[Analytical Perspectives]
[Federal Receipts and Collections]
[6. Tax Expenditures]
[From the U.S. Government Printing Office, www.gpo.gov]


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                           6. TAX EXPENDITURES

  The Congressional Budget Act of 1974 (Public Law 93-344) requires that 
a list of ``tax expenditures'' be included in the budget. Tax 
expenditures are defined in the law as ``revenue losses attributable to 
provisions of the Federal tax laws which allow a special exclusion, 
exemption, or deduction from gross income or which provide a special 
credit, a preferential rate of tax, or a deferral of liability.'' These 
exceptions may be viewed as alternatives to other policy instruments, 
such as spending or regulatory programs. Identification and measurement 
of tax expenditures depends importantly on the baseline tax system 
against which the actual tax system is compared.
  The largest reported tax expenditures tend to be associated with the 
individual income tax. For example, sizeable deferrals, deductions and 
exclusions are provided for pension contributions and earnings, employer 
contributions for medical insurance, capital gains, and payments of 
State and local individual income and property taxes. Reported tax 
expenditures under the corporate income tax tend to be related to timing 
differences in the rate of cost recovery for various investments. As is 
discussed below, the extent to which these provisions are classified as 
tax expenditures varies according to the conceptual baseline used.
  Each tax expenditure estimate in this chapter was calculated assuming 
other parts of the tax code remained unchanged. The estimates would be 
different if all tax expenditures or major groups of tax expenditures 
were changed simultaneously because of potential interactions among 
provisions. For that reason, this chapter does not present a grand total 
for the estimated tax expenditures. Moreover, past tax changes entailing 
broad elimination of tax expenditures were generally accompanied by 
changes in tax rates or other basic provisions, so that the net effects 
on Federal revenues were considerably (if not totally) offset.
  Tax expenditures relating to the individual and corporate income taxes 
are estimated for fiscal years 2002-2008 using three methods of 
accounting: revenue effects, outlay equivalent, and present value. The 
present value approach provides estimates of the cumulative revenue 
effects for tax expenditures that involve deferrals of tax payments into 
the future or have similar long-term effects.
  The section of the chapter on performance measures and economic 
effects presents information related to assessment of the effect of tax 
expenditures on the achievement of program performance goals. This 
section is a complement to the government-wide performance plan required 
by the Government Performance and Results Act of 1993.
  The 2003 Budget included a discussion of important ambiguities in the 
tax expenditure concept and indicated that the Treasury Department had 
begun a review of the tax expenditure presentation. Particular attention 
of this review has focused on defining tax expenditures relative to a 
comprehensive income 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. The Appendix presents the results from the 
preliminary stage of this review.

                   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, 2002. Expired or repealed provisions 
are not listed if their revenue effects result only from taxpayer 
activity occurring before fiscal year 2002. 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 2002-
2008 are displayed according to the budget's functional categories in 
Table 6-1. Descriptions of the specific tax expenditure provisions 
follow the tables of estimates and the discussion of general features of 
the tax expenditure concept.
  As in prior years, two baseline concepts--the normal tax baseline and 
the reference tax law baseline--are used to identify tax expenditures. 
For the most part, the two concepts coincide. However, items treated as 
tax expenditures under the normal tax baseline, but not the reference 
tax law baseline, are indicated by the designation ``normal tax method'' 
in the tables. The revenue effects for these indicated items are zero 
using the reference tax rules. The alternative baseline concepts are 
discussed in detail following the tables.
  Table 6-2 reports the respective portions of the total revenue effects 
that arise under the individual and corporate income taxes separately. 
The placement 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

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through which the various provisions are cleared. The ultimate 
beneficiaries of corporate tax expenditures could be shareholders, 
employees, customers, or other providers of capital, depending on 
economic forces.
  Table 6-3 ranks the major tax expenditures by the size of their 2004-
2008 revenue effect.

                 Interpreting Tax Expenditure Estimates

  The estimates shown for individual tax expenditures in Tables 6-1, 6-
2, and 6-3 do not necessarily equal the increase in Federal revenues (or 
the change in the budget balance) that would result from repealing these 
special provisions, for the following reasons:
  (1) 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.
  (2) 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 6-1 
are the totals of individual and corporate income tax revenue effects 
reported in Table 6-2 and do not reflect any possible interactions 
between the individual and corporate income tax receipts. For this 
reason, the estimates in Table 6-1 (as well as those in Table 6-5, which 
are also based on summing individual and corporate estimates) should be 
regarded as approximations.
  The annual value of tax expenditures for tax deferrals is reported on 
a cash basis in all tables except Table 6-4. Cash-based estimates 
reflect the difference between taxes deferred in the current year and 
incoming revenues that are received due to deferrals of taxes from prior 
years. Although such estimates are useful as a measure of cash flows 
into the Government, they do not accurately reflect the true economic 
cost of these provisions. For example, for a provision where activity 
levels have changed, so that incoming tax receipts from past deferrals 
are greater than deferred receipts from new activity, the cash-basis tax 
expenditure estimate can be negative, despite the fact that in present-
value terms current deferrals do have a real cost to the Government. 
Alternatively, in the case of a newly enacted deferral provision, a 
cash-based estimate can overstate the real effect on receipts to the 
Government because the newly deferred taxes will ultimately be received. 
Present-value estimates, which are a useful complement to the cash-basis 
estimates for provisions involving deferrals, are discussed below.

                         Present-Value Estimates

  Discounted present-value estimates of revenue effects are presented in 
Table 6-4 for certain provisions that involve tax deferrals or other 
long-term revenue effects. These estimates complement the cash-based tax 
expenditure estimates presented in the other tables.
  The present-value estimates represent the revenue effects, net of 
future tax payments, that follow from activities undertaken during 
calendar year 2002 which cause the deferrals or other long-term revenue 
effects. For instance, a pension contribution in 2002 would cause a 
deferral of tax payments on wages in 2002 and on pension earnings on 
this contribution (e.g., interest) in later years. In some future year, 
however, the 2002 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.

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                                                 Table 6-1.  ESTIMATES OF TOTAL INCOME TAX EXPENDITURES
                                                                (In millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Total from corporations and individuals
                                                                        --------------------------------------------------------------------------------
                                                                           2002      2003      2004      2005      2006      2007      2008    2004-2008
--------------------------------------------------------------------------------------------------------------------------------------------------------
             National Defense
       1       Exclusion of benefits and allowances to armed forces         2,190     2,210     2,240     2,260     2,290     2,310     2,330    11,430
                personnel..............................................
             International Affairs
       2       Exclusion of income earned abroad by U.S. citizens......     2,740     2,620     2,680     2,750     2,810     2,940     3,100    14,280
       3       Exclusion of certain allowances for Federal employees          760       800       840       880       930       980     1,030     4,660
                abroad.................................................
       4       Extraterritorial income exclusion.......................     4,820     5,150     5,510     5,890     6,290     6,730     7,200    31,620
       5       Inventory property sales source rules exception.........     1,470     1,540     1,620     1,700     1,790     1,880     1,980     8,970
       6       Deferral of income from controlled foreign corporations      7,000     7,450     7,900     8,400     8,930     9,550    10,210    44,990
                (normal tax method)....................................
       7       Deferred taxes for financial firms on certain income         1,950     2,050     2,130     2,190     2,260       960         0     7,540
                earned overseas........................................
             General Science, Space, and Technology
       8       Expensing of research and experimentation expenditures       1,660     2,200     2,760     3,390     3,990     4,270     4,380    18,790
                (normal tax method)....................................
       9       Credit for increasing research activities...............     6,870     5,640     4,990     2,910     1,240       520       170     9,830
             Energy
      10       Expensing of exploration and development costs, fuels...       150       170       150        80        60        40        30       360
      11       Excess of percentage over cost depletion, fuels.........       610       670       650       610       620       640       650     3,170
      12       Alternative fuel production credit......................     1,560       940       520       520       520       520       210     2,290
      13       Exception from passive loss limitation for working              10        10        10        10        10        10        10        50
                interests in oil and gas properties....................
      14       Capital gains treatment of royalties on coal............       100       110       110       120       120       130       140       620
      15       Exclusion of interest on energy facility bonds..........       110       120       130       140       140       150       160       720
      16       Enhanced oil recovery credit............................       330       340       350       360       360       370       390     1,830
      17       New technology credit...................................       100       180       250       270       270       270       270     1,330
      18       Alcohol fuel credits \1\................................        30        30        30        30        30        30        30       150
      19       Tax credit and deduction for clean-fuel burning vehicles        70        90        70        40       -10       -70       -70       -40
      20       Exclusion from income of conservation subsidies provided        80        80        80        80        80        80        80       400
                by public utilities....................................
             Natural Resources and Environment
      21       Expensing of exploration and development costs, nonfuel         30        30        30        30        30        40        40       170
                minerals...............................................
      22       Excess of percentage over cost depletion, nonfuel              260       260       270       280       290       290       300     1,430
                minerals...............................................
      23       Exclusion of interest on bonds for water, sewage, and          450       480       540       580       610       650       680     3,060
                hazardous waste facilities.............................
      24       Capital gains treatment of certain timber income........       100       110       110       120       120       130       140       620
      25       Expensing of multiperiod timber growing costs...........       360       370       380       380       400       410       410     1,980
      26       Tax incentives for preservation of historic structures..       200       210       230       240       250       260       280     1,260
             Agriculture
      27       Expensing of certain capital outlays....................       170       180       170       170       170       170       190       870
      28       Expensing of certain multiperiod production costs.......       130       130       120       120       120       120       120       600
      29       Treatment of loans forgiven for solvent farmers.........        10        10        10        10        10        10        10        50
      30       Capital gains treatment of certain income...............     1,010     1,060     1,120     1,180     1,250     1,310     1,380     6,240
      31       Income averaging for farmers............................        70        70        80        80        80        90        90       420
      32       Deferral of gain on sale of farm refiners...............        10        10        10        10        10        10        20        60
             Commerce and Housing
               Financial institutions and insurance:
      33        Exemption of credit union income.......................     1,020     1,090     1,160     1,240     1,320     1,410     1,510     6,640
      34        Excess bad debt reserves of financial institutions.....         0         0         0         0         0         0         0         0
      35        Exclusion of interest on life insurance savings........    17,690    19,130    20,740    22,470    24,390    26,350    28,310   122,260
      36        Special alternative tax on small property and casualty         10        10        10        10        10        10        10        50
                 insurance companies...................................
      37        Tax exemption of certain insurance companies owned by         210       220       240       250       270       280       290     1,330
                 tax-exempt organizations..............................
      38        Small life insurance company deduction.................       100       100       100       100       100       100       100       500
               Housing:
      39        Exclusion of interest on owner-occupied mortgage              870       960     1,050     1,140     1,210     1,270     1,360     6,030
                 subsidy bonds.........................................
      40        Exclusion of interest on rental housing bonds..........       180       200       220       240       250       260       280     1,250
      41        Deductibility of mortgage interest on owner-occupied       63,590    65,540    68,440    71,870    74,790    78,160    82,650   375,910
                 homes.................................................
      42        Deductibility of State and local property tax on owner-    21,760    22,320    22,160    19,750    16,240    14,580    13,580    86,310
                 occupied homes........................................
      43        Deferral of income from post 1987 installment sales....     1,050     1,080     1,100     1,120     1,140     1,160     1,190     5,710
      44        Capital gains exclusion on home sales..................    19,670    20,260    20,860    21,490    22,140    22,800    23,480   110,770
      45        Exception from passive loss rules for $25,000 of rental     5,690     5,270     4,920     4,600     4,290     4,020     3,790    21,620
                 loss..................................................
      46        Credit for low-income housing investments..............     3,290     3,450     3,640     3,820     3,990     4,160     4,360    19,970
      47        Accelerated depreciation on rental housing (normal tax      1,590     1,080       310      -520    -1,770    -3,310    -4,570    -9,860
                 method)...............................................
               Commerce:
      48        Cancellation of indebtedness...........................         0        10        30        50        60        60        50       250
      49        Exceptions from imputed interest rules.................        50        50        50        50        50        50        50       250
      50        Capital gains (except agriculture, timber, iron ore,       56,060    55,010    53,930    54,550    49,870    49,760    51,450   259,560
                 and coal) (normal tax method).........................
      51        Capital gains exclusion of small corporation stock.....       100       130       160       210       250       300       350     1,270
      52        Step-up basis of capital gains at death................    26,890    27,390    28,500    29,630    30,490    31,370    32,390   152,380
      53        Carryover basis of capital gains on gifts..............       640       640       450       540       640       650       630     2,910
      54        Ordinary income treatment of loss from small business          40        40        50        50        50        50        50       250
                 corporation stock sale................................
      55        Accelerated depreciation of buildings other than rental    -1,800    -2,530    -1,980    -6,520    -9,200   -12,360   -15,820   -45,880
                 housing (normal tax method)...........................
      56        Accelerated depreciation of machinery and equipment        47,770    31,110    16,670   -39,310   -35,260   -33,260   -31,570  -122,730
                 (normal tax method)...................................
      57        Expensing of certain small investments (normal tax           -360      -110       370     1,570     1,830     1,510     1,380     6,660
                 method)...............................................
      58        Amortization of start-up costs (normal tax method).....       110       130       150       160       160       170       170       810

