    [Budget of the U.S. Government]
    [V. Creating Opportunity, Demanding Responsibility, and Strengthening Community]
    [8. Promoting Tax Fairness]
    [From the U.S. Government Publishing Office, www.gpo.gov]

                           8.  PROMOTING TAX FAIRNESS

      ----------------------------------------------------------------------

      We should cut taxes for the family sending a child to college, for the worker returning to college, for the
    family saving to buy a home or for long-term health care, and [provide] a $500 per-child credit for middle-
    income families raising their children . . . . That is the right way to cut taxes--pro-family, pro-education,
    pro-economic growth.

                                          President Clinton
                                          August 29, 1996

      ----------------------------------------------------------------------
      The President proposes a tax plan that would promote a fairer tax
    system and encourage activities that contribute to economic growth--in
    short, a plan focused on fairness and America's future.
      The plan calls for tax cuts that would benefit middle-class families
    with children, encourage investment in higher education, and promote
    long-term saving. It would benefit millions of homeowners by ensuring
    that over 99 percent of home sales are exempt from capital gains taxes.
    It would provide incentives for employers to hire economically
    disadvantaged Americans, so they would benefit from wages rather than
    welfare. It would provide targeted relief to promote economic
    development and environmental cleanup in distressed areas. It would give
    estate tax relief to small businesses and farmers. And it would make the
    tax system more equitable for people with disabilities who are seeking
    refunds.
      The proposal is also fiscally responsible. The budget fully offsets
    the costs of these tax cuts by making cuts in spending and in
    unnecessary corporate subsidies and other unwarranted tax breaks.
      This chapter provides an overview of the President's tax plan. (See
    Table 8-1 for a summary of the plan.) Chapter 3 of Analytical
    Perspectives provides further details.
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                                          Table 8-1.  THE PRESIDENT'S TAX PLAN
                                                (In billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                                                Estimate                      Total,
                                                            ------------------------------------------------  1998-
                                                              1997    1998    1999    2000    2001    2002     2002
    ----------------------------------------------------------------------------------------------------------------
    Provide tax relief:
      Middle Class Bill of Rights:
        Tax credit for dependent children..................    -0.7    -9.9    -6.8    -8.6   -10.4   -10.4    -46.0
         Expand individual retirement accounts.............  ......    -1.5    -0.5    -0.8    -1.2    -1.7     -5.5
        Incentives for education and training..............    -0.1    -4.0    -6.2    -7.8    -8.6    -9.4    -36.1
                                                            --------------------------------------------------------
          Subtotal, Middle Class Bill of Rights............    -0.8   -15.4   -13.5   -17.2   -20.2   -21.4    -87.6

    Additional targeted tax relief:
      Capital gains exclusion on sale of principal
       residence...........................................    -0.1    -0.3    -0.3    -0.3    -0.3    -0.2     -1.4
      Extend the work opportunity tax credit for one year..  ......    -0.1    -0.2    -0.1      -*      -*     -0.4
      Targeted welfare-to-work tax credit..................  ......    -0.1    -0.1    -0.2    -0.1    -0.1     -0.6
      Tax incentives for distressed areas..................      -*    -0.4    -0.5    -0.5    -0.5    -0.4     -2.3
      Tax credit for investment in community development
       institutions and venture capital funds..............  ......      -*      -*      -*      -*      -*       -*
      Extend the R&E tax credit for one year...............    -0.4    -0.8    -0.5    -0.2    -0.1      -*     -1.7
      Extend the orphan drug credit for one year...........      -*      -*      -*      -*      -*      -*       -*
      Extend the income exclusion for employer-provided
       educational assistance through 2000.................    -0.1    -0.6    -0.7    -0.8    -0.2  ......     -2.3
      Extend and modify credit for corporations in U.S.
       possessions.........................................  ......      -*    -0.1    -0.1    -0.1    -0.1     -0.4
      District of Columbia tax incentive...................  ......      -*      -*    -0.1    -0.1    -0.1     -0.3
      Estate tax relief for small business.................  ......      -*    -0.2    -0.2    -0.2    -0.2     -0.7
      Equitable tolling....................................  ......  ......  ......  ......      -*      -*     -0.1
      Tax benefits to Foreign Sales Corporations for
       software licenses...................................      -*    -0.1    -0.1    -0.1    -0.1    -0.1     -0.6
      Extend the deduction for contributions of appreciated
       stock to private foundations for one year...........  ......      -*      -*  ......  ......  ......     -0.1
                                                            --------------------------------------------------------
        Total, Provide tax relief..........................    -1.4   -17.9   -16.2   -19.6   -21.9   -22.8    -98.4

