Results Act of 

1993 (GPRA) directs Federal agencies to develop annual 

and strategic plans for their programs and activities. 

These plans set out performance objectives to be 

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

to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA 3 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. 4

Because there is an existing public administrative and 

private compliance structure for the tax system, the 

incremental administrative and compliance costs for a 

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

some tax expenditures actually simplify the operation 

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

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

Finally, a variety of tax expenditure tools can be used 

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

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

expenses, or demographic characteristics (age, number 

of family members, etc.). This wide range 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 decision-making. The income 

tax system may have little or no contact with persons 

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

information on certain characteristics of individuals 

used in some spending programs, such as wealth. These 

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

Tax expenditures also generally do not enable the same 

degree of agency discretion as an outlay program. For 

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

with tax expenditures. 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 
19. TAX EXPENDITURES 333

quickly than tax expenditures, because they can often 

be changed as needed by the executive branch without 

legislation. Like tax expenditures, regulations often rely 

largely 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 degree of 

scrutiny that outlay programs receive. However, major 

regulations are subjected to a formal regulatory analysis that goes well beyond the analysis required for 

outlays and tax-expenditures. To some extent, the 

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

Some policy objectives are achieved using multiple 

approaches. For example, minimum wage legislation, 

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

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

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

measured against a comprehensive income tax, for example, these include: encouraging certain types of activities (e.g., saving for retirement or investing in certain sectors); increasing certain types of after-tax income (e.g., favorable tax treatment of Social Security 

income); reducing private compliance costs and Government administrative costs (e.g., the exclusion for up 

to $500,000 of capital gains on home sales); and promoting tax neutrality (e.g., accelerated depreciation in 

the presence of inflation). Some of these objectives are 

well suited to quantitative measurement, while others 

are less well suited. Also, many tax expenditures, including those cited above, may have more than one 

objective. For example, accelerated depreciation may 

encourage investment. In addition, the economic effects 

of particular provisions can extend beyond their intended objectives (e.g., a provision intended to promote 

an activity or raise certain incomes may have positive 

or negative effects on tax neutrality). 

Performance measurement is generally concerned 

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

expenditures, the principal input is usually the revenue 

effect. Outputs are quantitative or qualitative measures 

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

turn, represent the changes in the economy, society, 

or environment that are the ultimate goals of programs. 

Thus, for a provision that reduces taxes on certain 

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

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

inequity or unintended consequence in the tax code, 

an important performance measure might be how they 

change effective tax rates (the discounted present-value 

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

distortions caused by taxes). Effects on the incomes of 

members of particular groups may be an important 

measure for certain provisions. 

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

groups of tax expenditures. The discussion is intended 

to be illustrative and not all encompassing. However, 

it is premised on the assumption that the data needed 

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

major challenge, and data constraints may limit the 

assessment of the effectiveness of many provisions. In 

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

National defense. Some tax expenditures are intended 

to assist governmental activities. For example, tax preferences for military benefits reflect, among other 

things, the view that benefits such as housing, subsistence, and moving expenses are intrinsic aspects of military service, and are provided, in part, for the benefit 

of the employer, the U.S. Government. Tax benefits 

for combat service are intended to reduce tax burdens 

on military personnel undertaking hazardous service 

for the Nation. A portion of the tax expenditure associated with foreign earnings is targeted to benefit U.S. 

Government civilian personnel working abroad by offsetting the living costs that can be higher than those 

in the United States. These tax expenditures should 

be considered together with direct agency budget costs 

in making programmatic decisions. 

International affairs. Tax expenditures are also aimed 

at goals such as tax neutrality. These include the exclusion for income earned abroad by nongovernmental employees and exclusions for income of U.S.-controlled foreign corporations. Measuring the effectiveness of these 

provisions raises challenging issues. 

General science, space and technology; energy; natural 

resources and the environment; agriculture; and commerce and housing. A series of tax expenditures reduces 

the cost of investment, both in specific activities such 

as research and experimentation, extractive industries, 

and certain financial activities and more generally, 

through accelerated depreciation for plant and equipment. These provisions can be evaluated along a number of dimensions. For example, it could be useful to 

consider the strength of the incentives by measuring 

their effects on the cost of capital (the interest rate 

which investments must yield to cover their costs) and 

effective tax rates. The impact of these provisions on 

the amounts of corresponding forms of investment (e.g., 
334 ANALYTICAL PERSPECTIVES 

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 cost-effectiveness relative to other 

policies. Analysis could also consider objectives that are 

more difficult to measure but still are ultimate goals, 

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

growth. Such an assessment is likely to involve tax 

analysis as well as consideration of non-tax matters 

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

of various energy sources on the environment). 

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

personal residences also are reported as tax expenditures because the value of owner-occupied housing services is not included in a taxpayer’s taxable income. 

Taxpayers also may exclude up to $500,000 of the capital gains from the sale of personal residences. Measures of the effectiveness of these provisions could include their effects on increasing the extent of home 

ownership and the quality of housing. Similarly, analysis of the extent of accumulated inflationary gains is 

likely to be relevant to evaluation of the capital gains 

for home sales. Deductibility of State and local property 

taxes assists with making housing more affordable as 

well as easing the cost of providing community services 

through these taxes. Provisions intended to promote 

investment in rental housing could be evaluated for 

their effects on making such housing more available 

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

supply and demand. 

Transportation. Employer-provided parking is a 

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

taxation. The tax expenditure estimates reflect the cost 

of parking that is leased by employers for employees; 

an estimate is not currently available for the value 

of parking owned by employers and provided to their 

employees. The exclusion for employer-provided transit 

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

could be compared with alternative transportation policies. 

Community and regional development. A series of tax 

expenditures is intended to promote community and 

regional development by reducing the costs of financing 

specialized infrastructure, such as airports, docks, and 

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

with grants and other policies designed to spur economic development. 

Education, training, employment, and social services. 

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

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

loans, grants, and other programs designed to promote 

higher education and training. The child credits are 

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

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

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

the beneficiaries of these activities, who are generally 

not the parties receiving the tax reduction. 

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

of these benefits could include increased coverage and 

pooling of risks. The effects of insurance coverage on 

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

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

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

Income security, Social Security, and veterans benefits 

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

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

(which would include the effect on private savings as 

well as public savings or deficits). Interactions with 

other programs, including Social Security, also may 

merit analysis. As in the case of employer-provided 

health insurance, analysis of employer-provided pension 

programs requires imputing the value of benefits funded at the firm level to individuals. 

Other provisions principally affect the incomes of 

members of certain groups, rather than affecting incentives. For example, tax-favored treatment of Social Security benefits, certain veterans’ benefits, and deductions for the blind and elderly provide increased incomes to eligible parties. The earned-income tax credit, 

in contrast, should be evaluated for its effects on labor 

force participation as well as the income it provides 

lower-income workers. 

General purpose fiscal assistance and interest. The 

tax-exemption for public purpose State and local bonds 

reduces the costs of borrowing for a variety of purposes 

(borrowing for non-public purposes is reflected under 
19. TAX EXPENDITURES 335

5The determination of whether a provision is a tax expenditure is made on the basis 

of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under 

general U.S. income tax principles. For that reason, the tax expenditure estimates include, 

for example, estimates related to the exclusion of extraterritorial income, as well as other 

exclusions, notwithstanding that such exclusions define income under the general rule of 

U.S. income taxation. 

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, 2004, and do not reflect proposals made elsewhere 

in the Budget. Nine additional provisions are considered when compared to the 2005 Budget. These are: 

(1) Expensing of capital costs with respect to complying 

with EPA sulfur regulations, (2) Exclusion of gain or 

loss on sale or exchange of certain brownfield sites, 

(3) Bio-Diesel tax credit, (4) Imputed net rental income 

on owner occupied housing, (5) Deduction for US production activities, (6) Special rules for certain film and 

TV production, (7) Tax credit for certain expenditures 

for maintaining railroad tracks, (8) Deferral of capital 

gains with respect of dispositions of transmission property, and (9) Discharge of student loan indebtedness. 

National Defense 

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

amounts of pay related to combat service, are excluded 

from income subject to tax. 

International Affairs 

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

abroad, worked in the private sector, and satisfied a 

foreign residency requirement may exclude up to 

$80,000 in foreign earned income from U.S. taxes. In 

addition, if these taxpayers receive a specific allowance 

for foreign housing from their employers, they may also 

exclude the value of that allowance. If they do not 

receive a specific allowance for housing expenses, they 

may deduct against their U.S. taxes that portion of 

such expenses that exceeds one-sixth the salary of a 

civil servant at grade GS-14, step 1 ($74,335 in 2004). 

3. Exclusion of certain allowances for Federal 

employees abroad.—U.S. Federal civilian employees 

and Peace Corps members who work outside the continental United States are allowed to exclude from U.S. 

taxable income certain special allowances they receive 

to compensate them for the relatively high costs associated with living overseas. The allowances supplement 

wage income and cover expenses like rent, education, 

and the cost of travel to and from the United States. 

4. Extraterritorial income exclusion. 5—For purposes of calculating U.S. tax liability, a taxpayer may 

exclude from gross income the qualifying foreign trade 

income attributable to foreign trading gross receipts. 

The exclusion generally applies to income from the sale 

or lease of qualifying foreign trade property and certain 

types of services income. The FSC Repeal and 

Extraterritorial Income Exclusion Act of 2000 created 

the extraterritorial income exclusion to replace the foreign sales corporation provisions, which the Act repealed. The exclusion is generally available for transactions entered into after September 30, 2000. 

5. Sales source rule exceptions.—The worldwide 

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

and a credit for foreign taxes paid is allowed. The 

amount of foreign taxes that can be credited is limited 

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

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

exporters to use more foreign tax credits by allowing 

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

of earnings was based on actual economic activity. 

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

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

The income becomes taxable only when the controlling 

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

tax method, the currently attributable foreign source 

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

distributed. Thus, the normal tax method considers the 

amount of controlled foreign corporation income not yet 

distributed to a U.S. shareholder as tax-deferred income. 

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

income earned through December 31, 2006 can be deferred. 
336 ANALYTICAL PERSPECTIVES 

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 

January 1, 2006 and extends to research conducted in 

Puerto Rico and the U.S. possessions. 

Energy 

10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of 

unsalvageable materials used in constructing wells) 

may be expensed rather than amortized over the productive life of the property. Integrated oil companies 

may deduct only 70 percent of such costs and must 

amortize the remaining 30 percent over five years. The 

same rule applies to the exploration and development 

costs of surface stripping and the construction of shafts 

and tunnels for other fuel minerals. 

11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed 

to take percentage depletion deductions rather than 

cost depletion on limited quantities of output. Under 

cost depletion, outlays are deducted over the productive 

life of the property based on the fraction of the resource 

extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent 

for oil, gas and oil shale; and 10 percent for coal. The 

deduction is limited to 50 percent of net income from 

the property, except for oil and gas where the deduction 

can be 100 percent of net property income. Production 

from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit 

on output and no limitation with respect to qualified 

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

investment. 