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      59        Graduated corporation income tax rate (normal tax           4,870     5,380     5,700     5,880     6,100     6,350     6,640    30,670
                 method)...............................................
      60        Exclusion of interest on small issue bonds.............       330       360       400       430       450       470       510     2,260
             Transportation
      61       Deferral of tax on shipping companies...................        20        20        20        20        20        20        20       100
      62       Exclusion of reimbursed employee parking expenses.......     2,070     2,180     2,290     2,410     2,540     2,680     2,810    12,730
      63       Exclusion for employer-provided transit passes..........       250       320       380       450       530       600       670     2,630
             Community and Regional Development
      64       Investment credit for rehabilitation of structures              30        30        30        30        30        30        30       150
                (other than historic)..................................
      65       Exclusion of interest for airport, dock, and similar           690       750       830       890       950     1,000     1,060     4,730
                bonds..................................................
      66       Exemption of certain mutuals' and cooperatives' income..        60        60        60        70        70        70        70       340
      67       Empowerment zones, Enterprise communities, and Renewal         730     1,130     1,170     1,280     1,410     1,580     1,750     7,190
                communities............................................
      68       New markets tax credit..................................        90       190       290       430       610       830       870     3,030
      69       Expensing of environmental remediation costs............        80        80        20       -10       -10       -10       -10       -20
             Education, Training, Employment, and Social Services
               Education:
      70        Exclusion of scholarship and fellowship income (normal      1,270     1,260     1,260     1,340     1,400     1,410     1,420     6,830
                 tax method)...........................................
      71        HOPE tax credit........................................     4,110     3,520     2,880     2,930     2,730     2,900     2,790    14,230
      72        Lifetime Learning tax credit...........................     2,180     2,250     2,980     2,840     2,610     2,820     2,860    14,110
      73        Education Individual Retirement Accounts...............        50       100       160       240       330       440       560     1,730
      74        Deductibility of student-loan interest.................       450       640       660       680       700       720       720     3,480
      75        Deduction for higher education expenses................       420     2,230     2,880     3,620     2,940         0         0     9,440
      76        State prepaid tuition plans............................       270       340       400       470       560       660       750     2,840
      77        Exclusion of interest on student-loan bonds............       240       260       290       310       340       350       370     1,660
      78        Exclusion of interest on bonds for private nonprofit          580       640       700       760       810       850       900     4,020
                 educational facilities................................
      79        Credit for holders of zone academy bonds...............        50        80        90       100       100       100       100       490
      80        Exclusion of interest on savings bonds redeemed to             10        10        10        10        10        20        20        70
                 finance educational expenses..........................
      81        Parental personal exemption for students age 19 or over     2,480     3,310     3,230     2,690     2,020     1,670     1,470    11,080
      82        Deductibility of charitable contributions (education)..     4,020     4,140     4,350     4,640     4,820     4,970     5,230    24,010
      83        Exclusion of employer-provided educational assistance..       400       490       520       550       580       610       650     2,910
               Training, employment, and social services:
      84        Work opportunity tax credit............................       380       560       430       190        80        40        20       760
      85        Welfare-to-work tax credit.............................        80        70        80        60        40        20        10       210
      86        Employer provided child care exclusion.................       690       720       760       810       850       890       940     4,250
      87        Employer-provided child care credit....................        40        90       130       140       150       160       170       750
      88        Assistance for adopted foster children.................       220       250       290       330       380       430       480     1,910
      89        Adoption credit and exclusion..........................       140       220       450       500       540       560       570     2,620
      90        Exclusion of employee meals and lodging (other than           740       780       810       850       890       930       970     4,450
                 military).............................................
      91        Child credit \2\.......................................    22,170    21,440    21,310    22,480    24,280    23,940    23,660   115,670
      92        Credit for child and dependent care expenses...........     2,750     2,910     3,230     2,860     2,380     2,190     2,050    12,710
      93        Credit for disabled access expenditures................        50        50        50        60        60        60        60       290
      94        Deductibility of charitable contributions, other than      30,860    32,100    33,990    35,710    37,360    38,780    41,160   187,000
                 education and health..................................
      95        Exclusion of certain foster care payments..............       450       430       430       440       450       460       470     2,250
      96        Exclusion of parsonage allowances......................       350       380       400       420       450       480       510     2,260
               Health
      97        Exclusion of employer contributions for medical            99,060   108,500   120,160   132,240   144,710   157,180   170,230   724,520
                 insurance premiums and medical care...................
      98        Self-employed medical insurance premiums...............     1,760     2,500     3,690     3,940     4,220     4,520     4,980    21,350
      99        Workers' compensation insurance premiums...............     5,280     5,770     6,190     6,630     7,020     7,490     8,000    35,330
     100        Medical Savings Accounts...............................        20        30        30        30        30        30        20       140
     101        Deductibility of medical expenses......................     5,710     6,060     6,340     6,490     6,610     6,980     7,380    33,800
     102        Exclusion of interest on hospital construction bonds...     1,200     1,320     1,440     1,560     1,660     1,740     1,850     8,250
     103        Deductibility of charitable contributions (health).....     4,240     4,360     4,580     4,900     5,070     5,220     5,490    25,260
     104        Tax credit for orphan drug research....................       140       160       180       200       220       250       280     1,130
     105        Special Blue Cross/Blue Shield deduction...............       300       340       310       300       270       300       250     1,430
     106        Tax credit for health insurance purchased by certain            0         0        60        30        40        50        60       240
                 displaced and retired individuals.....................
             Income Security
     107       Exclusion of railroad retirement system benefits........       390       400       400       400       400       400       400     2,000
     108       Exclusion of workers' compensation benefits.............     5,750     6,100     6,460     6,850     7,270     7,710     8,190    36,480
     109       Exclusion of public assistance benefits (normal tax            380       400       410       430       450       470       440     2,200
                method)................................................
     110       Exclusion of special benefits for disabled coal miners..        70        60        60        50        50        50        40       250
     111       Exclusion of military disability pensions...............       110       110       120       120       130       130       140       640
               Net exclusion of pension contributions and earnings:             0         0         0         0         0         0         0         0
     112        Employer plans.........................................    51,260    63,480    67,870    70,540    73,200    67,500    61,440   340,550
     113        401(k) plans...........................................    50,830    52,920    55,290    57,830    61,490    65,060    68,030   307,700
     114        Individual Retirement Accounts.........................    19,080    20,840    23,130    22,400    22,380    20,540    19,800   108,250
     115        Low and moderate income savers credit..................       850     2,050     1,860     1,670     1,510       850         0     5,890
     116        Keogh plans............................................     7,000     7,282     7,616     7,904     8,166     8,402     9,196    41,284
               Exclusion of other employee benefits:                            0         0         0         0         0         0         0         0
     117        Premiums on group term life insurance..................     1,780     1,800     1,830     1,860     1,890     1,920     1,950     9,450

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     118        Premiums on accident and disability insurance..........       220       230       240       250       260       270       280     1,300
     119       Small business retirement plan credit...................        10        20        40        50        50        60        60       260
     120       Income of trusts to finance supplementary unemployment          20        30        30        30        30        30        30       150
                benefits...............................................
     121       Special ESOP rules......................................     1,630     1,710     1,790     1,890     1,990     2,090     2,200     9,960
     122       Additional deduction for the blind......................        40        40        40        40        40        40        40       200
     123       Additional deduction for the elderly....................     1,890     1,950     2,050     2,120     2,180     2,110     2,030    10,490
     124       Tax credit for the elderly and disabled.................        20        20        20        20        10        10        10        70
     125       Deductibility of casualty losses........................       280       400       420       440       460       500       540     2,360
     126       Earned income tax credit \3\............................     4,450     4,930     5,090     5,280     5,410     5,580     5,790    27,150
             Social Security
               Exclusion of social security benefits:
     127        Social Security benefits for retired workers...........    18,340    18,560    18,930    19,210    20,000    21,100    21,550   100,790
     128        Social Security benefits for disabled..................     2,910     3,210     3,570     3,950     4,360     4,870     4,390    21,140
     129        Social Security benefits for dependents and survivors..     3,730     3,910     4,140     4,360     4,590     4,920     4,820    22,830
             Veterans Benefits and Services
     130       Exclusion of veterans death benefits and disability          3,160     3,230     3,400     3,590     3,780     3,980     4,190    18,940
                compensation...........................................
     131       Exclusion of veterans pensions..........................        70        80        80        90        90        90       100       450
     132       Exclusion of GI bill benefits...........................        90        90        90       100       100       110       110       510
     133       Exclusion of interest on veterans housing bonds.........        40        40        50        50        50        60        60       270
             General Purpose Fiscal Assistance
     134       Exclusion of interest on public purpose State and local     25,250    26,780    27,310    27,720    27,810    27,530    28,360   138,730
                bonds..................................................
     135       Deductibility of nonbusiness state and local taxes other    47,430    50,520    50,910    47,770    40,480    37,190    36,080   212,430
                than on owner-occupied homes...........................
     136       Tax credit for corporations receiving income from doing      2,240     2,240     2,240     2,200     1,300         0         0     5,740
                business in U.S. possessions...........................
             Interest
     137       Deferral of interest on U.S. savings bonds..............       510       590       670       750       840       920     1,050     4,230
             Addendum: Aid to State and local governments:
               Deductibility of:
                Property taxes on owner-occupied homes.................    21,760    22,320    22,160    19,750    16,240    14,580    13,580    86,310
                Nonbusiness State and local taxes other than on owner-     47,430    50,520    50,910    47,770    40,480    37,190    36,080   212,430
                 occupied homes........................................
               Exclusion of interest on State and local bonds for:
                Public purposes........................................    25,250    26,780    27,310    27,720    27,810    27,530    28,360   138,730
                Energy facilities......................................       110       120       130       140       140       150       160       720
                Water, sewage, and hazardous waste disposal facilities.       450       480       540       580       610       650       680     3,060
                Small-issues...........................................       330       360       400       430       450       470       510     2,260
                Owner-occupied mortgage subsidies......................       870       960     1,050     1,140     1,210     1,270     1,360     6,030
                Rental housing.........................................       180       200       220       240       250       260       280     1,250
                Airports, docks, and similar facilities................       690       750       830       890       950     1,000     1,060     4,730
                Student loans..........................................       240       260       290       310       340       350       370     1,660
                Private nonprofit educational facilities...............       580       640       700       760       810       850       900     4,020
                Hospital construction..................................     1,200     1,320     1,440     1,560     1,660     1,740     1,850     8,250
                Veterans' housing......................................        40        40        50        50        50        60        60       270
               Credit for holders of zone academy bonds................        50        80        90       100       100       100       100       490
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as
  follows: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 $1,320; 2006 $1,370; 2007 $1,400; and 2008 $1,430.
\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as
  follows: 2002 $5,060; 2003 $5,870; 2004 $5,860; 2005 $5,700; 2006 $7,630; 2007 $7,630; and 2008 $7,500
\3\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of
  dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 $31,380; 2005 $32,090; 2006 $33,450; 2007 $34,480; and 2008 $35,380.
Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to
  the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.