    Eliminate unwarranted benefits.........................     0.6     4.1     6.3     7.3     7.6     8.9     34.3

    Other changes affecting receipts.......................  ......     1.0     1.1     1.1     1.2     1.1      5.5

    Extension of expired excise tax provisions.............     2.4     5.8     7.5     7.5     7.7     7.8     36.2

    Total proposals........................................     1.6    -7.0    -1.4    -3.7    -5.5    -4.9    -22.4

    ----------------------------------------------------------------------------------------------------------------
    * Less than $50 million.

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    The Middle-Class Tax Cut

      The President has long considered tax cuts for middle-income Americans
    and small businesses a top priority. In 1993, he worked with Congress to
    cut taxes for 15 million working families by expanding the Earned Income
    Tax Credit (EITC), and to help small business by increasing
    ``expensing'' \1\ of investment and capital gains incentives. A year
    later, he proposed his Middle Class Bill of Rights, including child tax
    credits, deductions for higher education, and expanded Individual
    Retirement Accounts. Then in 1996, he signed into law a number of other
    tax benefits for small businesses and their employees--including even
    more expensing for small-business investments, greater deductibility of
    health insurance premiums for the self-employed, and expanded and
    simplified opportunities for retirement savings. Also in 1996, the
    President signed into law a $5,000 tax credit for adoption expenses
    ($6,000 for adopting children with special needs) and higher limits for
    tax-deductible contributions by spouses to Individual Retirement
    Accounts.
    ---------------------------------------------------------------------------
      \1\ That is, up-front deductions.
    ---------------------------------------------------------------------------
      This year, the budget again proposes the President's Middle Class Bill
    of Rights. It would immediately and significantly benefit families with
    young children, encourage investment in post-secondary education and
    training, and promote long-term saving. This year's tax plan also goes
    further--it includes more tax incentives and relief with regard to
    education and training, work opportunities, capital gains on home sales,
    and the legal limits faced by people with disabilities who seek tax
    refunds.

      Tax Credit for Dependent Children: The budget proposes an income tax
    credit for each dependent child under age 13, as the President first
    proposed in 1994. The credit would bene-

    [[Page 112]]

    fit about 18 million families with 34 million dependent children. It would be phased in, starting at $300 per child in tax years 1997 through 1999, and rising to $500 in 2000 and beyond. It would be phased out for taxpayers with adjusted gross incomes between $60,000 and $75,000. Starting in the year 2001,
    the credit and the phase-out range would be indexed for inflation. The
    credit would be non-refundable, but working families would first deduct
    the child credit from their income taxes before deducting the refundable
    EITC--making it easier for them to get the benefit of both credits.
      This tax cut would benefit middle-income families; they have not
    enjoyed large gains in their incomes over the past 25 years. For a two-
    parent, two-child family with $50,000 of income and $12,500 of itemized
    deductions, the credit would cut taxes by 25 percent when fully in place
    in 2000. In total, the credit would lower families' taxes by $46 billion
    from 1998 to 2002.

      HOPE Scholarships and the Education and Job Training Tax Deduction:
    The President believes that the tax system should better encourage
    investment in college edu-