12. Alternative fuel production credit.—A 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 (indexed 

for inflation) is provided per kilowatt hour of electricity 

produced from certain renewable resources. Generally, 

qualifying sources include wind, closed-loop biomass, 

open-loop biomass including agricultural livestock 

waste nutrients, geothermal energy, solar energy, small 

irrigation, landfill gas, and trash combustion used to 

produce electricity at a facility placed in service before 

January 1, 2006. For facilities using open-loop biomass, 

small irrigation, landfill gas, or trash combustion, the 

credit rate is reduced by half. In addition, refined coal 

produced at a facility placed in service before January 

1, 2009 cn claim a credit at a rate of $4.375 per ton 

(indexed for inflation). 

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 through 2010. 

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 ex-
19. TAX EXPENDITURES 337

ceed $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 deduction and credit 

are reduced by 75 percent for vehicles placed in service 

in 2006 and are not available for vehicles placed in 

service after December 31, 2006. 

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 sales 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. 

27. Expensing of capital costs with respect to 

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

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

28. Exclusion of gain or loss on sale or exchange 

of certain brownfield sites.—This provision was introduced by the AJCA enacted in 2004. This exclusion 

applies to taxpayers who have incurred remediation expenditures in an amount which exceeds the greater of 

$550,000 or 12 percent of the fair market value of the 

property at the time such property was acquired by 

the eligible taxpayer, determined as if there were not 

a presence of a hazardous substance, pollutant, or contaminant on the property which is complicating the 

expansion, redevelopment, or reuse of the property. 

Agriculture 

29. 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. 

30. 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. 

31. Loans forgiven solvent farmers.—Farmers are 

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

the property to which the loan relates. If the debtor 

elects to reduce basis and the amount of forgiveness 

exceeds the basis in the property, the excess forgiveness 

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

the amount of loan forgiveness reduces carryover losses, 

then unused credits, and then basis; any remainder 

of the forgiven debt is excluded from tax. Farmers with 

forgiven debt are considered insolvent for tax purposes, 

and thus qualify for income tax forgiveness. 

32. Capital gains treatment of certain income.—

Certain agricultural income, such as unharvested crops, 

can be treated as capital gains rather than ordinary 

income. 

33. Income averaging for farmers.—Taxpayers can 

lower their tax liability by averaging, over the prior 

three-year period, their taxable income from farming 

and fishing. 

34. 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. 

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

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

gallon of biodiesel used or sold. Biodiesel derived from 

virgin sources (agri-biodiesel) receives an increased 

credit of $1.00 per gallon. The provision was introduced 

by the AJCA in 2004, and is set to expire on after 

December 31, 2006. 

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. 
338 ANALYTICAL PERSPECTIVES 

36. Credit union income.—The earnings of credit 

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

37. 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. 

38. 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. 

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

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

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

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

elect to pay tax only on the income earned by their 

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

companies are generally exempt from tax if their gross 

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

more than 50 percent of such gross receipts consists 

of premiums. Mutual non-life insurance companies are 

generally tax-exempt if their annual gross receipts do 

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

receipts consist of premiums. Also, for taxable years 

beginning after December 31, 2003, non-life insurance 

companies with no more than $1.2 million of annual 

net premiums may elect to pay tax only on their taxable 

investment income. 

40. 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. 

41. 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. 

42. Mortgage housing bonds.—Interest earned on 

State and local bonds used to finance homes purchased 

by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds 

that can be issued to finance these and other private 

activity is limited. The combined volume cap for private 

activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial 

development bonds was $62.50 per capita ($187.5 million minimum) per State in 2001, and $75 per capita 

($225 million minimum) in 2002. The Community Renewal Tax Relief Act of 2000 accelerated the scheduled 

increase in the state volume cap and indexed the cap 

for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax 

credits for a specified percentage of interest on qualified 

mortgages. The total amount of MCCs issued by a State 

cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds. 

43. 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. 

44. 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. 

45. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their 

primary and secondary residences even though they are 

not required to report the value of owner-occupied housing services as gross income. 

46. 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. 
19. TAX EXPENDITURES 339

47. 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. 

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

depreciation, is excluded from income. The appendix 

provides a greater explanation of this new addition to 

the tax expenditure budget. 

49. 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. 

50. 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. 

51. Accelerated depreciation of rental property.—

The tax depreciation allowance provisions are part of 

the reference law rules, and thus do not give rise to 

tax expenditures under the reference method. Under 

the normal tax method, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

52. 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. 

53. 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. 

54. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held 

for more than 1 year are taxed at a lower rate than 

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

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

not been previously taxed under the corporate income 

tax. As discussed above, this treatment partially adjusts 

for the double tax on corporate income and is more 

consistent with a comprehensive income tax base. 

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

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

top capital gains tax rate for assets held for more than 

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

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

are not recognized. 

For assets held for more than 1 year by taxpayers 

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

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

the top capital gains tax rate for assets held by these 

taxpayers for more than 5 years was 8 percent. 

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

previous 10 percent and 8 percent rates to 5 percent 

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

held for more than one year. The lower rates apply 

to assets sold after May 6, 2003 through 2008. 

55. 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. 

56. Step-up in basis of capital gains at death.—

Capital gains on assets held at the owner’s death are 

not subject to capital gains taxes. The cost basis of 

the appreciated assets is adjusted upward to the market value at the owner’s date of death. After repeal 

of the estate tax for 2010 under the Economic Growth 

and Tax Relief Reconciliation Act (EGTRRA) of 2001, 

the basis for property acquired from a decedent will 

be the lesser of fair market value or the decedent’s 

basis. Certain types of additions to basis will be allowed 

so that assets in most estates that are not currently 

subject to estate tax will not be subject to capital gains 

tax in the hands of the heirs. 

57. 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 
340 ANALYTICAL PERSPECTIVES 

EGTRRA, the gift tax is retained with a lifetime exemption of $1 million. 

58. 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. 

59. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus 

do not give rise to tax expenditures under reference 

law. Under normal law, however, economic depreciation 

is assumed. This calculation is described in more detail 

in the Appendix. 

60. Accelerated depreciation of machinery and 

equipment.—The tax depreciation allowance provisions 

are part of the reference law rules, and thus do not 

give rise to tax expenditures under reference law. 

Under the normal tax baseline, this tax depreciation 

allowance is measured relative to economic depreciation. This calculation is described in more detail in 

the Appendix. 

61. Expensing of certain small investments.—As 

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

rather than depreciated over time. The amount eligible 

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

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

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

was temporarily increased to $400,000, and computer 

software became temporarily eligible for expensing 

treatment. For 2004, through 2007, these higher limits 

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

amount expensed cannot exceed the taxpayer’s taxable 

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

62. Business start-up costs.—Business start-up 

costs are costs incurred prior to the creation of an active trade or business that would be deductible if incurred in connection with the operation of an existing 

trade or business. If the start-up costs were incurred 

on or before October 22, 2004, a taxpayer could elect 

to amortize them over 60 months. For costs incurred 

after that date, a taxpayer may elect to deduct up to 

$5,000 of start-up costs, but this deductible amount 

is reduced (but now below zero) by the amount by 

which the taxpayer’s total start-up costs for the year 

exceed $50,000. Non-deducted start-up costs incurred 

after October 22, 2004 are amortized over a 15-year 

period. The normal-tax method treats the 60-month amortized amounts and the deducted amounts as tax expenditures; the reference tax method does not. 

63. 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. 

64. 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. 

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

This provision was introduced by the AJCA in 2004 

and allows for a deduction equal to a portion of taxable 

income attributable to domestic production. For taxable 

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

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

respectively. For taxable years beginning after 2008, 

the amount of the deduction is 9 percent. 

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

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

may be deducted over three years using the straight 

line method. This provision was introduced by the 

AJCA enacted in 2004. Under prior law, production 

expenses were depreciated. 

Transportation 

67. 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. 

68. 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 2004, 
19. TAX EXPENDITURES 341

the maximum amount of the parking exclusion is $195 

(indexed) per month. The tax expenditure estimate does 

not include parking at facilities owned by the employer. 

69. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in 

lieu of wages to defray an employee’s commuting costs 

are excludable from the employee’s income. In 2005, 

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

per month. 

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

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

the number of miles of track owned or leased. This 

provision was introduced by the AJCA in 2004. 

Community and Regional Development 

71. 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. 

72. 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. 

73. 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. 

74. Empowerment zones, enterprise communities, 

and renewal communities.—Qualifying businesses in 

designated economically depressed areas can receive tax 

benefits such as an employer wage credit, increased 

expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain 

capital gains incentives. The Job Creation and Worker 

Assistance Act of 2002 expanded the existing provisions 

by adding the ‘‘New York City Liberty Zone.’’ In addition, the Working Families Tax Relief Act of 2004 extended the District of Columbia Enterprise Zone and 

the District of Columbia first time homebuyer credit 

by two years through 2005. 

75. 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. 

76. 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 Working Families Tax Relief Act of 2004 

extended this provision for two years, allowing remediation expenditures incurred before December 31, 2005 

to be eligible for expensing. 

77. Deferral of capital gains with respect of dispositions of transmission property.—This provision, 

introduced by the AJCA, provides for the deferral of 

gains from sales or dispositions to implement Federal 

Energy Regulatory Commission or State electric restructuring policy. 

Education, Training, Employment, and Social 

Services 

78. 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). 

79. HOPE tax credit.—The non-refundable HOPE 

tax credit allows a credit for 100 percent of an eligible 

student’s first $1,000 of tuition and fees and 50 percent 

of the next $1,000 of tuition and fees. The credit only 

covers tuition and fees paid during the first two years 

of a student’s post-secondary education. In 2004, the 

credit is phased out ratably for taxpayers with modified 

AGI between $85,000 and $105,000 ($42,000 and 

$52,000 for singles), indexed. 

80. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for 

20 percent of an eligible student’s tuition and fees. For 

tuition and fees paid after December 31, 2002, the maximum credit per return is $2,000. The credit is phased 

out ratably for taxpayers with modified AGI between 

$85,000 and $105,000 ($42,000 and $52,000 for singles) 

(indexed beginning in 2002). The credit applies to both 

undergraduate and graduate students. 

81. Deduction for Higher Education Expenses.—

The maximum annual deduction for qualified higher 

education expenses is $4,000 in 2004 for taxpayers with 
342 ANALYTICAL PERSPECTIVES 

adjusted gross income up to $130,000 on a joint return 

($65,000 for singles). Taxpayers with adjusted gross income up to $160,000 on a joint return ($80,000 for 

singles) may deduct up to $2,000 beginning in 2004. 

No deduction is allowed for expenses paid after December 31, 2005. 

82. 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 2004 is $2000 per 

beneficiary. The maximum contribution is phased down 

ratably for taxpayers with modified AGI between 

$190,000 and $220,000 ($95,000 and $110,000 for singles). 

83. 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 2004, the maximum deduction 

is phased down ratably for taxpayers with modified 

AGI between $100,000 and $130,000 ($50,000 and 

$65,000 for singles), indexed. 

84. 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. 

85. 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. 

86. 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. 

87. Credit for holders of zone academy bonds.—

Financial institutions that own zone academy bonds 

receive a non-refundable tax credit (at a rate set by 

the Treasury Department) rather than interest. The 

credit is included in gross income. Proceeds from zone 

academy bonds may only be used to renovate, but not 

construct, qualifying schools and for certain other 

school purposes. The total amount of zone academy 

bonds that may be issued is limited to $1.6 billion—

$400 million in each year from 1998 to 2005. 