[[Page 106]]


                                                                         Table 6-2.  ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES
                                                                                                        (In millions of dollars)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                  Corporations                                                                          Individuals
                                                               -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                         2004-                                                                                   2004-
                                                                  2002     2003     2004      2005       2006       2007       2008      2008        2002       2003       2004       2005       2006       2007       2008      2008
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

             National Defense
       1       Exclusion of benefits and allowances to armed    .......  .......  .......  .........  .........  .........  .........  .........      2,190      2,210      2,240      2,260      2,290      2,310      2,330     11,430
                forces personnel..............................
             International Affairs
       2       Exclusion of income earned abroad by U.S.        .......  .......  .......  .........  .........  .........  .........  .........      2,740      2,620      2,680      2,750      2,810      2,940      3,100     14,280
                citizens......................................
       3       Exclusion of certain allowances for Federal      .......  .......  .......  .........  .........  .........  .........  .........        760        800        840        880        930        980      1,030      4,660
                employees abroad..............................
       4       Extraterritorial income exclusion..............    4,820    5,150    5,510      5,890      6,290      6,730      7,200     31,620  .........  .........  .........  .........  .........  .........  .........  .........
       5       Inventory property sales source rules exception    1,470    1,540    1,620      1,700      1,790      1,880      1,980      8,970  .........  .........  .........  .........  .........  .........  .........  .........
       6       Deferral of income from controlled foreign         7,000    7,450    7,900      8,400      8,930      9,550     10,210     44,990  .........  .........  .........  .........  .........  .........  .........  .........
                corporations (normal tax method)..............
       7       Deferred taxes for financial firms on certain      1,950    2,050    2,130      2,190      2,260        960          0      7,540  .........  .........  .........  .........  .........  .........  .........  .........
                income earned overseas........................
             General Science, Space, and Technology
       8       Expensing of research and experimentation          1,630    2,160    2,710      3,320      3,910      4,190      4,300     18,430         30         40         50         70         80         80         80        360
                expenditures (normal tax method)..............
       9       Credit for increasing research activities......    6,810    5,590    4,950      2,890      1,240        520        170      9,770         60         50         40         20          0          0          0         60
             Energy
      10       Expensing of exploration and development costs,      130      150      130         70         50         40         30        320         20         20         20         10         10          0          0         40
                fuels.........................................
      11       Excess of percentage over cost depletion, fuels      510      550      530        500        510        530        540      2,610        100        120        120        110        110        110        110        560
      12       Alternative fuel production credit.............    1,500      900      500        500        500        500        200      2,200         60         40         20         20         20         20         10         90
      13       Exception from passive loss limitation for       .......  .......  .......  .........  .........  .........  .........  .........         10         10         10         10         10         10         10         50
                working interests in oil and gas properties...
      14       Capital gains treatment of royalties on coal...  .......  .......  .......  .........  .........  .........  .........  .........        100        110        110        120        120        130        140        620
      15       Exclusion of interest on energy facility bonds.       30       30       30         30         30         30         30        150         80         90        100        110        110        120        130        570
      16       Enhanced oil recovery credit...................      300      310      320        330        330        340        350      1,670         30         30         30         30         30         30         40        160
      17       New technology credit..........................      100      180      250        270        270        270        270      1,330          0          0          0          0          0          0          0          0
      18       Alcohol fuel credits \1\.......................       20       20       20         20         20         20         20        100         10         10         10         10         10         10         10         50
      19       Tax credit and deduction for clean-fuel burning       50       60       40         20        -10        -60        -60        -70         20         30         30         20          0        -10        -10         30
                vehicles......................................
      20       Exclusion from income of conservation subsidies  .......  .......  .......  .........  .........  .........  .........  .........         80         80         80         80         80         80         80        400
                provided by public utilities..................
             Natural Resources and Environment
      21       Expensing of exploration and development costs,       30       30       30         30         30         40         40        170          0          0          0          0          0          0          0          0
                nonfuel minerals..............................
      22       Excess of percentage over cost depletion,            240      240      250        260        270        270        280      1,330         20         20         20         20         20         20         20        100
                nonfuel minerals..............................
      23       Exclusion of interest on bonds for water,            110      110      120        120        120        130        130        620        340        370        420        460        490        520        550      2,440
                sewage, and hazardous waste facilities........
      24       Capital gains treatment of certain timber        .......  .......  .......  .........  .........  .........  .........  .........        100        110        110        120        120        130        140        620
                income........................................
      25       Expensing of multiperiod timber growing costs..      240      250      260        260        270        280        280      1,350        120        120        120        120        130        130        130        630
      26       Tax incentives for preservation of historic          160      170      180        190        200        210        220      1,000         40         40         50         50         50         50         60        260
                structures....................................
             Agriculture
      27       Expensing of certain capital outlays...........       20       20       20         20         20         20         30        110        150        160        150        150        150        150        160        760
      28       Expensing of certain multiperiod production           20       20       20         20         20         20         20        100        110        110        100        100        100        100        100        500
                costs.........................................
      29       Treatment of loans forgiven for solvent farmers  .......  .......  .......  .........  .........  .........  .........  .........         10         10         10         10         10         10         10         50
      30       Capital gains treatment of certain income......  .......  .......  .......  .........  .........  .........  .........  .........      1,010      1,060      1,120      1,180      1,250      1,310      1,380      6,240
      31       Income averaging for farmers...................  .......  .......  .......  .........  .........  .........  .........  .........         70         70         80         80         80         90         90        420
      32       Deferral of gain on sale of farm refiners......       10       10       10         10         10         10         20         60  .........  .........  .........  .........  .........  .........  .........  .........
             Commerce and Housing
               Financial institutions and insurance:
      33        Exemption of credit union income..............    1,020    1,090    1,160      1,240      1,320      1,410      1,510      6,640  .........  .........  .........  .........  .........  .........  .........  .........
      34        Excess bad debt reserves of financial                 0        0        0          0          0          0          0          0  .........  .........  .........  .........  .........  .........  .........  .........
                 institutions.................................
      35        Exclusion of interest on life insurance           1,770    1,800    1,830      1,860      1,890      1,920      1,950      9,450     15,920     17,330     18,910     20,610     22,500     24,430     26,360    112,810
                 savings......................................
      36        Special alternative tax on small property and        10       10       10         10         10         10         10         50  .........  .........  .........  .........  .........  .........  .........  .........
                 casualty insurance companies.................
      37        Tax exemption of certain insurance companies        210      220      240        250        270        280        290      1,330  .........  .........  .........  .........  .........  .........  .........  .........
                 owned by tax-exempt organizations............
      38        Small life insurance company deduction........      100      100      100        100        100        100        100        500  .........  .........  .........  .........  .........  .........  .........  .........
               Housing:
      39        Exclusion of interest on owner-occupied             210      220      230        230        240        250        260      1,210        660        740        820        910        970      1,020      1,100      4,820
                 mortgage subsidy bonds.......................
      40        Exclusion of interest on rental housing bonds.       40       50       50         50         50         50         50        250        140        150        170        190        200        210        230      1,000
      41        Deductibility of mortgage interest on owner-    .......  .......  .......  .........  .........  .........  .........  .........     63,590     65,540     68,440     71,870     74,790     78,160     82,650    375,910
                 occupied homes...............................
      42        Deductibility of State and local property tax   .......  .......  .......  .........  .........  .........  .........  .........     21,760     22,320     22,160     19,750     16,240     14,580     13,580     86,310
                 on owner-occupied homes......................

[[Page 107]]