    [[Page 113]]

    cation and job training. Therefore, the budget proposes:
      HOPE scholarships, which are tuition tax credits of up to
              $1,500 per year, available for the first two years of post-
              secondary education. To receive the credit in the second year,
              the student must maintain at least a B average. The $1,500
              amount (for each of two years) is a per student cap.\2\ HOPE
              scholarships are modeled after a successful program in
              Georgia.
    ---------------------------------------------------------------------------
      \2\ The budget also would increase Pell Grant college scholarships for
    low-income families who lack the tax liability to benefit from the tax
    cuts.
    ---------------------------------------------------------------------------
      The education and job training deduction, which would be
              available to families for tuition and fees for any college,
              graduate school, or qualified lifelong learning program. The
              deduction, which the President first proposed in 1994, would
              phase up from an annual cap of $5,000 per family in 1997 and
              1998 to $10,000 in 1999 and beyond. It would cover tuition at
              any education or training program that is at least half-time
              or related to a worker's career. Students who use the HOPE
              scholarships in their first two years of schooling could claim
              the tax deduction in their remaining years of qualified
              education or training (although families could not claim both
              the credit and the deduction for the same student at the same
              time).
      Both the credit and the deduction would be phased out for joint filers
    with incomes between $80,000 and $100,000. For single filers, the
    benefits would phase out between $50,000 and $70,000. From 1998 through
    2002, these two provisions would save taxpayers $36.1 billion.

      Expanded Individual Retirement Accounts (IRAs): The budget also
    repeats another proposal from 1994--to expand IRAs to provide greater
    incentives for long-term savings for retirement and other important
    purposes. Currently, for taxpayers who participate in employer-sponsored
    retirement plans and file joint returns, the tax code phases out the
    availability of deductible IRAs between $40,000 and $50,000 of adjusted
    gross income. The President's plan would double this range over time, to
    $80,000 and $100,000, and double the range for single taxpayers to
    between $50,000 and $70,000. The plan also would index for inflation
    both of these limits and the current maximum contribution of $2,000.
      In addition, the budget proposes that eligible taxpayers be able to
    contribute to a ``Special IRA'' as an alternative to a deductible IRA.
    Contributions to Special IRAs would not be tax deductible, but
    distributions of the contributions would be tax-free. If contributors
    kept their funds in the account for at least five years, earnings on the
    contributions would be available tax-free, too. Many taxpayers would be
    eligible to convert deductible IRAs to Special IRAs. Also, contributors
    to both types of IRAs could, under this proposal, withdraw funds without
    penalty at any time to pay for higher education, first-time home
    purchases, or expenses during a long period of unemployment.
      The greater availability of IRAs would enable many two-earner families
    to cut their taxes by up to $1,120 a year, if they make the maximum
    allowable IRA contributions. From 1998 to 2002, it would cut taxes by an
    estimated $5.5 billion.

    Additional Targeted Tax Incentives and Relief

      Targeted Homeownership Tax Cut: The budget proposes to allow married
    taxpayers to exclude from capital gains taxes up to $500,000 in gains
    from selling a home; single taxpayers could exclude up to $250,000. The
    exclusion would replace both the one-time exclusion of $125,000, now
    available for taxpayers over age 55, and the deferral of capital gains,
    now available when purchasing a more expensive home.
      This change would exempt over 99 percent of home sales from capital
    gains taxes, and dramatically simplify taxes and record-keeping for over
    60 million homeowners. It would benefit, in particular, older Americans
    moving to smaller homes and families moving to lower-cost areas.
    Taxpayers could use the exclusion every two years.

      Work Opportunity Tax Credit: The President wants to replace welfare
    with work, and to promote the hiring of the economically disadvantaged.
    The President and Congress last year enacted the Work Opportunity Tax
    Credit

    [[Page 114]]

    (WOTC) to replace the Targeted Jobs Tax Credit. Employers can
    claim a tax credit of 35 percent of the first $6,000 that they pay to
    members of target groups during their first year of employment.
      In August, the President also unveiled a Welfare-to-Work initiative,
    with two proposals that would build on the WOTC:
      A new Welfare-to-Work Credit, targeted to long-term welfare
              recipients. It would let employers claim a 50-percent credit
              on the first $10,000 of annual wages that they pay to long-
              term welfare recipients for up to two years. It would treat
              education and training, health care, and dependent care
              benefits as wages eligible for the credit.
      An expansion of the WOTC to include able-bodied childless
              adults aged 18 to 50 who, under the Administration's Food
              Stamp proposal, would face a more rigorous work requirement in
              order to continue receiving Food Stamps.