88. 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 $89,750 and $119.750 ($59,850 and 

$74,850 for singles) in 2004. 

89. 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. 

90. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to 

nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the asset’s current value without being taxed on 

any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent 

of adjusted gross income; a corporation’s total charitable 

contributions generally may not exceed 10 percent of 

pre-tax income. 

91. 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). 

92. Special deduction for teacher expenses.—Educators in both public and private elementary and secondary schools, who work at least 900 hours during 

a school year as a teacher, instructor, counselor, principal or aide, may subtract up to $250 of qualified expenses when figuring their adjusted gross income (AGI). 

93. Discharge of student loan indebtedness.—Certain professionals who perform in underserved areas, 

and as a consequence get their student loans discharged, may not recognize such discharge as income. 

This provision was expanded by the AJCA to include 

health professionals. 

94. Work opportunity tax credit.—Employers can 

claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2005 

and who are certified as members of various targeted 

groups. The amount of the credit that can be claimed 

is 25 percent for employment of less than 400 hours 

and 40 percent for employment of 400 hours or more. 

The maximum credit per employee is $2,400 and can 

only be claimed on the first year of wages an individual 

earns from an employer. Employers must reduce their 

deduction for wages paid by the amount of the credit 

claimed. 

95. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible 

wages paid to qualified long-term family assistance recipients during the first two years of employment. The 

credit is 35 percent of the first $10,000 of wages in 

the first year of employment and 50 percent of the 

first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The 

credit applies to wages paid to employees who are hired 

on or before December 31, 2005. 

96. Employer-provided child care exclusion.—Up 

to $5,000 of employer-provided child care is excluded 

from an employee’s gross income even though the em-
19. TAX EXPENDITURES 343

ployer’s costs for the child care are a deductible business expense. 

97. 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. 

98. 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. 

99. Adoption credit and exclusion.—Taxpayers can 

receive a nonrefundable tax credit for qualified adoption 

expenses. The maximum credit is $10,390 per child for 

2004, and is phased-out ratably for taxpayers with 

modified AGI between $155,860 and $195,860. 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. 

100. 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. 

101. Child credit.—Taxpayers with children under 

age 17 can qualify for a $1,000 refundable per child 

credit. The maximum credit declines to $500 in 2011 

and later years. The credit is phased out for taxpayers 

at the rate of $50 per $1,000 of modified AGI above 

$110,000 ($75,000 for singles). 

102. Child and dependent care expenses.—Married couples with child and dependent care expenses 

may claim a tax credit when one spouse works full 

time and the other works at least part time or goes 

to school. The credit may also be claimed by single 

parents and by divorced or separated parents who have 

custody of children. Expenditures up to a maximum 

$3,000 for one dependent and $6,000 for two or more 

dependents are eligible for the credit. The credit is 

equal to 35 percent of qualified expenditures for taxpayers with incomes of $15,000. The credit is reduced 

to a minimum of 20 percent by one percentage point 

for each $2,000 of income in excess of $15,000. 

103. 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. 

104. 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. 

105. 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. 

106. 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 

107. 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. 

108. 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. 

109. Medical and health savings accounts.—Some 

employees may deduct annual contributions to a medical savings account (MSA); employer contributions to 

MSAs (except those made through cafeteria plans) for 

qualified employees are also excluded from income. An 

employee may contribute to an MSA in a given year 

only if the employer does not contribute to the MSA 

in that year. MSAs are only available to self-employed 

individuals or employees covered under an employersponsored high deductible health plan of a small employer. The maximum annual MSA contribution is 75 

percent of the deductible under the high deductible plan 

for family coverage (65 percent for individual coverage). 

Earnings from MSAs are excluded from taxable income. 

Distributions from an MSA for medical expenses are 

not taxable. The number of taxpayers who may benefit 

annually from MSAs is generally limited to 750,000. 

No new MSAs may be established after December 31, 

2003. The Medicare Prescription Drug, Improvement, 
344 ANALYTICAL PERSPECTIVES 

and Modernization Act of 2003 introduced health savings accounts (HSA) which provides a tax-favored savings for health care expenses. The definition of a highdeductible health plan is less restrictive for HSAs than 

for MSAs. 

110. 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. 

111. Hospital construction bonds.—Interest earned 

on State and local government debt issued to finance 

hospital construction is excluded from income subject 

to tax. 

112. 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. 

113. 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. 

114. 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. 

115. Tax credit for health insurance purchased 

by certain displaced and retired individuals.—The 

Trade Act of 2002 provided a refundable tax credit of 

65 percent for the purchase of health insurance coverage by individuals eligible for Trade Adjustment Assistance and certain PBGC pension recipients. 

Income Security 

116. 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. 

117. Workers’ compensation benefits.—Workers 

compensation provides payments to disabled workers. 

These benefits, although income to the recipients, are 

not subject to the income tax. 

118. 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. 

119. 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. 

120. Military disability pensions.—Most of the 

military pension income received by current disabled 

retired veterans is excluded from their income subject 

to tax. 

121. 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. 

122. 401(k) plans.—Individual taxpayers can make 

tax-preferred contributions to certain types of employerprovided 401(k) plans (and 401(k)-type plans like 403(b) 

plans and the Federal government’s Thrift Savings 

Plan). In 2004, an employee could exclude up to $14,000 

of wages from AGI under a qualified arrangement with 

an employer’s 401(k) plan. This increases to $14,000 

in 2005 and $15,000 in 2006 (indexed thereafter). The 

tax on the investment income earned by 401(k)-type 

plans is deferred until withdrawn. 

Employees are allowed to make after-tax contributions to 401(k) and 401(k)-type plans. These contributions are not excluded from AGI, but the investment 

income of such after-tax contributions is not taxed when 

earned or withdrawn. 

123. Individual Retirement Accounts.—Individual 

taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs, 

non-deductible IRAs, and Roth IRAs. The annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. 

The IRA contribution limit is $3,000 in 2004, $4,000 

in 2005, and $5,000 in 2008 (indexed thereafter) and 

allows taxpayers over age 50 to make additional ‘‘catchup’’ contributions of $1,000 (by 2006). 

Taxpayers whose AGI is below $75,000 ($55,000 for 

non-joint filers) in 2004 can claim a deduction for IRA 

contributions. The IRA deduction is phased out for taxpayers with AGI between $65,000 and $75,000 ($45,000 

and $55,000 for non-joint). The phase-out range increases annually until it reaches $80,000 to $100,000 

in 2007 ($50,000 to $60,000 in 2005 for non-joint filers). 

Taxpayers whose AGI is above the phase-out range can 

also claim a deduction for their IRA contributions depending on whether they (or their spouse) are an active 

participant in an employer-provided retirement plan. 

The tax on the investment income earned by 401(k) 

plans, non-deductible IRAs, and deductible IRAs is deferred until the money is withdrawn. 

Taxpayers with incomes below $160,000 ($110,000 for 

nonjoint filers) can make contributions to Roth IRAs. 

The maximum contribution to a Roth IRA is phased 

out for taxpayers with AGI between $150,000 and 

$160,000 ($95,000 and $110,000 for singles). Investment 

income of a Roth IRA is not taxed when earned nor 

when withdrawn. Withdrawals from a Roth IRA are 

penalty free if: (1) the Roth IRA was opened at least 

5 years before the withdrawal, and (2) the taxpayer 

either (a) is at least 591/2, (b) dies, (c) is disabled, 

or (d) purchases a first-time house. 
19. TAX EXPENDITURES 345

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. 

124. Low and moderate income savers’ credit.—

The Tax Code provides an additional incentive for 

lower-income taxpayers to save through a nonrefundable credit of up to 50 percent on IRA and other retirement contributions of up to $2,000. This credit is in 

addition to any deduction or exclusion. The credit is 

completely phased out by $50,000 for joint filers and 

$25,000 for single filers. This temporary credit is in 

effect from 2002 through 2006. 

125. Keogh plans.—Self-employed individuals can 

make deductible contributions to their own retirement 

(Keogh) plans equal to 25 percent of their income, up 

to a maximum of $40,000 in 2001. Total plan contributions are limited to 25 percent of a firm’s total wages. 

The tax on the investment income earned by Keogh 

plans is deferred until withdrawn. 

126. Employer-provided life insurance benefits.—

Employer-provided life insurance benefits are excluded 

from an employee’s gross income even though the employer’s costs for the insurance are a deductible business expense, but only to the extent that the employer’s 

share of the total costs does not exceed the cost of 

$50,000 of such insurance. 

127. 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. 

128. 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. 

129. 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. 

130. 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. 

131. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,200 

standard deduction if single, or $950 if married in 2004. 

132. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,200 standard deduction if single, or $950 if 

married in 2004. 

133. 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. 

134. 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. 

135. 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 $7,660 of earned income in 2004. The credit 

is 40 percent of the first $10,750 of income for a family 

with two or more qualifying children. The credit is 

phased out beginning when the taxpayer’s income exceeds $14,040 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 $30,338 ($34,458 if 

two or more qualifying children are present), $31,338 

(or $35,458) for those married. 

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 2004, 

the credit is 7.65 percent of the first $5,100 of earned 

income. When the taxpayer’s income exceeds $6,390 

(7,390 if married), the credit is phased out at the rate 

of 7.65 percent. It is completely phased out at $11,490 

($12,490 for married) of modified adjusted gross income. 
346 ANALYTICAL PERSPECTIVES 

For workers with or without children, the income 

levels at which the credit begins to phase-out and the 

maximum amounts of income on which the credit can 

be taken are adjusted for inflation. For married taxpayers filing a joint return, the base amount for the 

phase-out increases by $2,000 in 2005 through 2007, 

and $3,000 in 2008 (indexed thereafter). 

Earned income tax credits in excess of tax liabilities 

owed through the individual income tax system are refundable to individuals. This portion of the credit is 

shown as an outlay, while the amount that offsets tax 

liabilities is shown as a tax expenditure. 

Social Security 

136. Social Security benefits for retired workers.—The non-taxation of Social Security benefits that 

exceed the beneficiary’s contributions out of taxed income is a tax expenditure. These additional retirement 

benefits are paid for partly by employers’ contributions 

that were not included in employees’ taxable compensation. Portions (reaching as much as 85 percent) of recipients’ Social Security and Tier 1 Railroad Retirement 

benefits are included in the income tax base, however, 

if the recipient’s provisional income exceeds certain 

base amounts. Provisional income is equal to adjusted 

gross income plus foreign or U.S. possession income 

and tax-exempt interest, and one half of Social Security 

and tier 1 railroad retirement benefits. The tax expenditure is limited to the portion of the benefits received 

by taxpayers who are below the base amounts at which 

85 percent of the benefits are taxable. 

137. Social Security benefits for the disabled.—

Benefit payments from the Social Security Trust Fund 

for disability are partially excluded from a beneficiary’s 

gross incomes. 

138. Social Security benefits for dependents and 

survivors.—Benefit payments from the Social Security 

Trust Fund for dependents and survivors are partially 

excluded from a beneficiary’s gross income. 

Veterans Benefits and Services 

139. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded 

from taxable income. 

140. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income. 

141. G.I. Bill benefits.—G.I. Bill benefits paid by 

the Veterans Administration are excluded from gross 

income. 