      43        Deferral of income from post 1987 installment       270      280      290        290        300        300        310      1,490        780        800        810        830        840        860        880      4,220
                 sales........................................
      44        Capital gains exclusion on home sales.........  .......  .......  .......  .........  .........  .........  .........  .........     19,670     20,260     20,860     21,490     22,140     22,800     23,480    110,770
      45        Exception from passive loss rules for $25,000   .......  .......  .......  .........  .........  .........  .........  .........      5,690      5,270      4,920      4,600      4,290      4,020      3,790     21,620
                 of rental loss...............................
      46        Credit for low-income housing investments.....    2,630    2,760    2,910      3,060      3,190      3,330      3,490     15,980        660        690        730        760        800        830        870      3,990
      47        Accelerated depreciation on rental housing           70       30      -20        -80       -160       -260       -330       -850      1,520      1,050        330       -440     -1,610     -3,050     -4,240     -9,010
                 (normal tax method)..........................
               Commerce:
      48        Cancellation of indebtedness..................  .......  .......  .......  .........  .........  .........  .........  .........          0         10         30         50         60         60         50        250
      49        Exceptions from imputed interest rules........  .......  .......  .......  .........  .........  .........  .........  .........         50         50         50         50         50         50         50        250
      50        Capital gains (except agriculture, timber,      .......  .......  .......  .........  .........  .........  .........  .........     56,060     55,010     53,930     54,550     49,870     49,760     51,450    259,560
                 iron ore, and coal) (normal tax method)......
      51        Capital gains exclusion of small corporation    .......  .......  .......  .........  .........  .........  .........  .........        100        130        160        210        250        300        350      1,270
                 stock........................................
      52        Step-up basis of capital gains at death.......  .......  .......  .......  .........  .........  .........  .........  .........     26,890     27,390     28,500     29,630     30,490     31,370     32,390    152,380
      53        Carryover basis of capital gains on gifts.....  .......  .......  .......  .........  .........  .........  .........  .........        640        640        450        540        640        650        630      2,910
      54        Ordinary income treatment of loss from small    .......  .......  .......  .........  .........  .........  .........  .........         40         40         50         50         50         50         50        250
                 business corporation stock sale..............
      55        Accelerated depreciation of buildings other      -1,710   -2,250   -1,470     -5,280     -7,440     -9,980    -12,820    -36,990        -90       -280       -510     -1,240     -1,760     -2,380     -3,000     -8,890
                 than rental housing (normal tax method)......
      56        Accelerated depreciation of machinery and        40,670   26,390   14,140    -33,390    -29,330    -26,960    -25,000   -100,540      7,100      4,720      2,530     -5,920     -5,930     -6,300     -6,570    -22,190
                 equipment (normal tax method)................
      57        Expensing of certain small investments (normal     -140      -80      130        560        720        580        520      2,510       -220        -30        240      1,010      1,110        930        860      4,150
                 tax method)..................................
      58        Amortization of start-up costs (normal tax           90      110      120        130        130        140        140        660         20         20         30         30         30         30         30        150
                 method)......................................
      59        Graduated corporation income tax rate (normal     4,870    5,380    5,700      5,880      6,100      6,350      6,640     30,670  .........  .........  .........  .........  .........  .........  .........  .........
                 tax method)..................................
      60        Exclusion of interest on small issue bonds....       80       80       90         90         90         90        100        460        250        280        310        340        360        380        410      1,800
             Transportation
      61       Deferral of tax on shipping companies..........       20       20       20         20         20         20         20        100  .........  .........  .........  .........  .........  .........  .........  .........
      62       Exclusion of reimbursed employee parking         .......  .......  .......  .........  .........  .........  .........  .........      2,070      2,180      2,290      2,410      2,540      2,680      2,810     12,730
                expenses......................................
      63       Exclusion for employer-provided transit passes.  .......  .......  .......  .........  .........  .........  .........  .........        250        320        380        450        530        600        670      2,630
             Community and Regional Development
      64       Investment credit for rehabilitation of               20       20       20         20         20         20         20        100         10         10         10         10         10         10         10         50
                structures (other than historic)..............
      65       Exclusion of interest for airport, dock, and         170      170      180        180        190        200        200        950        520        580        650        710        760        800        860      3,780
                similar bonds.................................
      66       Exemption of certain mutuals' and cooperatives'       60       60       60         70         70         70         70        340  .........  .........  .........  .........  .........  .........  .........  .........
                income........................................
      67       Empowerment zones, Enterprise communities, and       220      300      300        320        350        390        420      1,780        510        830        870        960      1,060      1,190      1,330      5,410
                Renewal communities...........................
      68       New markets tax credit.........................       20       50       70        110        150        210        220        760         70        140        220        320        460        620        650      2,270
      69       Expensing of environmental remediation costs...       70       70       20        -10        -10        -10        -10        -20         10         10          0          0          0          0          0          0
             Education, Training, Employment, and Social
              Services
               Education:
      70        Exclusion of scholarship and fellowship income  .......  .......  .......  .........  .........  .........  .........  .........      1,270      1,260      1,260      1,340      1,400      1,410      1,420      6,830
                 (normal tax method)..........................
      71        HOPE tax credit...............................  .......  .......  .......  .........  .........  .........  .........  .........      4,110      3,520      2,880      2,930      2,730      2,900      2,790     14,230
      72        Lifetime Learning tax credit..................  .......  .......  .......  .........  .........  .........  .........  .........      2,180      2,250      2,980      2,840      2,610      2,820      2,860     14,110
      73        Education Individual Retirement Accounts......  .......  .......  .......  .........  .........  .........  .........  .........         50        100        160        240        330        440        560      1,730
      74        Deductibility of student-loan interest........  .......  .......  .......  .........  .........  .........  .........  .........        450        640        660        680        700        720        720      3,480
      75        Deduction for higher education expenses.......  .......  .......  .......  .........  .........  .........  .........  .........        420      2,230      2,880      3,620      2,940          0          0      9,440
      76        State prepaid tuition plans...................  .......  .......  .......  .........  .........  .........  .........  .........        270        340        400        470        560        660        750      2,840
      77        Exclusion of interest on student-loan bonds...       60       60       60         60         70         70         70        330        180        200        230        250        270        280        300      1,330
      78        Exclusion of interest on bonds for private          140      150      150        160        160        170        170        810        440        490        550        600        650        680        730      3,210
                 nonprofit educational facilities.............
      79        Credit for holders of zone academy bonds......       50       80       90        100        100        100        100        490  .........  .........  .........  .........  .........  .........  .........  .........
      80        Exclusion of interest on savings bonds          .......  .......  .......  .........  .........  .........  .........  .........         10         10         10         10         10         20         20         70
                 redeemed to finance educational expenses.....
      81        Parental personal exemption for students age    .......  .......  .......  .........  .........  .........  .........  .........      2,480      3,310      3,230      2,690      2,020      1,670      1,470     11,080
                 19 or over...................................
      82        Deductibility of charitable contributions           720      700      710        830        820        810        810      3,980      3,300      3,440      3,640      3,810      4,000      4,160      4,420     20,030
                 (education)..................................
      83        Exclusion of employer-provided educational      .......  .......  .......  .........  .........  .........  .........  .........        400        490        520        550        580        610        650      2,910
                 assistance...................................
               Training, employment, and social services:
      84        Work opportunity tax credit...................      350      490      360        160         70         30         10        630         30         70         70         30         10         10         10        130
      85        Welfare-to-work tax credit....................       70       60       70         50         30         20         10        180         10         10         10         10         10          0          0         30

[[Page 108]]


      86        Employer provided child care exclusion........  .......  .......  .......  .........  .........  .........  .........  .........        690        720        760        810        850        890        940      4,250
      87        Employer-provided child care credit...........  .......  .......  .......  .........  .........  .........  .........  .........         40         90        130        140        150        160        170        750
      88        Assistance for adopted foster children........  .......  .......  .......  .........  .........  .........  .........  .........        220        250        290        330        380        430        480      1,910
      89        Adoption credit and exclusion.................  .......  .......  .......  .........  .........  .........  .........  .........        140        220        450        500        540        560        570      2,620
      90        Exclusion of employee meals and lodging (other  .......  .......  .......  .........  .........  .........  .........  .........        740        780        810        850        890        930        970      4,450
                 than military)...............................
      91        Child credit \2\..............................  .......  .......  .......  .........  .........  .........  .........  .........     22,170     21,440     21,310     22,480     24,280     23,940     23,660    115,670
      92        Credit for child and dependent care expenses..  .......  .......  .......  .........  .........  .........  .........  .........      2,750      2,910      3,230      2,860      2,380      2,190      2,050     12,710
      93        Credit for disabled access expenditures.......       10       10       10         20         20         20         20         90         40         40         40         40         40         40         40        200
      94        Deductibility of charitable contributions,          890      870      880      1,040      1,010      1,010      1,010      4,950     29,970     31,230     33,110     34,670     36,350     37,770     40,150    182,050
                 other than education and health..............
      95        Exclusion of certain foster care payments.....  .......  .......  .......  .........  .........  .........  .........  .........        450        430        430        440        450        460        470      2,250
      96        Exclusion of parsonage allowances.............  .......  .......  .......  .........  .........  .........  .........  .........        350        380        400        420        450        480        510      2,260
             Health
      97       Exclusion of employer contributions for medical  .......  .......  .......  .........  .........  .........  .........  .........     99,060    108,500    120,160    132,240    144,710    157,180    170,230    724,520
                insurance premiums and medical care...........
      98       Self-employed medical insurance premiums.......  .......  .......  .......  .........  .........  .........  .........  .........      1,760      2,500      3,690      3,940      4,220      4,520      4,980     21,350
      99       Workers' compensation insurance premiums.......  .......  .......  .......  .........  .........  .........  .........  .........       5280       5770       6190       6630       7020       7490       8000     35,330
     100       Medical Savings Accounts.......................  .......  .......  .......  .........  .........  .........  .........  .........         20         30         30         30         30         30         20        140
     101       Deductibility of medical expenses..............  .......  .......  .......  .........  .........  .........  .........  .........      5,710      6,060      6,340      6,490      6,610      6,980      7,380     33,800
     102       Exclusion of interest on hospital construction       290      300      310        320        330        340        350      1,650        910      1,020      1,130      1,240      1,330      1,400      1,500      6,600
                bonds.........................................
     103       Deductibility of charitable contributions            870      850      860      1,010        990        980        980      4,820      3,370      3,510      3,720      3,890      4,080      4,240      4,510     20,440
                (health)......................................
     104       Tax credit for orphan drug research............      140      160      180        200        220        250        280      1,130  .........  .........  .........  .........  .........  .........  .........  .........
     105       Special Blue Cross/Blue Shield deduction.......      300      340      310        300        270        300        250      1,430  .........  .........  .........  .........  .........  .........  .........  .........
     106       Tax credit for health insurance purchased by     .......  .......  .......  .........  .........  .........  .........  .........          0          0         60         30         40         50         60        240
                certain displaced and retired individuals.....
             Income Security
     107       Exclusion of railroad retirement system          .......  .......  .......  .........  .........  .........  .........  .........        390        400        400        400        400        400        400      2,000
                benefits......................................
     108       Exclusion of workers' compensation benefits....  .......  .......  .......  .........  .........  .........  .........  .........      5,750      6,100      6,460      6,850      7,270      7,710      8,190     36,480
     109       Exclusion of public assistance benefits (normal  .......  .......  .......  .........  .........  .........  .........  .........        380        400        410        430        450        470        440      2,200
                tax method)...................................
     110       Exclusion of special benefits for disabled coal  .......  .......  .......  .........  .........  .........  .........  .........         70         60         60         50         50         50         40        250
                miners........................................
     111       Exclusion of military disability pensions......  .......  .......  .......  .........  .........  .........  .........  .........        110        110        120        120        130        130        140        640
               Net exclusion of pension contributions and
                earnings:
     112        Employer plans................................  .......  .......  .......  .........  .........  .........  .........  .........     51,260     63,480     67,870     70,540     73,200     67,500     61,440    340,550
     113        401(k) plans..................................  .......  .......  .......  .........  .........  .........  .........  .........     50,830     52,920     55,290     57,830     61,490      65060      68030    307,700
     114        Individual Retirement Accounts................  .......  .......  .......  .........  .........  .........  .........  .........     19,080     20,840     23,130     22,400     22,380     20,540     19,800    108,250
     115        Low and moderate income savers credit.........  .......  .......  .......  .........  .........  .........  .........  .........        850      2,050      1,860      1,670      1,510        850          0      5,890
     116        Keogh plans...................................  .......  .......  .......  .........  .........  .........  .........  .........      7,000      7,282      7,616      7,904      8,166      8,402      9,196     41,284
               Exclusion of other employee benefits:
     117        Premiums on group term life insurance.........  .......  .......  .......  .........  .........  .........  .........  .........      1,780      1,800      1,830      1,860      1,890      1,920      1,950      9,450
     118        Premiums on accident and disability insurance.  .......  .......  .......  .........  .........  .........  .........  .........        220        230        240        250        260        270        280      1,300
     119       Small business retirement plan credit..........  .......  .......  .......  .........  .........  .........  .........  .........         10         20         40         50         50         60         60        260
     120       Income of trusts to finance supplementary             20       30       30         30         30         30         30        150
                unemployment benefits.........................
     121       Special ESOP rules.............................     1330     1400     1470       1550       1640       1720       1810      8,190        300        310        320        340        350        370        390      1,770
     122       Additional deduction for the blind.............  .......  .......  .......  .........  .........  .........  .........  .........         40         40         40         40         40         40         40        200
     123       Additional deduction for the elderly...........  .......  .......  .......  .........  .........  .........  .........  .........      1,890      1,950      2,050      2,120      2,180      2,110      2,030     10,490
     124       Tax credit for the elderly and disabled........  .......  .......  .......  .........  .........  .........  .........  .........         20         20         20         20         10         10         10         70
     125       Deductibility of casualty losses...............  .......  .......  .......  .........  .........  .........  .........  .........        280        400        420        440        460        500        540      2,360
     126       Earned income tax credit \3\...................  .......  .......  .......  .........  .........  .........  .........  .........      4,450      4,930      5,090      5,280      5,410      5,580      5,790     27,150
             Social Security
               Exclusion of social security benefits:
     127        Social Security benefits for retired workers..  .......  .......  .......  .........  .........  .........  .........  .........     18,340     18,560     18,930     19,210     20,000     21,100     21,550    100,790
     128        Social Security benefits for disabled.........  .......  .......  .......  .........  .........  .........  .........  .........      2,910      3,210      3,570      3,950      4,360      4,870      4,390     21,140
     129        Social Security benefits for dependents and     .......  .......  .......  .........  .........  .........  .........  .........      3,730      3,910      4,140      4,360      4,590      4,920      4,820     22,830
                 survivors....................................
             Veterans Benefits and Services
     130       Exclusion of veterans death benefits and         .......  .......  .......  .........  .........  .........  .........  .........      3,160      3,230      3,400      3,590      3,780      3,980      4,190     18,940
                disability compensation.......................
     131       Exclusion of veterans pensions.................  .......  .......  .......  .........  .........  .........  .........  .........         70         80         80         90         90         90        100        450
     132       Exclusion of GI bill benefits..................  .......  .......  .......  .........  .........  .........  .........  .........         90         90         90        100        100        110        110        510
     133       Exclusion of interest on veterans housing bonds       10       10       10         10         10         10         10         50         30         30         40         40         40         50         50        220
             General Purpose Fiscal Assistance
     134       Exclusion of interest on public purpose State      6,170    6,360    6,550      6,750      6,950      7,160      7,370     34,780     19,080     20,420     20,760     20,970     20,860     20,370     20,990    103,950
                and local bonds...............................
     135       Deductibility of nonbusiness state and local     .......  .......  .......  .........  .........  .........  .........  .........     47,430     50,520     50,910     47,770     40,480     37,190     36,080    212,430
                taxes other than on owner-occupied homes......