      Tax Incentives to Boost Investment in Distressed Areas: The budget
    proposes a three-part strategy to increase investment in disadvantaged
    areas:
      Expanded Empowerment Zones (EZs) and Enterprise Communities
              (ECs): The budget proposes a second round of competition to
              designate additional EZs and ECs and provides over $1 billion
              in tax incentives to these areas through 2002. Among other
              things, the plan would create 20 new EZs and 80 new ECs. The
              plan promises to mobilize communities to promote business
              development and create jobs. (For more information on EZs and
              ECs, see Chapter 6.)
      Brownfields Cleanup: The budget proposes to allow businesses
              to deduct, in the year incurred, certain costs associated with
              cleaning up ``brownfields''--contaminated, and often
              abandoned, industrial sites--in economically distressed urban
              and rural areas. (For more information on brownfields, see
              Chapter 3.)
      Community Development Financial Institution (CDFI) Tax
              Credits: The budget proposes non-refundable tax credits for
              equity investments in qualified CDFIs. (For more information
              on CDFIs, see Chapter 6.)

      Research and Experimentation Tax Credit (R&E): The budget proposes to
    extend the R&E tax credit for one year, from its current expiration date
    of May 31, 1997 to May 31, 1998. \3\ It provides a credit against 20
    percent of a business's qualified research spending above a base level.
    Research and experimentation contribute greatly to the Nation's growth
    in productivity, and the private sector may under-invest in this
    activity in the absence of this Federal incentive.
    ---------------------------------------------------------------------------
      \3\ The credit, which was first enacted in 1981, expired in mid-1995.
    The Small Business Job Protection Act of 1996, however, reinstated the
    credit for the period from July 1, 1996 to May 31, 1997.
    ---------------------------------------------------------------------------

      Employer-Provided Education: The budget proposes to extend, through
    December 31, 2000, the income exclusion for employer-provided
    educational assistance that Congress recently extended through mid-1997,
    and to expand the exclusion to cover graduate education. The exclusion
    enables employees to get additional forms of training and education
    benefits without facing income taxes on those benefits. Small businesses
    also would be able to claim a 10-percent tax credit for providing such
    benefits to their employees.
      Economic Incentives for U.S. Businesses in Puerto Rico: The budget
    proposes to modify Section 936 of the tax code, which allows U.S.
    companies to claim a credit against the tax they pay for income that
    they derive in Puerto Rico--specifically, to extend the availability of
    the economic activity credit and to allow new firms to claim it.
      Estate Tax Benefits for Closely Held Businesses: The budget proposes
    to ease the burden of estate taxes on farms and other small businesses,
    allowing their owners to defer taxes on $2.5 million of value, up from
    $1 million under current law. The deferred taxes could be paid over 14
    years, at a favorable interest rate. In addition, the budget would
    expand the types of businesses eligible for such treatment by making the
    form of business organization irrelevant. It also would cut the
    administrative burden on taxpayers who elected deferral.

    [[Page 115]]

      Equitable Tolling: The budget proposes to extend the period during
    which taxpayers with serious disabilities can file claims for refunds,
    helping to ensure that such taxpayers are not unfairly disadvantaged by
    the tax system.

    Unwarranted Benefits and Other Measures

      The budget eliminates or shrinks a wide range of tax loopholes and
    preferences that are no longer warranted. Some involve highly
    specialized financial and accounting techniques. Restricting them would
    help balance the budget, increase the equity and efficiency of the tax
    system, and keep corporations focused on productivity and profits,
    rather than on tax minimization.
      For example, the plan:
      Prevents certain tax-motivated financial manipulations, used
              to avoid capital gains taxes.
      Clarifies the treatment of new financial instruments that aim
              to exploit the different tax treatment of equity and debt, by
              denying or deferring interest deductions on certain
              instruments that have substantial equity features.
      Limits the ability of some corporations to deduct the cost of
              interest associated with purchasing tax-exempt debt.
      Increases the penalty for substantial understatement of taxes,
              to reduce incentives for excessively aggressive tax planning
              by corporations with tax liabilities of $100 million or more.
      Finally, the plan extends the Airport and Airway excise taxes, the
    Leaking Underground Storage Tank excise tax, and the Hazardous Substance
    Superfund excise and corporate income taxes, through 2007. The
    Administration, however, will propose legislation to replace the Airport
    and Airway excise taxes with fees for services that the Federal Aviation
    Adminstration provides.