142. 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 

143. 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. 

144. 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. 

145. 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 

146. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until 

the bonds are redeemed. 

Appendix: 

TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION 

This appendix provides a presentation of the Treasury Department’s continuing review of the tax expenditure budget. The review focuses on three issues: (1) 

using comprehensive income as a baseline tax system, 

(2) using a consumption tax as a baseline tax system, 

and (3) defining negative tax expenditures (provisions 

that cause taxpayers to pay too much tax). 

The first section of this appendix compares major 

tax expenditures in the current budget to those implied 

by a comprehensive income baseline. This comparison 

includes a discussion of negative tax expenditures. The 

second section compares the major tax expenditures in 

the current budget to those implied by a consumption 

tax baseline, and also discusses negative tax expenditures. The final section addresses concerns that have 

been raised over the measurement of some current tax 

expenditures by describing new estimates of the tax 

expenditure caused by accelerated depreciation and by 

the tax exemption of the return earned on owner-occupied housing, and an alternative estimate of the tax 

expenditure for the preferential treatment of capital 

gains. The final section also provides an estimate of 

the negative tax expenditure caused by the double tax 

on corporate profits. 
19. TAX EXPENDITURES 347

6See, e.g., David F. Bradford, Untangling the Income Tax (Cambridge, MA: Harvard 

University Press, 1986), pp. 15–31, and Richard Goode, ‘‘The Economic Definition of Income’’ 

in Joseph Pechman, ed., Comprehensive Income Taxation (Washington, D.C.: The Brookings 

Institution, 1977), pp. 1–29. 

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON 

COMPREHENSIVE INCOME 

As discussed in the main body of the tax expenditure 

chapter, official tax expenditures are measured relative 

to normal law or reference law baselines that deviate 

from a uniform tax on a comprehensive concept of income. Consequently, tax expenditures identified in the 

budget can differ from those that would be identified 

if a comprehensive income tax were chosen as the baseline tax system. This appendix addresses this issue by 

comparing major tax expenditures listed in the current 

tax expenditure budget with those implied by a comprehensive income baseline. Many large tax expenditures would continue to be tax expenditures were the 

baseline taken to be comprehensive income, although 

some would be smaller. A comprehensive income baseline would also result in a number of additional tax 

provisions being counted as tax expenditures. 

Current budgetary practice excludes from the list of 

official tax expenditures those provisions that over-tax 

certain items of income. This exclusion conforms to the 

view that tax expenditures are substitutes for direct 

Government spending programs. However, this treatment gives a one-sided picture of how current law deviates from the baseline tax system. Relative to comprehensive income, a number of current tax provisions 

would be negative tax expenditures. Some of these also 

might be negative tax expenditures under the reference 

law or normal law baselines, expanded to admit negative tax expenditures.

Treatment of Major Tax Expenditures from the Current 

Budget under a Comprehensive Income Tax Baseline

Comprehensive income, also called Haig-Simons income, is the real, inflation adjusted, accretion to one’s 

economic power arising between two points in time, 

e.g., the beginning and ending of the year. It includes 

all accretions to wealth, whether or not realized, whether or not related to a market transaction, and whether 

a return to capital or labor. Inflation adjusted capital 

gains (and losses) would be included in comprehensive 

income as they accrue. Business, investment, and casualty losses, including losses caused by depreciation, 

would be deducted. Implicit returns, such as those accruing to homeowners, also would be included in comprehensive income. A comprehensive income tax baseline would tax all sources of income once. Thus, it 

would not include a separate tax on corporate income 

that leads to the double taxation of corporate profits. 

While comprehensive income can be defined on the 

sources side of the consumer’s balance sheet, it sometimes is instructive to use the identity between the 

sources of wealth and the uses of wealth to redefine 

it as the sum of consumption during the period plus 

the change in net worth between the beginning and 

the end of the period. 

Comprehensive income is widely held to be the idealized base for an income tax even though it is not a 

perfectly defined concept. 6 It suffers from conceptual 

ambiguities, some of which are discussed below, as well 

as practical problems in measurement and tax administration, e.g., how to implement a practicable deduction 

for economic depreciation or include in income the return earned on consumer durable goods, including housing, automobiles, and major appliances. 

Furthermore, comprehensive income does not necessarily represent an ideal tax base; efficiency or equity 

might be improved by deviating from comprehensive 

income as a tax base, e.g., by reducing the tax on capital income in order to further spur economic growth 

or by subsidizing certain types of activities in order 

to correct for market failures or to improve the aftertax distribution of income. In addition, some elements 

of comprehensive income would be difficult or impossible to include in a tax system that is administrable. 

Classifying individual tax provisions relative to a 

comprehensive income baseline is difficult, in part because of the ambiguity of the baseline. It also is difficult 

because of interactions between tax provisions (or their 

absence). These interactions mean that it may not always be appropriate to consider each provision in isolation. Nonetheless, Appendix Table 1 attempts such a 

classification for each of the thirty largest tax expenditures from the Budget. 

We classify fifteen of the thirty items as tax expenditures under a comprehensive tax base (those in panel 

A). Most of these give preferential tax treatment to 

the return on certain types of savings or investment. 

They are a result of the explicitly hybrid nature of 

the existing tax system, and arise out of policy decisions 

that reflect discomfort with the high tax rate on capital 

income that would otherwise arise under the current 

structure of the income tax. Even these relatively clear 

cut items, however, can raise ambiguities particularly 

in light of the absence of integration of the corporate 

and individual tax systems. Given current law’s corporate income tax, the reduction or elimination of individual level tax on income from investment in corporate 

equities might not be a tax expenditure relative to a 

comprehensive income baseline. Rather, an individual 

income tax preference might undo the corporate tax 

penalty (i.e., the double tax). This perspective is reflected in adjustments that have been made to the calculation of the tax expenditures for pensions and several other items in the 2006 budget (as discussed 

above). However, these adjustments have not been 

made in all tax expenditure calculations, e.g., no adjustment was made in the exclusion of interest on life insurance saving. A similar line of reasoning could be 

used to argue that in the case of corporations, expens-
348 ANALYTICAL PERSPECTIVES 

7 Expensing means immediate deduction. Proper income tax treatment requires capitalization followed by annual depreciation allowances reflecting the decay in value of the associated R&E spending. 8Suppose a taxpayer buys a one year term unemployment insurance policy at the beginning of the year. At that time he exchanges one asset, cash, for another, the insurance 

policy, so there is no change in net worth. But, at the end of the year, the policy expires 

and so is worthless, hence the taxpayer has a reduction in net worth equal to the premium. 

If the policy pays off during the year (i.e., the taxpayer has a work related injury), then 

the taxpayer would include the proceeds in income because they represent an increase 

in his net worth. 9The treatment of insurance premiums and benefits is discussed more completely below. 

10 If there were no deduction for interest and property taxes, the tax expenditure base 

(i.e., the proper tax base minus the actual tax base) for owner-occupied housing would 

equal the homeowner’s net rental income: gross rents—(depreciation+interest+property 

taxes+other expenses). With the deduction for interest and property taxes, the tax expenditure base rises to gross rents minus (depreciation+other expenses). 

11Fiscal Year 2003 Budget of the United States Government, Analytical Perspectives (Washington, D.C.: U.S. Government Printing Office, 2002) p. 127. 12Property taxes on owner-occupied housing also might serve as a proxy for the value 

of untaxed local services provided to homeowners. As such, they would be listed in the 

tax expenditure budget (as configured, i.e., building on the estimate for the failure to 

tax net rents) twice, once because current law does not tax rental income and again as 

a proxy for government services received. Property taxes on other consumer durables such 

as automobiles also might be included twice, owing to current law’s exclusion from income 

of the associated service flow. 13 U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: U.S. Government 

Printing Office, 1977) p. 92. 14 Under the normal tax method employed by the Joint Committee on Taxation, the 

value of some public assistance benefits provided by State Governments is included as 

a tax expenditure, thereby raising a potential double counting issue. 

ing 7 of R&E is not a tax expenditure because it serves 

to offset the corporate tax penalty. 

In contrast to treatment in previous budgets, the 

2006 budget includes as a tax expenditure the failure 

to tax net rental income from owner-occupied housing. 

Because net rental income (gross rents minus depreciation, interest, taxes, and other expenses) would be in 

the homeowner’s tax base under a comprehensive income tax baseline, this item would be a tax expenditure 

relative to a comprehensive income baseline. 

The exclusion of worker’s compensation benefits also 

would be a tax expenditure under comprehensive income principles. Under comprehensive income tax principles, if the worker were to buy the insurance himself, 

he would be able to deduct the premium (since it represents a reduction in net worth) but should include 

in income the benefit when paid (since it represents 

an increase in net worth). 8 If the employer pays the 

premium, the proper treatment would allow the employer a deduction and allow the employee to disregard 

the premium, but he would take the proceeds, if any, 

into income. Current law allows the employer to deduct 

the premium and excludes both the premium and the 

benefits from the employee’s tax base. 

Veteran’s death and disability benefits seem likely 

to represent a tax expenditure. This is clearly the case 

to the extent they are seen as deferred wages or as 

transfers. It also is the case to the extent that they 

are seen as insurance benefits, since the premiums, 

which come in the form of foregone wages, were not 

included in taxable income. 9

Panel B deals with items that probably are tax expenditures, but that raise issues. Current law allows 

deductions for home mortgage interest and for property 

taxes on owner-occupied housing. The tax expenditure 

budget includes both of these deductions. From one perspective, these two deductions would not be considered 

tax expenditures relative to a comprehensive tax base; 

a comprehensive base would allow both deductions. 

However, this perspective ignores current law’s failure 

to impute gross rental income. Conditional on this failure, the deductions for interest and property taxes 

might be viewed as inappropriate, because they move 

the tax system away from rather than towards a comprehensive income tax base. 10 Indeed, the sum of the 

tax expenditure for these two deductions, plus the tax 

expenditure for the failure to include net rental income, 

sums to the tax expenditure for owner-occupied housing 

relative to a comprehensive income tax base. Consequently, there is a strong argument for classifying 

them as tax expenditures relative to a comprehensive 

income baseline. 

The deduction of nonbusiness State and local taxes 

other than on owner-occupied homes also is included 

in this section. These taxes include income, sales, and 

property taxes. The stated justification for this tax expenditure is that ‘‘Taxpayers may deduct State and 

local income taxes and property taxes even though 

these taxes primarily pay for services that, if purchased 

directly by taxpayers, would not be deductible. 11 The 

idea is that these taxes represent (or serve as proxies 

for) consumption expenditures for which current law 

makes no imputations to income. 12

In contrast to the view in the official Budget, however, the deduction for State and local taxes might not 

be a tax expenditure if the baseline were comprehensive 

income. Properly measured comprehensive income 

would include the value of State and local government 

benefits received, but would allow a deduction for State 

and local taxes paid. 13 Thus, in this sense the deductibility of State and local taxes is consistent with comprehensive income tax principles; it should not be a 

tax expenditure. Nonetheless, imputing the value of 

State and local services is difficult and is not done 

under current law. Consequently, a deduction for taxes 

might sensibly be viewed as a tax expenditure relative 

to a comprehensive income baseline. 14

To the extent that the personal and dependent care 

exemptions and the standard deduction properly remove from taxable income all expenditures that do not 

yield suitably discretionary consumption value, or otherwise appropriately adjust for differing taxpaying capacity, then the child care credit and the earned income 

tax credit would be tax expenditures. In contrast, a 

competing perspective views these credits as appropriate modifications that account for differing taxpaying 

capacity. Even accepting this competing perspective, 

however, one might question why these programs come 

in the form of credits rather than deductions. 