[[Page 109]]


     136       Tax credit for corporations receiving income       2,240    2,240    2,240      2,200      1,300          0          0      5,740  .........  .........  .........  .........  .........  .........  .........  .........
                from doing business in U.S. possessions.......
             Interest
     137       Deferral of interest on U.S. savings bonds.....  .......  .......  .......  .........  .........  .........  .........  .........        510        590        670        750        840        920      1,050      4,230
             Addendum: Aid to State and local governments:
               Deductibility of:
                Property taxes on owner-occupied homes........  .......  .......  .......  .........  .........  .........  .........  .........     21,760     22,320     22,160     19,750     16,240     14,580     13,580     86,310
                Nonbusiness State and local taxes other than    .......  .......  .......  .........  .........  .........  .........  .........     47,430     50,520     50,910     47,770     40,480     37,190     36,080    212,430
                 on owner-occupied homes......................
               Exclusion of interest on State and local bonds
                for:
                Public purposes...............................    6,170    6,360    6,550      6,750      6,950      7,160      7,370     34,780     19,080     20,420     20,760     20,970     20,860     20,370     20,990    103,950
                Energy facilities.............................       30       30       30         30         30         30         30        150         80         90        100        110        110        120        130        570
                Water, sewage, and hazardous waste disposal         110      110      120        120        120        130        130        620        340        370        420        460        490        520        550      2,440
                 facilities...................................
                Small-issues..................................       80       80       90         90         90         90        100        460        250        280        310        340        360        380        410      1,800
                Owner-occupied mortgage subsidies.............      210      220      230        230        240        250        260      1,210        660        740        820        910        970      1,020      1,100      4,820
                Rental housing................................       40       50       50         50         50         50         50        250        140        150        170        190        200        210        230      1,000
                Airports, docks, and similar facilities.......      170      170      180        180        190        200        200        950        520        580        650        710        760        800        860      3,780
                Student loans.................................       60       60       60         60         70         70         70        330        180        200        230        250        270        280        300      1,330
                Private nonprofit educational facilities......      140      150      150        160        160        170        170        810        440        490        550        600        650        680        730      3,210
                Hospital construction.........................      290      300      310        320        330        340        350      1,650        910      1,020      1,130      1,240      1,330      1,400      1,500      6,600
                Veterans' housing.............................       10       10       10         10         10         10         10         50         30         30         40         40         40         50         50        220
               Credit for holders of zone academy bonds.......       50       80       90        100        100        100        100        490  .........  .........  .........  .........  .........  .........  .........  .........
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 $1,320; 2006 $1,370; 2007
  $1,400; and 2008 $1,430.
\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $5,060; 2003 $5,870; 2004 $5,860; 2005 $5,700; 2006 $7,630; 2007
  $7,630; and 2008 $7,500
\3\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 $31,380; 2005 $32,090; 2006
  $33,450; 2007 $34,480; and 2008 $35,380.
Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each
  year are not included in the table.


[[Page 110]]


             Table 6-3.  INCOME TAX EXPENDITURES RANKED BY TOTAL 2004-2008 PROJECTED REVENUE EFFECT
                                            (In millions of dollars)
----------------------------------------------------------------------------------------------------------------
                                    Provision                                         2004          2004-2008
----------------------------------------------------------------------------------------------------------------
Exclusion of employer contributions for medical insurance premiums and medical     120,160          724,520
 care.........................................................................
Deductibility of mortgage interest on owner-occupied homes....................      68,440          375,910
Net exclusion of pension contributions and earnings: Employer plans...........      67,870          340,550
Net exclusion of pension contributions and earnings: 401(k) plans.............      55,290          307,700
Capital gains (except agriculture, timber, iron ore, and coal) (normal tax          53,930          259,560
 method)......................................................................
Deductibility of nonbusiness state and local taxes other than on owner-             50,910          212,430
 occupied homes...............................................................
Deductibility of charitable contributions, other than education and health....      33,990          187,000
Step-up basis of capital gains at death.......................................      28,500          152,380
Exclusion of interest on public purpose State and local bonds.................      27,310          138,730
Exclusion of interest on life insurance savings...............................      20,740          122,260
Child credit..................................................................      21,310          115,670
Capital gains exclusion on home sales.........................................      20,860          110,770
Net exclusion of pension contributions and earnings: Individual Retirement          23,130          108,250
 Accounts.....................................................................
Social Security benefits for retired workers..................................      18,930          100,790
Deductibility of State and local property tax on owner-occupied homes.........      22,160           86,310
Deferral of income from controlled foreign corporations (normal tax method)...       7,900           44,990
Net exclusion of pension contributions and earnings: Keough Plans.............       7,616           41,284
Exclusion of workers' compensation benefits...................................       6,460           36,480
Workers' compensation insurance premiums......................................       6,190           35,330
Deductibility of medical expenses.............................................       6,340           33,800
Extraterritorial income exclusion.............................................       5,510           31,620
Graduated corporation income tax rate (normal tax method).....................       5,700           30,670
Earned income tax credit......................................................       5,090           27,150
Deductibility of charitable contributions (health)............................       4,580           25,260
Deductibility of charitable contributions (education).........................       4,350           24,010
Social Security benefits for dependents and survivors.........................       4,140           22,830
Exception from passive loss rules for $25,000 of rental loss..................       4,920           21,620
Self-employed medical insurance premiums......................................       3,690           21,350
Social Security benefits for disabled.........................................       3,570           21,140
Credit for low-income housing investments.....................................       3,640           19,970
Exclusion of veterans death benefits and disability compensation..............       3,400           18,940
Expensing of research and experimentation expenditures (normal tax method)....       2,760           18,790
Exclusion of income earned abroad by U.S. citizens............................       2,680           14,280
HOPE tax credit...............................................................       2,880           14,230
Lifetime Learning tax credit..................................................       2,980           14,110
Exclusion of reimbursed employee parking expenses.............................       2,290           12,730
Credit for child and dependent care expenses..................................       3,230           12,710
Exclusion of benefits and allowances to armed forces personnel................       2,240           11,430
Parental personal exemption for students age 19 or over.......................       3,230           11,080
Additional deduction for the elderly..........................................       2,050           10,490
Special ESOP rules............................................................       1,790            9,960
Credit for increasing research activities.....................................       4,990            9,830
Premiums on group term life insurance.........................................       1,830            9,450
Deduction for higher education expenses.......................................       2,880            9,440
Inventory property sales source rules exception...............................       1,620            8,970
Exclusion of interest on hospital construction bonds..........................       1,440            8,250
Deferred taxes for financial firms on certain income earned overseas..........       2,130            7,540
Empowerment zones, Enterprise communities, and Renewal communities............       1,170            7,190
Exclusion of scholarship and fellowship income (normal tax method)............       1,260            6,830
Expensing of certain small investments (normal tax method)....................         370            6,660
Exemption of credit union income..............................................       1,160            6,640
Capital gains treatment of certain income.....................................       1,120            6,240
Exclusion of interest on owner-occupied mortgage subsidy bonds................       1,050            6,030
Low and moderate income savers credit.........................................       1,860            5,890
Tax credit for corporations receiving income from doing business in U.S.             2,240            5,740
 possessions..................................................................
Deferral of income from post 1987 installment sales...........................       1,100            5,710
Exclusion of interest for airport, dock, and similar bonds....................         830            4,730
Exclusion of certain allowances for Federal employees abroad..................         840            4,660
Exclusion of employee meals and lodging (other than military).................         810            4,450
Employer provided child care exclusion........................................         760            4,250
Exclusion of interest on bonds for private nonprofit educational facilities...         700            4,020
Deferral of interest on U.S. savings bonds....................................         670            4,230
Deductibility of student-loan interest........................................         660            3,480
Excess of percentage over cost depletion, fuels...............................         650            3,170
Exclusion of interest on bonds for water, sewage, and hazardous waste                  540            3,060
 facilities...................................................................
New markets tax credit........................................................         290            3,030
Exclusion of employer-provided educational assistance.........................         520            2,910
Carryover basis of capital gains on gifts.....................................         450            2,910
State prepaid tuition plans...................................................         400            2,840

[[Page 111]]


Exclusion for employer-provided transit passes................................         380            2,630
Adoption credit and exclusion.................................................         450            2,620
Deductibility of casualty losses..............................................         420            2,360
Alternative fuel production credit............................................         520            2,290
Exclusion of interest on small issue bonds....................................         400            2,260
Exclusion of parsonage allowances.............................................         400            2,260
Exclusion of certain foster care payments.....................................         430            2,250
Exclusion of public assistance benefits (normal tax method)...................         410            2,200
Exclusion of railroad retirement system benefits..............................         400            2,000
Expensing of multiperiod timber growing costs.................................         380            1,980
Assistance for adopted foster children........................................         290            1,910
Enhanced oil recovery credit..................................................         350            1,830
Education Individual Retirement Accounts......................................         160            1,730
Exclusion of interest on student-loan bonds...................................         290            1,660
Special Blue Cross/Blue Shield deduction......................................         310            1,430
Excess of percentage over cost depletion, nonfuel minerals....................         270            1,430
New technology credit.........................................................         250            1,330
Tax exemption of certain insurance companies owned by tax-exempt organizations         240            1,330
Premiums on accident and disability insurance.................................         240            1,300
Capital gains exclusion of small corporation stock............................         160            1,270
Tax incentives for preservation of historic structures........................         230            1,260
Exclusion of interest on rental housing bonds.................................         220            1,250
Tax credit for orphan drug research...........................................         180            1,130
Expensing of certain capital outlays..........................................         170              870
Amortization of start-up costs (normal tax method)............................         150              810
Work opportunity tax credit...................................................         430              760
Employer-provided child care credit...........................................         130              750
Exclusion of interest on energy facility bonds................................         130              720
Exclusion of military disability pensions.....................................         120              640
Capital gains treatment of royalties on coal..................................         110              620
Capital gains treatment of certain timber income..............................         110              620
Expensing of certain multiperiod production costs.............................         120              600
Exclusion of GI bill benefits.................................................          90              510
Small life insurance company deduction........................................         100              500
Credit for holders of zone academy bonds......................................          90              490
Exclusion of veterans pensions................................................          80              450
Income averaging for farmers..................................................          80              420
Exclusion from income of conservation subsidies provided by public utilities..          80              400
Expensing of exploration and development costs, fuels.........................         150              360
Exemption of certain mutuals' and cooperatives' income........................          60              340
Credit for disabled access expenditures.......................................          50              290
Exclusion of interest on veterans housing bonds...............................          50              270
Small business retirement plan credit.........................................          40              260
Exclusion of special benefits for disabled coal miners........................          60              250
Exceptions from imputed interest rules........................................          50              250
Ordinary income treatment of loss from small business corporation stock sale..          50              250
Cancellation of indebtedness..................................................          30              250
Tax credit for health insurance purchased by certain displaced and retired              60              240
 individuals..................................................................
Welfare-to-work tax credit....................................................          80              210
Additional deduction for the blind............................................          40              200
Expensing of exploration and development costs, nonfuel minerals..............          30              170
Alcohol fuel credits 1/.......................................................          30              150
Income of trusts to finance supplementary unemployment benefits...............          30              150
Investment credit for rehabilitation of structures (other than historic)......          30              150
Medical Savings Accounts......................................................          30              140
Deferral of tax on shipping companies.........................................          20              100
Tax credit for the elderly and disabled.......................................          20               70
Exclusion of interest on savings bonds redeemed to finance educational                  10               70
 expenses.....................................................................
Deferral of gain on sale of farm refiners.....................................          10               60
Exception from passive loss limitation for working interests in oil and gas             10               50
 properties...................................................................
Treatment of loans forgiven for solvent farmers...............................          10               50
Special alternative tax on small property and casualty insurance companies....          10               50
Expensing of environmental remediation costs..................................          20              -20
Tax credit and deduction for clean-fuel burning vehicles......................          70              -40
Accelerated depreciation on rental housing (normal tax method)................       1,080           -4,570
Accelerated depreciation of buildings other than rental housing (normal tax         -2,530          -15,820
 method)......................................................................
Accelerated depreciation of machinery and equipment (normal tax method).......      31,110          -31,570
----------------------------------------------------------------------------------------------------------------


[[Page 112]]


            Table 6-4.  PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2002
                                            (In millions of dollars)
----------------------------------------------------------------------------------------------------------------
                                                                                                       Present
                                                   Provision                                          Value of
                                                                                                    Revenue Loss
----------------------------------------------------------------------------------------------------------------
       1     Deferral of income from controlled foreign corporations (normal tax method)..........     7,180
       2     Deferred taxes for financial firms on income earned overseas.........................     1,740
       3     Expensing of research and experimentation expenditures (normal tax method)...........     1,800
       4     Expensing of exploration and development costs--fuels................................       140
       5     Expensing of exploration and development costs--nonfuels.............................        10
       6     Expensing of multiperiod timber growing costs........................................       210
       7     Expensing of certain multiperiod production costs--agriculture.......................       240
       8     Expensing of certain capital outlays--agriculture....................................       270
       9     Deferral of income on life insurance and annuity contracts...........................    24,210
      10     Expensing of certain small investments (normal tax method)...........................       700
      11     Amortization of start-up costs (normal tax method)...................................        30
      12     Deferral of tax on shipping companies................................................        20
      13     Credit for holders of zone academy bonds.............................................       120
      14     Credit for low-income housing investments............................................     3,580
      15     Deferral for state prepaid tuition plans.............................................       590
      16     Exclusion of pension contributions--employer plans...................................    90,570
      17     Exclusion of 401(k) contributions....................................................    81,000
      18     Exclusion of IRA contributions and earnings..........................................    10,650
      19     Exclusion of contributions and earnings for Keogh plans..............................     9,290
      20     Exclusion of interest on public-purpose bonds........................................    23,560
      21     Exclusion of interest on non-public purpose bonds....................................     6,070
      22     Deferral of interest on U.S. savings bonds...........................................       470
----------------------------------------------------------------------------------------------------------------

                           Outlay Equivalents

  The concept of ``outlay equivalents'' is another theoretical measure 
of the budget effect of tax expenditures. It is the amount of budget 
outlays that would be required to provide the taxpayer the same after-
tax income as would be received through the tax provision. The outlay-
equivalent measure allows the cost of a tax expenditure to be compared 
with a direct Federal outlay on a more even footing. Outlay equivalents 
are reported in Table 6-5.

                                              Table 6-5.  OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES
                                                                (In millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                        Outlay Equivalents
                                                                        --------------------------------------------------------------------------------
                                                                           2002      2003      2004      2005      2006      2007      2008    2004-2008
--------------------------------------------------------------------------------------------------------------------------------------------------------
             National Defense
       1       Exclusion of benefits and allowances to armed forces         2,540     2,570     2,600     2,620     2,650     2,680     2,710    13,260
                personnel..............................................

             International affairs:
       2       Exclusion of income earned abroad by U.S. citizens......     3,810     3,470     3,530     3,640     3,700     3,880     4,100    18,850
       3       Exclusion of certain allowances for Federal employees        1,000     1,060     1,110     1,170     1,220     1,290     1,360     6,150
                abroad.................................................
       4       Extraterritorial income exclusion.......................     7,410     7,920     8,480     9,060     9,680    10,350    11,080    48,650
       5       Inventory property sales solurce rules exception........     2,260     2,370     2,490     2,620     2,750     2,890     3,050    13,800
       6       Deferral of income from controlled foreign corporations      7,000     7,450     7,900     8,400     8,930     9,550    10,210    44,990
                (normal tax method)....................................
       7       Deferred taxes for financial firms on certain income         1,950     2,050     2,130     2,190     2,260       960         0     7,540
                earned overseas........................................

             General Science, Space, and Technology
       8       Expensing of research and experimentation expenditures       1,660     2,200     2,760     3,390     3,990     4,270     4,380    18,790
                (normal tax method)....................................
       9       Credit for increasing research activities...............    10,560     8,670     7,680     4,470     1,910       800       260    15,120

             Energy
      10       Expensing of exploration and development costs, fuels...       170       180       150        80        60        50        40       380
      11       Excess of percentage over cost depletion, fuels.........       850       930       810       790       840       850       850     4,140
      12       Alternative fuel production credit......................     2,100     1,260       700       700       700       700       280     3,080
      13       Exception from passive loss limitation for working               0
                interests in oil and gas properties....................
      14       Capital gains treatment of royalties on coal............       130       140       150       160       170       170       180       830
      15       Exclusion of interest on energy facility bonds..........       160       170       180       200       200       210       230     1,020
      16       Enhanced oil recovery credit............................       540       560       570       590       600       620       630     3,010
      17       New technology credit...................................       140       240       330       350       360       360       370     1,770
      18       Alcohol fuel credits \1\................................        30        30        30        30        30        30        30       150
      19       Tax credit and deduction for clean-fuel burning vehicles       100       120       100        60       -10       -90      -100       -40
      20       Exclusion from income of conservation subsidies provided       100       110       110       110       110       100       100       530
                by public utilities....................................

             Natural Resources and Environment

[[Page 113]]


      21       Expensing of exploration and development costs, nonfuel         40        40        40        40        50        50        50       230
                minerals...............................................
      22       Excess of percentage over cost depletion, nonfuel              330       340       350       360       370       380       390     1,850
                minerals...............................................
      23       Exclusion of interest on bonds for water, sewage, and          640       690       780       840       880       930       980     4,410
                hazardous waste facilities.............................
      24       Capital gains treatment of certain timber income........       130       140       150       160       170       170       180       830
      25       Expensing of multiperiod timber growing costs...........       470       480       490       510       520       530       540     2,590
      26       Tax incentives for preservation of historic structures..       200       210       220       240       250       260       270     1,240

             Agriculture
      27       Expensing of certain capital outlays....................       220       230       210       210       210       210       230     1,070
      28       Expensing of certain multiperiod production costs.......       160       160       150       150       140       140       140       720
      29       Treatment of loans forgiven for solvent farmers.........        10        10        10        10        10        10        10        50
      30       Capital gains treatment of certain income...............     1,350     1,420     1,500     1,580     1,660     1,750     1,840     8,330
      31       Income averaging for farmers............................        90        90       100       100       100       100       110       510
      32       Deferral of gain on sale of farm refiners...............        10        10        10        10        10        10        20        60

             Commerce and Housing
               Financial institutions and insurance:
      33        Exemption of credit union income.......................     1,300     1,380     1,480     1,580     1,690     1,800     1,920     8,470
      34        Excess bad debt reserves of financial institutions.....         0         0         0         0         0         0         0         0
      35        Exclusion of interest on life insurance savings........    19,630    21,230    23,010    24,940    27,060    29,250    31,420   135,680
      36        Special alternative tax on small property and casualty         10        10        10        10        10        10        10        50
                 insurance companies...................................
      37        Tax exemption of certain insurance companies owned by         290       310       330       350       370       390       400     1,840
                 tax-exempt organizations..............................
      38        Small life insurance company deduction.................       120       120       120       120       120       120       120       600

               Housing:
      39        Exclusion of interest on owner-occupied mortgage            1,250     1,380     1,510     1,640     1,730     1,830     1,950     8,660
                 subsidy bonds.........................................
      40        Exclusion of interest on rental housing bonds..........       260       290       320       350       360       370       400     1,800
      41        Deductibility of mortgage interest on owner-occupied       63,590    65,540    68,440    71,870    74,790    78,160    82,650   375,910
                 homes.................................................
      42        Deductibility of State and local property tax on owner-    21,760    22,320    22,160    19,750    16,240    14,580    13,580    86,310
                 occupied homes........................................
      43        Deferral of income from post 1987 installment sales....     1,040     1,060     1,080     1,100     1,120     1,140     1,170     5,610
      44        Capital gains exclusion on home sales..................    24,580    25,320    26,080    26,860    27,670    28,500    29,350   138,460
      45        Exception from passive loss rules for $25,000 of rental     5,690     5,270     4,920     4,600     4,290     4,020     3,790    21,620
                 loss..................................................
      46        Credit for low-income housing investments..............     4,450     4,670     4,920     5,170     5,390     5,620     5,900    27,000
      47        Accelerated depreciation on rental housing (normal tax      1,590     1,080       310      -510    -1,770    -3,310    -4,570    -9,860
                 method)...............................................