The step-up of basis at death lowers the income tax 

on capital gains for those who inherit assets below what 

it would be otherwise. From that perspective it would 

be a tax expenditure under a comprehensive income 

baseline. Nonetheless, there are ambiguities. Under a 

comprehensive income baseline, all real inflation adjusted gains would be taxed as accrued, so there would 

be no deferred unrealized gains on assets held at death. 

The lack of full taxation of Social Security benefits 

also is listed in panel B. Consider first Social Security 

retirement benefits. To the extent that Social Security 
19. TAX EXPENDITURES 349

15 As a practical matter, this may be impossible to do. Valuing claims subject to future 

contingencies is very difficult, as discussed in Bradford, Untangling the Income Tax, pp. 

23–24. 16This includes the tax expenditure for benefits paid to workers, that for benefits paid 

to survivors and dependents, and that for benefits paid to dependents. 17The current budget does not include as a tax expenditure the absence of income taxation 

on the employer’s contributions (payroll taxes) to Social Security retirement at the time 

these contributions are made. 

18Private pensions allow the employee to defer tax on all inside build-up. They also 

allow the employee to defer tax on contributions made by the employer, but not on contributions made directly by the employee. Applying these tax rules to Social Security would 

require the employee to include in his taxable income benefits paid out of inside buildup and out of the employer’s contributions, but would allow the employee to exclude from 

his taxable income benefits paid out of his own contributions. 19See, for example, Goode, The Economic Definition of Income, pp. 16–17, and Bradford, 

Untangling the Income Tax, pp. 19–21, and pp.30–31. 20The item also includes gifts of appreciated property, at least part of which represents 

a tax expenditure relative to an ideal income tax, even if one assumes that charitable 

donations are not consumption. 

is viewed as a pension, a comprehensive income tax 

would include in income all contributions to Social Security retirement funds (payroll taxes) and tax accretions to value as they arise (inside build-up). 15 Benefits 

paid out of prior contributions and the inside buildup, however, would not be included in the tax base 

because the fall in the value of the individual’s Social 

Security account would be offset by an increase in cash. 

In contrast, to the extent that Social Security is viewed 

as a transfer program, all contributions should be deductible from the income tax base and all benefits received should be included in the income tax base. 

A similar analysis applies to Social Security benefits 

paid to dependents and survivors. If these benefits represent transfers from the Government, then they should 

be included in the tax base. If the taxpaying unit consists of the worker plus dependents and survivors, then 

to the extent that Social Security benefits represent 

payments from a pension, the annual pension earnings 

should be taxed in the same way that earnings accruing 

to retirees are taxed. However, benefits paid to dependents and survivors might be viewed as a gift or transfer 

from the decedent, in which case the dependents and 

survivors should pay tax on the full amount of the 

benefit received. (In this case the decedent or his estate 

should pay tax on the pension income as well, to the 

extent that the gift represents consumption rather than 

a reduction in net worth). 

In addition, dependent and survivors benefits might 

be viewed in part as providing life insurance. In that 

case, the annual premiums paid each year, or the portion of Social Security taxes attributable to the premiums, should be deducted from income, since they 

represent a decline in net worth, while benefits should 

be included in income. Alternatively, taxing premiums 

and excluding benefits also would represent appropriate 

income tax policy. 

In contrast to any of these treatments, current law 

excludes one-half of Social Security contributions (employer-paid payroll taxes) from the base of the income 

tax, makes no attempt to tax accretions, and subjects 

some, but not all, benefits to taxation. The difference 

between current law’s treatment of Social Security benefits and their treatment under a comprehensive income tax would qualify as a tax expenditure, but such 

a tax expenditure differs in concept from that included 

in the official budget. 

The tax expenditures in the official budget 16 reflect 

exemptions for lower income beneficiaries from the tax 

on 85 percent of Social Security benefits. 17 Historically, 

payroll taxes paid by the employee represented no more 

than 15 percent of the expected value of the retirement 

benefits received by a lower-earnings Social Security 

beneficiary. The 85 percent inclusion rate is intended 

to tax upon distribution the remaining amount of the 

retirement benefit payment—the portion arising from 

the payroll tax contributions made by employers and 

the implicit return on the employee and employer contributions. Thus, the tax expenditure conceived and 

measured in the current budget is not intended to capture the deviation from a comprehensive income baseline, which would additionally account for the deferral 

of tax on the employer’s contributions and on the rate 

of return (less an inflation adjustment attributable to 

the employee’s payroll tax contributions). Rather, it is 

intended to approximate the taxation of private pensions with employee contributions made from after-tax 

income, 18 on the assumption that Social Security is 

comparable to such pensions. Hence, the official tax 

expenditure understates the tax advantage accorded Social Security retirement benefits relative to a comprehensive income baseline. 

To the extent that the benefits paid to dependents 

and survivors should be taxed as private pensions, the 

same conclusion applies: the official tax expenditure 

understates the tax advantage. 

The deduction for U.S. production activities also 

raises some problems. To the extent it is viewed as 

a tax break for certain qualifying businesses (‘‘manufacturers’’), it would be a tax expenditure. In contrast, 

the deduction may prove to be so broad that it is available to most U.S. businesses, in which case it might 

not be seen as a tax expenditure. Rather, it would 

represent a feature of the baseline tax rate system, 

because the deduction is equivalent to a lower tax rate. 

In addition, to the extent that it is viewed as providing 

relief from the double tax on corporate profits, it might 

not be a tax expenditure. 

The next category (panel C) includes items whose 

treatment is less certain. The proper treatment of some 

of these items under a comprehensive income tax is 

ambiguous, while others perhaps serve as proxies for 

what would be a tax expenditure under a comprehensive income base. 19 Consider, for example, the items 

relating to charitable contributions. Under existing law, 

charitable contributions are deductible, and this deduction is considered on its face a tax expenditure in the 

current budget. 20

The treatment of charitable donations, however, is 

ambiguous under a comprehensive income tax. If charitable contributions are a consumption item for the 

giver, then they are properly included in his taxable 

income; a deduction for contributions would then be 

a tax expenditure relative to a comprehensive income 

tax baseline. In contrast, charitable contributions could 

represent a transfer of purchasing power from the giver 
350 ANALYTICAL PERSPECTIVES 

21 If recipients tend to be in lower tax brackets, then the tax expenditure is smaller 

than when measured at the donor’s tax rates. 

22 In contrast, the passive loss rules themselves, which restrict the deduction of losses, 

would be a negative tax expenditure when compared to a comprehensive tax base. 23To the extent that premiums are deductible.

to the receiver. As such, they would represent a reduction in the giver’s net worth, not an item of consumption, and so properly would be deductible, implying that 

current law’s treatment is not a tax expenditure. At 

the same time, however, the value of the charitable 

benefits received is income to the recipient. Under current law, such income generally is not taxed, and so 

represents a tax expenditure whose size might be approximated by the size of the donor’s contribution. 21

Medical expenditures may or may not be an element 

of income (or consumption). Some argue that medical 

expenditures don’t represent discretionary spending, 

and so aren’t really consumption. Instead, they are a 

reduction of net worth and should be excluded from 

the tax base. In contrast, others argue that there is 

no way to logically distinguish medical care from other 

consumption items. Those who view medical spending 

as consumption point out that there is choice in many 

health care decisions, e.g., whether to go to the best 

doctor, whether to have voluntary surgical procedures, 

and whether to exercise and eat nutritiously so as to 

improve and maintain one’s health and minimize medical expenditures. This element of choice makes it more 

difficult to argue, at least in many cases, that medical 

spending is more ‘‘necessary’’ than, or otherwise different from, other consumption spending. 

The exemption of full taxation of Social Security benefits paid to the disabled also raises some issues. Social 

Security benefits for the disabled most closely resemble 

either Government transfers or insurance. A comprehensive income tax would require the worker to include the benefit fully in his income and would allow 

him to deduct associated Social Security taxes. If 

viewed as insurance, he also could include the premium 

(i.e., tax) and exclude the benefit. The deviation between such treatment and current law’s treatment (described above) would be a tax expenditure under a comprehensive income baseline. 

In contrast, as described above, the official tax expenditure measures the benefit of exemption for low 

income beneficiaries from the tax on 85 percent of Social Security benefits. This measurement does not correspond closely to that required under a comprehensive 

income base. If the payment of the benefit is viewed 

as a transfer and divorced from the treatment of Social 

Security taxes, then the current tax expenditure understates the tax expenditure measured relative to a comprehensive income baseline. If the payment of the benefit is viewed as a transfer but the inability to deduct 

the employee’s share of the Social Security tax is simultaneously considered, then it is less likely that the current tax expenditure overstates the tax expenditure relative to a comprehensive income baseline, and in some 

cases it may generate a negative tax expenditure. If 

the benefit is viewed as insurance and the tax as a 

premium, then the current tax expenditure overstates 

the tax expenditure relative to a comprehensive income 

baseline. Indeed, in the insurance model, the ability 

to exclude from tax only 1⁄2 of the premium might suggest that 1⁄2 of the payout should be taxed, so that 

the current tax rules impose a greater tax burden than 

that implied by a comprehensive income tax, i.e., a 

negative tax expenditure. 22

The final category (panel D) includes items that 

would not be tax expenditures under a comprehensive 

income tax base. A tax based on comprehensive income 

would allow all losses to be deducted. Hence, the exception from the passive loss rules would not be a tax 

expenditure.

Major Tax Expenditures under a Comprehensive Income 

Tax That Are Excluded from the Current Budget

While most of the major tax expenditures in the current budget also would be tax expenditures under a 

comprehensive income base, there also are tax expenditures relative to a comprehensive income base that are 

not found on the existing tax expenditure list. These 

additional tax expenditures include the imputed return 

from certain consumer durables (e.g., automobiles), the 

imputed return to consumption of financial services 

(e.g., checking account services received in kind and 

paid for by accepting a below market interest rate on 

deposits), the difference between capital gains (and 

losses) as they accrue and capital gains as they are 

realized, private gifts and inheritances received, in-kind 

benefits from such Government programs as foodstamps, Medicaid, and public housing, the value of payouts from insurance policies, 23 and benefits received 

from private charities. Under some ideas of comprehensive income, the value of leisure and of household production of goods and services also would be included 

as tax expenditures. The personal exemption and standard deduction also might be considered tax expenditures, although they can be viewed differently, e.g., as 

elements of the basic tax rate schedule. The foreign 

tax credit also might be a tax expenditure, since a 

deduction for foreign taxes, rather than a credit, would 

seem to measure the income of U.S. residents properly. 

Negative Tax Expenditures

Under current budgetary practice, negative tax expenditures, tax provisions that raise rather than lower 

taxes, are excluded from the official tax expenditure 

list. This exclusion conforms with the view that tax 

expenditures are intended to be similar to Government 

spending programs. 