               Commerce:
      48        Cancellation of indebtedness...........................         0        10        30        50        60        60        50       250
      49        Exceptions from imputed interest rules.................        50        50        50        50        50        50        50       250
      50        Capital gains (except agriculture, timber, iron ore,       74,750    73,350    71,910    72,730    66,490    66,340    68,590   346,060
                 and coal) (normal tax method).........................
      51        Capital gains exclusion of small corporation stock.....       130       170       220       270       340       400       460     1,690
      52        Step-up basis of capital gains at death................    35,850    36,520    38,000    39,500    40,650    41,830    43,190   203,170
      53        Carryover basis of capital gains on gifts..............       640       640       450       540       640       650       630     2,910
      54        Ordinary income treatment of loss from small business          50        50        60        60        60        60        60       300
                 corporation stock sale................................
      55        Accelerated depreciation of buildings other than rental    -1,800    -2,530    -1,980    -6,520    -9,200   -12,360   -15,820   -45,880
                 housing (normal tax method)...........................
      56        Accelerated depreciation of machinery and equipment        47,770    31,110    16,670   -39,310   -35,260   -33,260   -31,570  -122,730
                 (normal tax method)...................................
      57        Expensing of certain small investments (normal tax           -360      -110       370     1,570     1,830     1,510     1,380     6,660
                 method)...............................................
      58        Amortization of start-up costs (normal tax method).....       110       130       150       160       160       170       170       810
      59        Graduated corporation income tax rate (normal tax           7,490     8,280     8,770     9,040     9,380     9,770    10,210    47,170
                 method)...............................................
      60        Exclusion of interest on small issue bonds.............       470       520       570       610       640       670       730     3,220

             Transportation
      61       Deferral of tax on shipping companies...................        20        20        20        20        20        20        20       100
      62       Exclusion of reimbursed employee parking expenses.......     2,710     2,860     3,020     3,190     3,360     3,550     3,730    16,850
      63       Exclusion for employer-provided transit passes..........       310       400       480       560       660       750       840     3,290

             Community and Regional Development
      64       Investment credit for rehabilitation of structures              30        30        30        30        30        30        30       150
                (other than historic)..................................
      65       Exclusion of interest for airport, dock, and similar            30        30        30        30        30        30        30       150
                bonds..................................................
      66       Exemption of certain mutuals' and cooperatives' income..        60        60        60        70        70        70        70       340
      67       Empowerment zones, Enterprise communities and Renewal          730     1,120     1,170     1,280     1,410     1,580     1,750     7,190
                communities............................................
      68       New markets tax credit..................................        90       190       300       420       610       830       870     3,030
      69       Expensing of environmental remediation costs............       110       110        40       -20       -10       -10       -10       -10

             Education, Training, Employment, and Social Services
               Education:
      70        Exclusion of scholarship and fellowship income (normal      1,390     1,390     1,380     1,480     1,540     1,550     1,560     7,510
                 tax method)...........................................
      71        HOPE tax credit........................................     5,270     4,510     3,690     3,760     3,500     3,720     3,580    18,250
      72        Lifetime Learning tax credit...........................     2,790     2,880     3,820     3,640     3,340     3,610     3,660    18,070
      73        Education Individual Retirement Accounts...............        60       120       190       280       390       520       660     2,040
      74        Deductibility of student-loan interest.................       540       760       790       820       840       850       860     4,160
      75        Deduction for higher education expenses................       540     2,860     3,700     4,640     3,760         0         0    12,100
      76        State prepaid tuition plans............................       270       340       400       470       560       660       750     2,840

[[Page 114]]


      77        Exclusion of interest on student-loan bonds............       340       370       410       440       490       510       530     2,380
      78        Exclusion of interest on bonds for private nonprofit          830       920     1,010     1,090     1,160     1,220     1,300     5,780
                 educational facilities................................
      79        Credit for holders of zone academy bonds...............        70       110       130       140       150       150       150       720
      80        Exclusion of interest on savings bonds redeemed to             20        20        20        20        20        20        20       100
                 finance educational expenses..........................
      81        Parental personal exemption for students age 19 or over     2,750     3,670     3,570     2,980     2,240     1,850     1,630    12,270
      82        Deductibility of charitable contributions (education)..     5,670     5,830     6,130     6,560     6,800     7,000     7,380    33,870
      83        Exclusion of employer-provided educational assistance..       500       610       650       680       720       760       800     3,610
               Training, employment, and social services:..............
      84        Work opportunity tax credit............................       380       560       430       190        80        40        20       760
      85        Welfare-to-work tax credit.............................        80        70        80        60        40        20        10       210
      86        Exclusion of employer provided child care..............       920       960     1,010     1,080     1,130     1,190     1,250     5,660
      87        Employer-provided child care...........................        60       120       170       190       200       220       230       840
      88        Assistance for adopted foster children.................       250       280       330       370       420       480       540     2,140
      89        Adoption credit and exclusion..........................       180       280       570       640       690       710       730     3,340
      90        Exclusion of employee meals and lodging (other than           910       950       990      1030      1080      1130      1180     5,410
                 military).............................................
      91        Child credit \2\.......................................    29,560    28,590    28,410    29,970    32,370    31,920    31,550   154,220
      92        Credit for child and dependent care expenses...........     3,670     3,880     4,310     3,810     3,170     2,920     2,730    16,940
      93        Credit for disabled access expenditures................        60        70        70        70        80        80        80       380
      94        Deductibility of charitable contributions, other than      42,840    44,510    47,190    49,550    51,910    53,760    57,280   259,690
                 education and health..................................
      95        Exclusion of certain foster care payments..............       520       490       500       510       520       530       540     2,600
      96        Exclusion of parsonage allowances......................       430       460       490       520       550       580       620     2,760

             Health
      97       Exclusion of employer contributions for medical            128,510   140,330   155,930   172,140   188,900   205,820   223,620   946,410
                insurance premiums and medical care....................
      98       Self-employed medical insurance premiums................     2,200     3,110     4,590     4,870     5,200     5,560     6,150    26,370
      99       Workers' compensation insurance premiums................     6,580     7,200     7,710     8,250     8,720     9,300     9,950    43,930
     100       Medical Savings Accounts................................        30        30        40        40        40        40        30       190
     101       Deductibility of medical expenses.......................     6,210     6,600     6,910     7,050     7,160     7,560     7,990    36,670
     102       Exclusion of interest on hospital construction bonds....     1,720     1,900     2,070     2,240     2,390     2,500     2,660    11,860
     103       Deductibility of charitable contributions (health)......     5,990     6,160     6,470     6,940     7,180     7,380     7,770    35,740
     104       Tax credit for orphan drug research.....................       210       240       270       300       330       370       420     1,690
     105       Special Blue Cross/Blue Shield deduction................       400       450       410       400       360       400       330     1,900
     106       Tax credit for health insurance purchased by certain             0         0        70        40        50        60        70       290
                displaced and retired individuals......................

             Income Security
     107       Exclusion of railroad retirement system benefits........       390       400       400       400       400       400       400     2,000
     108       Exclusion of workers' compensation benefits.............     5,750     6,100     6,460     6,850     7,270     7,710     8,190    36,480
     109       Exclusion of public assistance benefits (normal tax            380       400       410       430       450       470       440     2,200
                method)................................................
     110       Exclusion of special benefits for disabled coal miners..        70        60        60        50        50        50        40       250
     111       Exclusion of military disability pensions...............       110       110       120       120       130       130       140       640
               Net exclusion of pension contributions and earnings:....
     112        Employer plans.........................................    63,280    77,890    82,770    86,020    89,270    82,320    74,930   415,310
     113        401(k) plans...........................................    62,750    64,930    67,430    70,520    74,990    79,340    82,960   375,240
     114        Individual Retirement Accounts.........................    25,790    28,010    30,690    29,930    29,420    27,630    26,730   144,400
     115        Low and moderate income savers credit..................        20        30        30        30        30        30        30       150
     116        Keogh plans............................................     8,943     9,272     9,661     9,976    10,259    10,521    11,516    51,933
               Exclusion of other employee benefits:...................
     117        Premiums on group term life insurance..................      2360      2400      2440      2480      2520      2560      2610    12,610
     118        Premiums on accident and disability insurance..........       290       310       320       330       350       360       370     1,730
     119        Small business retirement plan credit..................        10        20        40        50        50        60        60       260
     120        Income of trusts to finance supplementary unemployment         20        30        30        30        30        30        30       150
                 benefits..............................................
     121        Special ESOP rules.....................................     2,220     2,340     2,450     2,580     2,720     2,860     2,990    13,600
     122        Additional deduction for the blind.....................        40        50        50        50        50        50        50       250
     123        Additional deduction for the elderly...................     2,290     2,360     2,480     2,570     2,630     2,550     2,460    12,690
     124        Tax credit for the elderly and disabled................        30        20        20        20        20        20        10        90
     125        Deductibility of casualty losses.......................       310       440       460       480       510       500       540     2,490
     126        Earned income tax credit \3\...........................     4,930     5,470     5,660     5,860     6,010     6,200     6,430    30,160

             Social Security
               Exclusion of social security benefits:..................
     127        Social Security benefits for retired workers...........    18,340    18,560    18,930    19,210    20,000    21,100    21,550   100,790
     128        Social Security benefits for disabled..................     2,910     3,210     3,570     3,950     4,360     4,870     4,390    21,140
     129        Social Security benefits for dependents and survivors..     3,730     3,910     4,140     4,360     4,590     4,920     4,820    22,830

               Veterans Benefits and Services..........................
     130        Exclusion of veterans death benefits and disability         3,160     3,230     3,400     3,590     3,780     3,980     4,190    18,940
                 compensation..........................................
     131        Exclusion of veterans pensions.........................        70        80        80        90        90        90       100       450
     132        Exclusion of GI bill benefits..........................        90        90        90       100       100       110       110       510
     133        Exclusion of interest on veterans housing bonds........        50        50        70        70        70        80        80       370


[[Page 115]]


             General Purpose Fiscal Assistance
     134       Exclusion of interest on public purpose State and local     36,190    38,400    39,160    39,740    39,850    39,430    40,630   198,810
                bonds..................................................
     135       Deductibility of nonbusiness state and local taxes other    47,430    50,520    50,910    47,770    40,480    37,190    36,080   212,430
                than on owner-occupied homes...........................
     136       Tax credit for corporations receiving income from doing      3,190     3,190     3,190     3,140     1,860         0         0     8,190
                business in U.S. possessions...........................

             Interest
     137       Deferral of interest on U.S. savings bonds..............       510       590       670       750       840       920     1,050     4,230

             Addendum: Aid to State and local governments:
               Deductibility of:
                Property taxes on owner-occupied homes.................    21,760    22,320    22,160    19,750    16,240    14,580    13,580    86,310
                Nonbusiness State and local taxes other than on owner-     47,430    50,520    50,910    47,770    40,480    37,190    36,080   212,430
                 occupied homes........................................

               Exclusion of interest on State and local bonds for:
                Public purposes........................................    36,190    38,400    39,160    39,740    39,850    39,430    40,630   198,810
                Energy facilities......................................       160       170       180       200       200       210       230     1,020
                Water, sewage, and hazardous waste disposal facilities.       640       690       780       840       880       930       980     4,410
                Small-issues...........................................       470       520       570       610       640       670       730     3,220
                Owner-occupied mortgage subsidies......................     1,250     1,380     1,510     1,640     1,730     1,830     1,950     8,660
                Rental housing.........................................       260       290       320       350       360       370       400     1,800
                Airports, docks, and similar facilities................        30        30        30        30        30        30        30       150
                Student loans..........................................       340       370       410       440       490       510       530     2,380
                Private nonprofit educational facilities...............       830       920     1,010     1,090     1,160     1,220     1,300     5,780
                Hospital construction..................................     1,720     1,900     2,070     2,240     2,390     2,500     2,660    11,860
                Veterans' housing......................................        50        50        70        70        70        80        80       370
                Credit for holders of zone academy bonds...............        70       110       130       140       150       150       150       720
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as
  follows: 2002 $1,070; 2003 $1,140; 2004 $1,230; 2005 $1,320; 2006 $1,370; 2007 $1,400; and 2008 $1,430.

\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as
  follows: 2001 $980; 2002 $5,060 2003 $5,870; 2004 $5,860; 2005 $5,700; 2006 $7,630; 2007 $7,630; and 2008 $7,500

\3\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of
  dollars) is as follows: 2002 $27,830; 2003 $30,610; 2004 $31,380; 2005 $32,090; 2006 $33,450; 2007 $34,480; and 2008 $35,380.