If attention is expanded from a focus on spendinglike programs to include any deviation from the baseline tax system, negative tax expenditures would be 

of interest. Relative to a comprehensive income baseline, there are a number of important negative tax expenditures, some of which also might be viewed as negative tax expenditures under an expanded interpretation of the normal or reference law baseline. Among 

the more important negative tax expenditures is the 

corporation income tax, or more generally the double 
19. TAX EXPENDITURES 351

24 Current law offers favorable treatment to some education costs, thereby creating (positive) tax expenditures. Current law allows expensing of that part of the cost of education 

and career training that is related to foregone earnings and this would be a tax expenditure 

under a comprehensive income baseline. 

25See Bradford, Untangling the Income Tax, p. 41. 26 Accelerated depreciation can be described as the equivalent of an interest free loan 

from the Government to the taxpayer. Under federal budget accounting principles, such 

a loan would be treated as an outlay equal to the present value of the foregone interest. 

tax on corporate profits, which would be eliminated 

under a comprehensive income tax. The Jobs and 

Growth Tax Relief and Reconciliation Act of 2003 

(JGTRRA) reduced the tax rate on dividends and capital gains to 15 percent, thus reducing the double tax 

compared to prior law. Nonetheless, as discussed later 

in the Appendix, current law still imposes a substantial 

double tax on corporate profits. The passive loss rules, 

restrictions on the deductibility of capital losses, and 

NOL carry-forward requirements each would generate 

a negative tax expenditure, since a comprehensive income tax would allow full deductibility of losses. If 

human capital were considered an asset, then its cost 

(e.g., certain education and training expenses, including 

perhaps the cost of college and professional school) 

should be amortizable, but it is not under current 

law. 24 Some restricted deductions under the individual 

AMT might be negative tax expenditures as might the 

phase-out of personal exemptions and of itemized deductions. The inability to deduct consumer interest also 

might be a negative tax expenditure, as an interest 

deduction may be required to properly measure income, 

as seen by the equivalence between borrowing and reduced lending. 25 As discussed above, the current treatment of Social Security payments to the disabled also 

might represent a negative tax expenditure, if viewed 

as payments on an insurance policy. 

Current tax law also fails to index for inflation interest receipts, capital gains, depreciation, and inventories. 

This failure leads to negative tax expenditures because 

comprehensive income would be indexed for inflation. 

Current law, however, also fails to index for inflation 

the deduction for interest payments; this represents a 

(positive) tax expenditure. 

The issue of indexing also highlights that even if 

one wished to focus only on tax policies that are similar 

to spending programs, accounting for some negative tax 

expenditures may be required. For example, the net 

subsidy created by accelerated depreciation is properly 

measured by the difference between depreciation allowances specified under existing tax law and economic 

depreciation, which is indexed for inflation. 26

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES RELATIVE 

TO A CONSUMPTION BASE 

This section compares tax expenditures listed in the 

official tax expenditure budget with those implied by 

a comprehensive consumption tax baseline. It first discusses some of the difficulties encountered in trying 

to compare current tax provisions to those that would 

be observed under a comprehensive consumption tax. 

Next, it discusses which of the thirty largest official 

tax expenditures would be tax expenditures under the 

consumption tax baseline, concluding that about onehalf of the top thirty official tax expenditures would 

remain tax expenditures under a consumption tax baseline. Most of those that fall off the list are tax incentives for saving and investment. 

The section next discusses some major differences between current law and a comprehensive consumption 

tax baseline that are excluded from the current list 

of tax expenditures. These differences include the consumption value of owner-occupied housing and other 

consumer durables, benefits from in-kind Government 

transfers, and gifts. It concludes with a discussion of 

negative tax expenditures relative to a consumption tax 

baseline

Ambiguities in Determining Tax Expenditures Relative 

to a Consumption Baseline

A broad-based consumption tax is a combination of 

an income tax plus a deduction for net saving. This 

follows from the definition of comprehensive income as 

consumption plus the change in net worth. It therefore 

seems straightforward to say that current law’s deviations from a consumption base are the sum of (a) 

tax expenditures on an income base associated with 

exemptions and deductions for certain types of income, 

plus (b) overpayments of tax, or negative tax expenditures, to the extent net saving is not deductible from 

the tax base. In reality, however, the situation is more 

complicated. A number of issues arise, some of which 

also are problems in defining a comprehensive income 

tax, but seem more severe, or at least only more obvious, for the consumption tax baseline. 

It is not always clear how to treat certain items 

under a consumption tax. One problem is determining 

whether a particular expenditure is an item of consumption. Spending on medical care and charitable donations are two examples. The classification below suggests that medical spending and charitable contributions might be included in the definition of consumption, but also considers an alternative view. 

There may be more than one way to treat various 

items under a consumption tax. For example, a consumption tax might ignore borrowing and lending by 

excluding from the borrower’s tax base the proceeds 

from loans, denying the borrower a deduction for payments of interest and principal, and excluding interest 

and principal payments received from the lender’s tax 

base. On the other hand, a consumption tax might include borrowing and lending in the tax base by requiring the borrower to add the proceeds from loans in 

his tax base, allowing the lender to deduct loans from 

his tax base, allowing the borrower to deduct payments 

of principal and interest, and requiring the lender to 

include receipt of principal and interest payments. In 
352 ANALYTICAL PERSPECTIVES 

present value terms, the two approaches are equivalent 

for both the borrower and the lender; in particular both 

allow the tax base to measure consumption and both 

impose a zero effective tax rate on interest income. 

But which approach is taken obviously has different 

implications (at least on an annual flow basis) for the 

treatment of many important items of income and expense, such as the home mortgage interest deduction. 

The classification below suggests that the deduction for 

home mortgage interest could well be a tax expenditure, 

but takes note of alternative views. 

Some exclusions of income are equivalent in many 

respects to consumption tax treatment that immediately deducts the cost of an investment while taxing 

the future cash-flow. For example, exempting investment income is equivalent to consumption tax treatment as far as the normal rate of return on new investment is concerned. This is because expensing generates 

a tax reduction that offsets in present value terms the 

tax paid on the investment’s future normal returns. 

Expensing gives the income from a marginal investment a zero effective tax rate. However, a yield exemption approach differs from a consumption tax as far 

as the distribution of income and Government revenue 

is concerned. Pure profits in excess of the normal rate 

of return would be taxed under a consumption tax, 

because they are an element of cash-flow, but would 

not be taxed under a yield exemption tax system. 

Should exemption of certain kinds of investment income, and certain investment tax credits, be regarded 

as the equivalent of consumption tax treatment? The 

classification that follows takes a fairly broad view of 

this equivalence and considers many tax provisions that 

reduce or eliminate the tax on capital income to be 

roughly consistent with a broad-based consumption tax. 

Looking at provisions one at a time can be misleading. The hybrid character of the existing tax system 

leads to many provisions that might make good sense 

in the context of a consumption tax, but that generate 

inefficiencies because of the problem of the ‘‘uneven 

playing field’’ when evaluated within the context of the 

existing tax rules. It is not clear how these should 

be classified. For example, many saving incentives are 

targeted to specific tax favored sources of capital income. The inability to save on a similar tax-favored 

basis irrespective of the ultimate purpose to which the 

saving is applied potentially distorts economic choices 

in ways that would not occur under a broad-based consumption tax. As another example, under a consumption VAT based on the destination principle, there 

would be a rebate of the VAT on exports and a tax 

on imports. Does this mean that the extraterritorial 

income exclusion (the successor of the Foreign Sales 

Corporation provision) is not a tax expenditure? Resolution comes down to judgments about how broad is broad 

enough to be considered general, or whether it even 

matters at all that a provision is targeted in some 

way. The classification that follows views many savings 

incentives, even if targeted, as roughly consistent with 

a broad based consumption tax. 

In addition, provisions can interact even once an appropriate treatment is determined. For example, suppose that it is determined that financial flows are out 

of the tax base. Then the deduction for home mortgage 

interest would seem to be a tax expenditure. However, 

this conclusion is cast into doubt because current law 

generally taxes interest income. When combined with 

the homeowners’ deduction, this results in a zero tax 

rate on the interest flow, consistent with consumption 

tax treatment. 

Capital gains would not be a part of a comprehensive 

consumption tax base. Proceeds from asset sales and 

sometimes borrowing would be part of the cash-flow 

tax base, but, for transactions between domestic investors at a flat tax rate, would cancel out in the economy 

as a whole. How should existing tax expenditures related to capital gains be classified? The classification 

below generally views available capital gains tax breaks 

as consistent with a broad-based consumption tax because they lower the tax rate on capital income toward 

the zero rate that is consistent with a consumptionbased tax. 

Such considerations suggest that trying to compute 

the current tax’s deviations from ‘‘the’’ base of a consumption tax is impossible because deviations cannot 

be uniquely determined, making it very difficult to do 

a consistent accounting of the differences between the 

current tax base and a consumption tax base. Nonetheless, Appendix Table 2 attempts a classification based 

on the judgments outlined above.

Treatment of Major Tax Expenditures under a Comprehensive Consumption Baseline

As noted above, the major difference between a comprehensive consumption tax and a comprehensive income tax is in the treatment of saving, or in the taxation of capital income. Consequently, many current 

tax expenditures related to preferential taxation of capital income would not be tax expenditures under a consumption tax. However, preferential treatment of items 

of income that is unrelated to moderately broad-based 

saving or investment incentives would remain tax expenditures under a consumption baseline. In addition, 

several official tax expenditures relating to items of 

income and expense are difficult to classify properly, 

while others may serve as proxies for properly measured tax expenditures. 

Appendix Table 2 shows thirty large official tax expenditures from the Budget classified according to 

whether they would be considered a tax expenditure 

under a consumption tax. Two of the thirty items clearly would be a tax expenditure (shown in panel A) under 

a consumption tax, while an additional seven (those 

in panel B) probably would be tax expenditures. 

A consumption tax would include in the homeowners’ 

tax base the value of the implicit (gross) rental income 

from owner-occupied housing. Net rental income is a 
19. TAX EXPENDITURES 353

27Suppose that the rental value of a house is $100 per year, and that depreciation 

is $20, interest is $15, property taxes are $10, and other expenses are $5. Net rental 

income is $50 (gross rents less all items of expense). Hence, net rental income is a component 

of the gross rent, which is the consumption value of the housing services. Under a real 

based cash flow tax, in which financial flows are outside the tax base, the homeowner’s 

net tax base would be $85: gross rents—(property taxes + other expenses), assuming that 

property taxes are viewed as a reduction in net worth and that he makes no new investment 

(which would be deductible). 28 Using the figures from the example in the previous footnote, the homeowner would 

pay tax on gross rents minus property taxes minus other expenses, or on $85. If property 

taxes and mortgage interest were not deducted, then this would be the size of the tax 

expenditure. However, current law allows these deductions, which raises the tax expenditure 

base to $110. 29One must guard against double counting here, however, to the extent that current 

law’s general taxation of capital income is calculated elsewhere in the tax expenditure 

budget as a negative tax expenditure. 

component of this, and so would be included as a tax 

expenditure, relative to a consumption tax baseline. 27

Exclusion of workers’ compensation benefits allows 

an exclusion from income that is unrelated to investment, and so should be included in the base of a comprehensive consumption tax. 

Consider next the deductibility of home mortgage interest and of property taxes on owner-occupied housing. 

Both items would seem to be strong candidates for inclusion as a tax expenditure, given current law’s failure 

to impute the consumption value of housing. That is, 

focusing on the homeowner’s tax base, these deductions 

move the tax system away from rather than towards 

the proper treatment of housing services. 28

However, with respect to the home mortgage interest 

deduction, some ambiguity is introduced by the taxation 

of interest income to lenders. In a sense, the homeowner’s deduction offsets the lenders inclusion, leaving 

(for equal tax rates) no net tax due on the interest 

flow, as would be appropriate under a consumption tax. 

Hence, from the perspective of the entire tax system, 

it is less clear that the home mortgage interest deduction represents a tax expenditure. 29

Some ambiguity also is introduced by the variable 

treatment of financial flows possible under a consumption tax. That is, the proper treatment of interest under 

a consumption tax depends on whether financial flows 

are in or out of the consumption tax base. If the loans 

are taken into income (as they would be under some 

types of consumption taxes), then the associated interest and principal payments should be deductible, otherwise not. 

With respect to property taxes on housing as well 

as other State and local taxes, some ambiguity arises 

because the tax might not represent consumption—it 

might be considered a reduction in net worth. Considered alone, this argument perhaps has some merit. 

However, there are two problems with this argument 

when viewed from the context of the entire tax system. 

First, the deduction for property taxes would seem to 

be inappropriate when there is no imputation for the 

associated consumption value, as discussed above. Second, the current tax system does not impute the consumption value of State and local services, and tax 

payments might serve as a proxy for that value, making 

their deduction unnecessary for the proper measurement of consumption. 

The official tax expenditures for Social Security benefits reflects exceptions for low income taxpayers from 

the general rule that 85 percent of Social Security benefits are included in the recipient’s tax base. The 85 

percent inclusion is intended as a simplified mechanism 

for taxing Social Security benefits as if the Social Security program were a private pension with employee contributions made from after-tax income. Under these tax 

rules, income earned on contributions made by both 

employers and employees benefits from tax deferral, 

but employer contributions also benefit because the employee may exclude them from his taxable income, 

while the employee’s own contributions are included 

in his taxable income. These tax rules give the equivalent of consumption tax treatment, a zero effective tax 

rate on the return, to the extent that the original pension contributions are made by the employer, but give 

less generous treatment to the extent that the original 

contributions are made by the employee. Income earned 

on employee contributions is taxed at a low, but positive, effective tax rate. Based on historical calculations, 

the 85 percent inclusion reflects roughly the outcome 

of applying these tax rules to a lower-income earner 

when one-half of the contributions are from the employer and one-half from the employee. 

The current tax expenditure measures a tax benefit 

relative to a baseline that is somewhere between a comprehensive income tax and a consumption tax. The 

properly measured tax expenditure relative to a consumption tax baseline would include only those Social 

Security benefits that are accorded treatment more favorable than that implied by a consumption tax, which 

would correspond to including 50 percent of Social Security benefits in the recipient’s tax base. 

A similar analysis would apply to exclusion of Social 

Security benefits of dependents and retirees. 

There is a strong case for viewing the child credit 

and the earned income tax credit as social welfare programs (transfers). As such, they would be tax expenditures relative to a consumption baseline. Nonetheless, 

these credits could alternatively be viewed as relieving 

tax on ‘‘nondiscretionary’’ consumption, and so not properly considered a tax expenditure. 

The treatment of the items in panels C is less uncertain. Several of these items relate to the costs of medical care or to charitable contributions. As discussed 

in the previous section of the appendix, there is disagreement within the tax policy community over the 

extent to which medical care and charitable giving represent consumption items. Medical care is widely held 

to be consumption, except perhaps the medical care 

that actually raises, rather than simply sustains the 

individual’s ability to work. Charitable giving, on the 

other hand, may be considered to be a reduction in 

net worth that should be excluded from the tax base 

because it does not yield direct satisfaction to taxpayer 

who makes the expenditure. In this case, the tax expenditure lies not with the individual making the charitable deduction, but with the exclusion from taxation 

of the amounts received by the recipient. 

There also is the issue of how to tax medical insurance premiums. Under current law, employees do not 
354 ANALYTICAL PERSPECTIVES 

have to include insurance premiums paid for by employers in their income. The self-employed also may exclude 

(via a deduction) medical insurance premiums from 

their taxable income. From some perspectives, these 

premiums should be in the tax base because they appear to represent consumption. Yet an alternative perspective would support excluding the premium from tax 

as long as the consumption tax base included the value 

of any medical services paid for by the insurance policy, 

because the premium equals the expected value of insurance benefits received. But even from this alternative perspective, the official tax expenditure might 

continue to be a tax expenditure under a consumption 

tax baseline because current law excludes the value 

of medical services paid with insurance benefits from 

the employee’s taxable income. 

If medical spending is not consumption, one approach 

to measuring the consumption base would ignore insurance, but allow the consumer to deduct the value of 

all medical services obtained. An alternative approach 

would allow a deduction for the premium but include 

the value of any insurance benefits received, while continuing to allow a deduction for a value of all medical 

services obtained. In either case, the official tax expenditure for the exclusion of employer provided medical 

insurance and expenses would not be a tax expenditure 

relative to a consumption tax baseline. 

The extraterritorial income exclusion replaces the 

previous Foreign Sales Corporation program. It provides an exclusion from income for certain exports. To 

the extent that the program is viewed as a component 

of a destination based VAT it might not be a tax expenditure. In addition, to the extent that the exclusion 

reduces the income tax bias against investment it might 

be consistent with consumption tax principles (i.e., a 

low tax rate on capital income). 

The taxation of Social Security benefits for the disabled also is difficult to classify. As discussed in this 

appendix above, these benefits generally ought to be 

taxed because they represent purchasing power. However, the associated Social Security taxes ought to be 

fully deductible, but they are not. Hence the proper 

treatment is unclear. Moreover, if the insurance model 

is applied, the taxation of Social Security benefits might 

be a negative tax expenditure. 

The credit for low income housing acts to lower the 

tax burden on qualified investment, and so from one 

perspective would not be a tax expenditure under a 

consumption tax baseline. However, in some cases the 

credit is too generous; it can give a negative tax on 

income from qualified investment rather than the zero 

tax called for under consumption tax principles. In addition, the credit is very narrowly targeted. Consequently, it could be considered a tax expenditure relative to a consumption tax baseline. 

The final panel (D) shows items that are not likely 

to be tax expenditures under a consumption base. Most 

of these relate to tax provisions that eliminate or reduce the tax on various types of capital income because 

a zero tax on capital income is consistent with consumption tax principles. 

The deduction for U.S. production activities is not 

classified as a tax expenditure. This reflects the view 

that it represents a widespread reduction in taxes on 

capital income or an offset to the corporate income tax. 

In contrast to this classification, however, it would be 

a tax expenditure to the extent that it is viewed as 

a targeted tax incentive. 

The exception from the passive loss rules probably 

would not be a tax expenditure because proper measurement of income, and hence of consumption, requires 

full deduction of losses.

Major Tax Expenditures under a Consumption Tax That 

Are Excluded from the Current Budget

Several differences between current law and a consumption tax are left off the official tax expenditure 

list. Additional tax expenditures include the imputed 

consumption value from consumer durables and financial services received in kind, private gifts and inheritances received, possibly benefits paid by insurance policies, in-kind benefits from such Government programs 

as food-stamps, Medicaid, and public housing, and benefits received from charities. Under some ideas of a comprehensive consumption tax, the value of leisure and 

of household production of goods and services would 

be included as a tax expenditure. 

A consumption tax implemented as a tax on cash 

flows would tax all proceeds from sales of capital assets 

when consumed, rather than just capital gains; because 

of expensing, taxpayers effectively would have a zero 

basis. The proceeds from borrowing would be in the 

base of a consumption tax that also allowed a deduction 

for repayment of principal and interest, but are excluded from the current tax base. The deduction of business interest expense might be a tax expenditure, since 

under some forms of consumption taxation interest is 

neither deducted from the borrower’s tax base nor included in the lender’s tax base. The personal exemption 

and standard deduction also might be considered tax 

expenditures, although they can be viewed differently, 

e.g., as elements of the basic tax rate schedule.

Negative Tax Expenditures

Importantly, current law also deviates from a consumption tax norm in ways that increase, rather than 

decrease, tax liability. These could be called negative 

tax expenditures. The official budget excludes negative 

tax expenditures on the theory that tax expenditures 

are intended to substitute for Government spending 

programs. Yet excluding negative tax expenditures 

gives a very one-sided look at the differences between 

the existing tax system and a consumption tax. 

A large item on this list would be the inclusion of 

capital income in the current individual income tax 

base, including the income earned on inside-build up 

in Social Security accounts. The revenue from the corporation income tax, or more generally a measure of 

the double tax on corporate profits, also would be a 

negative tax expenditure. Depreciation allowances, even 
19. TAX EXPENDITURES 355

30See Barbara Fraumeni, ‘‘The Measurement of Depreciation in the U.S. National Income 

and Product Accounts,’’ in Survey of Current Business 77 No. 7 (Washington, D.C.: Department of Commerce, Bureau of Economic Analysis, July, 1997), pp. 7–42, and the National 

Income and Product Accounts of the United States, Table 7.6, ‘‘Chain-type Quantity and 

Price Indexes for Private Fixed Investment by Type,’’ U.S. Department of Commerce, Bureau 

of Economic Analysis. 31The temporary provision allows 30 percent of the cost of a qualifying investment to 

be deducted immediately rather than capitalized and depreciated over time. It is generally 

effective for qualifying investments made after September 10, 2001 and before September 

11, 2004. The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the deduction 

to 50 percent depreciation (up from 30 percent) of the cost new equipment purchased 

after May 5, 2003 and placed into service before January 1, 2005. Qualifying investments 

generally are limited to tangible property with depreciation recovery periods of 20 years 

or less, certain software, and leasehold improvements, but this set of assets corresponds 

closely to machinery and equipment. 32 Estimates under the old methodology are no longer shown in the tables. 

33 U.S. Department of the Treasury, Report to the Congress on Depreciation Recovery 

Periods and Methods (Washington, D.C.: U.S. Government Printing Office, July, 2000), 

p. 32.

if accelerated, would be a negative tax expenditure 

since consumption tax treatment generally would require expensing. Depending on the treatment of loans, 

the borrower’s inability to deduct payments of principal 

and the lender’s inability to deduct loans might be a 

negative tax expenditure. The passive loss rules and 

NOL carry-forward provisions also might generate negative tax expenditures, because the change in net worth 

requires a deduction for losses (consumption = income—

the change in net worth). If human capital were considered an asset, then its cost (e.g., certain education and 

training expenses, including perhaps costs of college 

and professional school) should be expensed, but it is 

not under current law. Certain restrictions under the 

individual AMT as well as the phase-out of personal 

exemptions and of itemized deductions also might be 

considered negative tax expenditures. Under some 

views, the current tax treatment of Social Security benefits paid to the disabled would be a negative tax expenditure. 

REVISED ESTIMATES OF SELECTED TAX EXPENDITURES

Accelerated Depreciation

Under the reference tax law baseline no tax expenditures arise from accelerated depreciation. In the past, 

official tax expenditure estimates of accelerated depreciation under the normal tax law baseline compared 

tax allowances based on the historic cost of an asset 

with allowances calculated using the straight-line method over relatively long recovery periods. Normal law 

allowances also were determined by the historical cost 

of the asset and so did not adjust for inflation, although 

such an adjustment is required when measuring economic depreciation, the age related fall in the real value 

of the asset. 

Beginning with the 2004 Budget, the tax expenditures for accelerated depreciation under the normal law 

concept have been recalculated using as a baseline depreciation rates and replacement cost indexes from the 

National Income and Product Accounts. 30 The revised 

estimates are intended to approximate the degree of 

acceleration provided by current law over a baseline 

determined by real, inflation adjusted, and economic 

depreciation. Current law depreciation allowances for 

machinery and equipment include the benefits of a temporary expensing provision. 31 The estimates are shown 

in tables in the body of the main text, e.g., Table 19–1. 

The revised tax expenditure estimates differ substantially from estimates calculated under the old methodology. In general, the new tax expenditure estimates 

are smaller than the old estimates. 32 In part, this is 

because the new baseline uses depreciation allowances 

that are faster than those in the old baseline. In addition, the new baseline calculates depreciation on a replacement cost basis rather on the historic cost basis 

previously used; this translates into larger depreciation 

allowances to the extent that asset prices rise over 

time. In many years the new tax expenditures are negative, indicating that current law’s tax depreciation allowances are smaller than those implied by economic 

depreciation. Because these estimates are on a cash 

flow, rather than a present value, basis, the negative 

value does not necessarily indicate that tax depreciation 

is decelerated relative to economic depreciation over the 

life of an investment. Even when tax depreciation is 

accelerated over the life of an investment, negative annual cash flow estimates could obtain in the later years 

of an investment’s economic life. This type of vintage 

effect contributes importantly to the negative tax expenditures calculated for equipment in 2006–2010 because the temporary expensing provision expires at the 

end of 2004. Calculations that compare the present 

value of tax depreciation (without the temporary expensing) with the present value of inflation indexed 

economic depreciation over each investment’s economic 

life show that for many types of assets tax depreciation 

is accelerated, but only slightly, assuming a moderate 

rate of inflation. 33

Owner-Occupied Housing

A homeowner receives a flow of housing services 

equal in gross value to the rent that could have been 

earned had the owner chosen to rent the house to others. Comprehensive income would include in the homeowner’s tax base this gross rental flow, and would allow 

the homeowner a deduction for expenses such as interest, depreciation, property taxes, and other costs associated with earning the rental income. Thus, a comprehensive tax base would include in its base the homeowner’s implicit net rental income (gross income minus 

deductions) earned on investment in owner-occupied 

housing. 

In contrast to a comprehensive income tax, current 

law makes no imputation for gross rental income and 

allows no deduction for depreciation or for other expenses, such as utilities and maintenance. Current law 

does, however, allow a deduction for home mortgage 

interest and for property taxes. Consequently, relative 

to a comprehensive income baseline, the total tax expenditure for owner-occupied housing is the sum of tax 

on net rental income plus the tax saving from the de-
356 ANALYTICAL PERSPECTIVES 

34The homeowner’s tax base under a comprehensive income tax is net rents. Under 

current law, the homeowner’s tax base is–(interest + property taxes). The tax expenditure 

base is the difference between the comprehensive income base and current law’s tax base, 

which for homeowners is the sum of net rents plus interest plus property taxes. 35This estimate combines the positive tax expenditure for the failure to impute rental 

income with the negative tax expenditure for the failure to allow a deduction for depreciation 

and other costs. 36 National Income and Production Accounts, Table 2.4.

duction for property taxes and for home mortgage interest. 34

Prior to 2006, the official list of tax expenditures 

did not include the exclusion of net implicit rental income on owner-occupied housing. Instead, it included 

as a tax expenditure deductions for home mortgage interest and for property taxes. While these deductions 

are legitimately considered tax expenditures, given current law’s failure to impute rental income, they are 

highly flawed as estimates of the total tax advantage 

to housing; they overlook the additional exclusion of 

implicit net rental income. To the extent that a homeowner owns his house outright, unencumbered by a 

mortgage, he would have no home mortgage interest 

deduction, yet he still would enjoy the benefits of receiving tax free the implicit rental income earned on his 

house. The treatment of owner-occupied housing has 

been revised in the 2006 budget, which now includes 

an item for the exclusion of net rental income of homeowners. 35

Appendix Table 3 as well as the Tables in the body 

of the main text, e.g., Table 19–1 show estimates of 

the tax expenditure caused by the exclusion of implicit 

net rental income from investment in owner-occupied 

housing. This estimate starts with the NIPA calculated 

value of gross rent on owner-occupied housing, and subtracts interest, taxes, economic depreciation, and other 

costs in arriving at an estimate of net-rental income 

from owner-occupied housing. 36

Accrued Capital Gains

Under a comprehensive income baseline, all real 

gains would be taxed as accrued. These gains would 

be taxed as ordinary income rather than at preferential 

rates. There would be no deferred unrealized gains on 

assets held at death, nor gains carried over on gifts, 

or other preferential treatments. Indeed, all of the provisions related to capitals gains listed in the tax expenditure budget would be dropped. Instead, in their 

place the difference between the ordinary tax on real 

gains accrued and the actual tax paid would be calculated. For 1999, for instance, the tax on real accrued 

gains on corporate equity is estimated at $594 billion. 

This compares to an estimated tax on realized gains 

of $62 billion, for forgone revenues of $562 billion. However, this forgone revenue may easily turn into a revenue gain given the limits on capital losses. For 2000, 

for instance, real accrued losses in corporate equity 

amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion in capital gains taxes. This roughly 

translates into an overpayment of taxes to the tune 

of $464 billion.

Double Tax on Corporate Profits

A comprehensive income tax would tax all sources 

of income once. Taxes would not vary by type or source 

of income. 

In contrast to this benchmark, current law taxes income that shareholders earn on investment in corporate 

stocks at least twice, and at combined rates that generally are higher than those imposed on other sources 

of income. Corporate profits are taxed once at the company level under the corporation income tax. They are 

taxed again at the shareholder level when received as 

a dividend or recognized as a capital gain. Corporate 

profits can be taxed more then twice when they pass 

through multiple corporations before being distributed 

to noncorporate shareholders. Corporate level taxes cascade because corporations are taxed on capital gains 

they realize on the sale of stock shares and on some 

dividend income received. Compared to a comprehensive income tax current law’s double (or more) tax on 

corporate profits is an example of a negative tax expenditure because it subjects income to a larger tax 

burden than implied by a comprehensive income baseline. 

Appendix Table 3 provides an estimate of the negative tax expenditure caused by the multiple levels of 

tax on corporate profits. This negative tax expenditure 

is measured as the shareholder level tax on dividends 

paid and capital gains realized out of earnings that 

have been fully taxed at the corporate level. It also 

includes the corporate tax paid on inter-corporate dividends and on corporate capital gains attributable to 

the sale of stock shares. The estimate includes the reduction in the dividends and capital gains tax rates 

enacted in JGTRRA. 

The negative tax expenditure is large in magnitude; 

it exceeds $33 billion in the years 2006 through in 

2010. It is comparable in size (but opposite in sign) 

to all but the largest official tax expenditures. JGTRRA 

reduced but did not eliminate the double tax on corporate profits.
19. TAX EXPENDITURES 357

Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE INCOME TAX 1

Description Revenue Effect

2006

A. Tax Expenditure Under a Comprehensive Income Tax 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140

Capital gains exclusion on home sales ............................................................................................................................... 36,270

Exclusion of net imputed rental income on owner-occupied housing ................................................................................ 29,720

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610

Exclusion of interest on life insurance savings ................................................................................................................... 24,070

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,980

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310

Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940

Extraterritorial income exclusion .......................................................................................................................................... 4,260

Credit for low-income housing investments ......................................................................................................................... 4,010

Exclusion of veterans death beenfits and disability compensation .................................................................................... 3,750

B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications 

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 34,620

Child credit ............................................................................................................................................................................ 32,810

Step-up basis of capital gains at death .............................................................................................................................. 28,760

Exclusion of Social Security benefits for retired workers ................................................................................................... 19,770

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830

Earned income tax credit ..................................................................................................................................................... 5,423

Deduction for U.S. production activities .............................................................................................................................. 5,420

Exclusion of Social security benefits of dependents and survivors ................................................................................... 3,990

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690

Deductibility of charitable contributions, other than education and health ......................................................................... 32,550

Deductibility of medical expenses ........................................................................................................................................ 9,140

Deductibility of self-employed medical insurance premiums .............................................................................................. 4,330

Social Security benefits for disabled ................................................................................................................................... 3,870

D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax 

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750

1 The measurement of certain tax expenditures under a comprehensive income tax baseline may differ from the official budget estimate even when the provision would be a tax expenditure under both baselines.

Source: Table 19–2, Tax Expenditure Budget. 
358 ANALYTICAL PERSPECTIVES 

Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A 

COMPREHENSIVE CONSUMPTION TAX 1

Description Revenue Effect

2006

A. Tax Expenditure Under a Consumption Base 

Exclusion of net imputed rental income on owner-occupied housing ................................................................................ 29,720

Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940

B. Probably a Tax Expenditure Under a Consumption Base 

Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030

Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 34,620

Child credit ............................................................................................................................................................................ 32,810

Exclusion of Social Security benefits for retired workers ................................................................................................... 19,770

Earned income tax credit ..................................................................................................................................................... 5,423

Exclusion of Social Security benefits of dependents and survivors ................................................................................... 3,990

Exclusion of veterans death beenfits and disability compensation .................................................................................... 3,750

C. Uncertain 

Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690

Deductibility of charitable contributions, other than education and health ......................................................................... 32,550

Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830

Deductibility of medical expenses ........................................................................................................................................ 9,140

Deductibility of self-employed medical insurance premiums .............................................................................................. 4,330

Extraterritorial income exclusion .......................................................................................................................................... 4,260

Credit for low-income housing investments ......................................................................................................................... 4,010

Social Security benefits for disabled ................................................................................................................................... 3,870

D. Not a Tax Expenditure Under a Consumption Base 

Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050

Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140

Capital gains exclusion on home sales ............................................................................................................................... 36,270

Step-up basis of capital gains at death .............................................................................................................................. 28,760

Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370

Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610

Exclusion of interest on life insurance savings ................................................................................................................... 24,070

Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,980

Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920

Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440

Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310

Deduction for U.S. production activities .............................................................................................................................. 5,420

Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750

1 The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even 

when the provision would be a tax expenditure under both baselines.

Source: Table 19–2, Tax Expenditure Budget. 

Appendix Table 3. REVISED TAX EXPENDITURE ESTIMATES 1

Provision

Revenue Loss 

2004 2005 2006 2007 2008 2009 2010

Imputed Rent On Owner-Occupied Housing ..................................... 24,590 28,600 29,720 33,210 36,860 40,630 44,786

Double Tax on corporate profit 2 ....................................................... –23,730 –30,170 –29,600 –30,330 –31,540 –33,260 –35,074

1 Calculations described in the appendix text. 

2 This is a negative tax expenditure, a tax provision that overtaxes income relative to the treatment specified by the baseline tax system.