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

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

                        Tax Expenditure Baselines

  A tax expenditure is an exception to baseline provisions of the tax 
structure. The 1974 Congressional Budget Act, which mandated the tax 
expenditure budget, did not specify the baseline provisions of the tax 
law. As noted previously, deciding whether provisions are exceptions, 
therefore, is a matter of judgment. As in prior years, this year's tax 
expenditure estimates are presented using two baselines: the normal tax 
baseline and the reference tax law baseline.
  The normal tax baseline is patterned on a comprehensive income tax, 
which defines income as the sum of consumption and the change in net 
wealth in a given period of time. The normal tax baseline allows 
personal exemptions, a standard deduction, and deductions of the 
expenses incurred in earning income. It is not limited to a particular 
structure of tax rates, or by a specific definition of the taxpaying 
unit.
  The reference tax law baseline is also patterned on a comprehensive 
income tax, but it is closer to existing law. Tax expenditures under the 
reference law baseline are always tax expenditures under the normal tax 
baseline, but the reverse is not always true.
  Both the normal and reference tax baselines allow several major 
departures from a pure comprehensive income tax. For example:
    Income is taxable only when it is realized in exchange. 
          Thus, neither the deferral of tax on unrealized capital gains 
          nor the tax exclusion of imputed income (such as the rental 
          value of owner-occupied housing or farmers' consumption of 
          their own produce) is regarded as a tax expenditure. Imputed 
          income would be taxed under a comprehensive income tax, and 
          all income would be taxed as it accrued.
    There is a separate corporation income tax. Under a 
          comprehensive income tax, corporate income would be taxed only 
          once--at the shareholder level, whether or not distributed in 
          the form of dividends. (This budget proposes to eliminate the 
          double taxation of corporate income.)
    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).

[[Page 116]]

  Although the reference law and normal tax baselines are generally 
similar, areas of difference include:
  (1) Tax rates. The separate schedules applying to the various 
taxpaying units are included in the reference law baseline. Thus, 
corporate tax rates below the maximum statutory rate do not give rise to 
a tax expenditure. The normal tax baseline is similar, except that it 
specifies the current maximum rate as the baseline for the corporate 
income tax. The lower tax rates applied to the first $10 million of 
corporate income are thus regarded as a tax expenditure. Similarly, 
under the reference law baseline, preferential tax rates for capital 
gains generally do not yield a tax expenditure; only capital gains 
treatment of otherwise ``ordinary income,'' such as that from coal and 
iron ore royalties and the sale of timber and certain agricultural 
products, is considered a tax expenditure. The alternative minimum tax 
is treated as part of the baseline rate structure under both the 
reference and normal tax methods.
  (2) 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\
---------------------------------------------------------------------------
  \1\ Gross income does, however, include transfer payments associated 
with past employment, such as Social Security benefits.
  \2\ In the case of individuals who hold ``passive'' equity interests 
in businesses, however, the pro-rata shares of sales and expense 
deductions reportable in a year are limited. A passive business activity 
is defined to be one in which the holder of the interest, usually a 
partnership interest, does not actively perform managerial or other 
participatory functions. The taxpayer may generally report no larger 
deductions for a year than will reduce taxable income from such 
activities to zero. Deductions in excess of the limitation may be taken 
in subsequent years, or when the interest is liquidated. In addition, 
costs of earning income may be limited under the alternative minimum 
tax.
---------------------------------------------------------------------------
  (3) 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 in the 2004 
Budget. The Appendix provides further details on the new methodology and 
how it differs from the prior methodology.
  (4) Treatment of foreign income. Both the normal and reference tax 
baselines allow a tax credit for foreign income taxes paid (up to the 
amount of U.S. income taxes that would otherwise be due), which prevents 
double taxation of income earned abroad. Under the normal tax method, 
however, controlled foreign corporations (CFCs) are not regarded as 
entities separate from their controlling U.S. shareholders. Thus, the 
deferral of tax on income received by CFCs is regarded as a tax 
expenditure under this method. In contrast, except for tax haven 
activities, the reference law baseline follows current law in treating 
CFCs as separate taxable entities whose income is not subject to U.S. 
tax until distributed to U.S. taxpayers. Under this baseline, deferral 
of tax on CFC income is not a tax expenditure because U.S. taxpayers 
generally are not taxed on accrued, but unrealized, income.
  In addition to these areas of difference, the Joint Committee on 
Taxation considers a somewhat broader set of tax expenditures under its 
normal tax baseline than is considered here.

    Performance Measures and the Economic Effects of Tax Expenditures

  The Government Performance and Results Act of 1993 (GPRA) directs 
Federal agencies to develop annual and strategic plans for their 
programs and activities. These plans set out performance objectives to 
be achieved over a specific time period. Most of these objectives will 
be achieved through direct expenditure programs. Tax expenditures, 
however, may also contribute to achieving these goals. The report of the 
Senate Governmental Affairs Committee on GPRA \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.
---------------------------------------------------------------------------
  \3\ Committee on Government Affairs, United States Senate, 
``Government Performance and Results Act of 1993'' (Report 103-58, 
1993).
---------------------------------------------------------------------------
  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 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 in

[[Page 117]]

come tax. Thus, they may be relatively advantageous policy approaches 
when the benefit or incentive is related to income and is intended to be 
widely available. \4\ Because there is an existing public administrative 
and private compliance structure for the tax system, the incremental 
administrative and compliance costs for a tax expenditure may be low in 
many cases. In addition, some tax expenditures actually simplify the tax 
system, (for example, the exclusion for up to $500,000 of capital gains 
on home sales).
---------------------------------------------------------------------------
  \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.
---------------------------------------------------------------------------
  Tax expenditures also have important limitations. In many cases they 
add to the complexity of the tax system, which raises both 
administrative and compliance costs. For example, targeting personal 
exemptions and credits can complicate filing and decisionmaking. The 
income tax system may have little or no contact with persons who have no 
or very low incomes, and does not require information on certain 
characteristics of individuals used in some spending programs, such as 
wealth. Verifying eligibility criteria can be costly. The tax system 
also operates on the basis of annual income and it may be poorly 
targeted when taxpayer characteristics change within the course of a 
year. 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. 
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 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, but tax expenditures can have similar effects by requiring 
government to make up for lost revenue. Finally, spending programs, 
particularly on the discretionary side, may respond less readily to 
changing activity levels and economic conditions than tax expenditures.
  Regulations have more direct and immediate effects than outlay and 
tax-expenditure programs because regulations apply directly and 
immediately to the regulated party (i.e., the intended actor)--generally 
in the private sector. Regulations can also be fine-tuned more quickly 
than tax expenditures, because they can generally be changed by the 
executive branch without legislation. Like tax expenditures, regulations 
often rely largely upon voluntary compliance, rather than detailed 
inspections and policing. As such, the public administrative costs tend 
to be modest, relative to the private resource costs associated with 
modifying activities. Historically, regulations have tended to rely on 
proscriptive measures, as opposed to economic incentives. This reliance 
can diminish their economic efficiency, although this feature can also 
promote full compliance where (as in certain safety-related cases) 
policymakers believe that trade-offs with economic considerations are 
not of paramount importance. Also, regulations generally do not directly 
affect Federal outlays or receipts. Thus, like tax expenditures, they 
may escape the type of scrutiny that outlay programs receive. However, 
most regulations are subjected to a formal benefit-cost analysis that 
goes well beyond the analysis required for outlays and tax-expenditures. 
To some extent, the GPRA requirement for performance evaluation will 
address this lack of formal analysis.
  Some policy objectives are achieved using multiple approaches. For 
example, minimum wage legislation, the earned income tax credit, and the 
food stamp program are regulatory, tax expenditure, and direct outlay 
programs, respectively, all having the objective of improving the 
economic welfare of low-wage workers.
  Tax expenditures, like spending and regulatory programs, have a 
variety of objectives and effects. These include: encouraging certain 
types of activities (e.g., saving for retirement or investing in certain 
sectors); increasing certain types of after-tax income (e.g., favorable 
tax treatment of Social Security income); reducing private compliance 
costs and government administrative costs (e.g., the exclusion for up to 
$500,000 of capital gains on home sales); and promoting tax neutrality 
(e.g., accelerated depreciation in the presence of inflation). Some of 
these objectives are well suited to quantitative measurement, while 
others are less well suited. Also, many tax expenditures, including 
those cited above, may have more than one objective. For example, 
accelerated depreciation may encourage investment. In addition, the 
economic effects of particular provisions can extend beyond their 
intended objectives (e.g., a provision intended to promote an activity 
or raise certain incomes may have positive or negative effects on tax 
neutrality).
  Performance measurement is generally concerned with inputs, outputs, 
and outcomes. In the case of tax expenditures, the principal input is 
usually the revenue effect. Outputs are quantitative or qualitative 
measures

[[Page 118]]

of goods and services, or changes in income and investment, directly 
produced by these inputs. Outcomes, in turn, represent the changes in 
the economy, society, or environment that are the ultimate goals of 
programs.
  Thus, for a provision that reduces taxes on certain investment 
activity, an increase in the amount of investment would likely be a key 
output. The resulting production from that investment, and, in turn, the 
associated improvements in national income, welfare, or security, could 
be the outcomes of interest. For other provisions, such as those 
designed to address a potential inequity or unintended consequence in 
the tax code, an important performance measure might be how they change 
effective tax rates (the discounted present-value of taxes owed on new 
investments or incremental earnings) or excess burden (an economic 
measure of the distortions caused by taxes). Effects on the incomes of 
members of particular groups may be an important measure for certain 
provisions.
  An overview of evaluation issues by budget function. The discussion 
below considers the types of measures that might be useful for some 
major programmatic groups of tax expenditures. The discussion is 
intended to be illustrative and not all encompassing. However, it is 
premised on the assumption that the data needed to perform the analysis 
are available or can be developed. In practice, data availability is 
likely to be a major challenge, and data constraints may limit the 
assessment of the effectiveness of many provisions. In addition, such 
assessments can raise significant challenges in economic modeling.

  National defense.--Some tax expenditures are intended to assist 
governmental activities. For example, tax preferences for military 
benefits reflect, among other things, the view that benefits such as 
housing, subsistence, and moving expenses are intrinsic aspects of 
military service, and are provided, in part, for the benefit of the 
employer, the U.S. Government. Tax benefits for combat service are 
intended to reduce tax burdens on military personnel undertaking 
hazardous service for the Nation. A portion of the tax expenditure 
associated with foreign earnings is targeted to benefit U.S. Government 
civilian personnel working abroad by offsetting the living costs that 
can be higher than those in the United States. These tax expenditures 
should be considered together with direct agency budget costs in making 
programmatic decisions.
  International affairs.--Tax expenditures are also aimed at goals such 
as tax neutrality. These include the exclusion for income earned abroad 
by nongovernmental employees and exclusions for income of U.S.-
controlled foreign corporations. Measuring the effectiveness of these 
provisions raises challenging issues.
  General science, space and technology; energy; natural resources and 
the environment; agriculture; and commerce and housing.--A series of tax 
expenditures reduces the cost of investment, both in specific 
activities--such as research and experimentation, extractive industries, 
and certain financial activities--and more generally, through 
accelerated depreciation for plant and equipment. These provisions can 
be evaluated along a number of dimensions. For example, it could be 
useful to consider the strength of the incentives by measuring their 
effects on the cost of capital (the interest rate which investments must 
yield to cover their costs) and effective tax rates. The impact of these 
provisions on the amounts of corresponding forms of investment (e.g., 
research spending, exploration activity, equipment) might also be 
estimated. In some cases, such as research, there is evidence that the 
investment can provide significant positive externalities--that is, 
economic benefits that are not reflected in the market transactions 
between private parties. It could be useful to quantify these 
externalities and compare them with the size of tax expenditures. 
Measures could also indicate the effects on production from these 
investments--such as numbers or values of patents, energy production and 
reserves, and industrial production. Issues to be considered include the 
extent to which the preferences increase production (as opposed to 
benefitting existing output) and their 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 mortgage 
interest deduction on personal residences is reported as a tax 
expenditure because the value of owner-occupied housing services is not 
included in a taxpayer's taxable income. Taxpayers also may exclude up 
to $500,000 of the capital gains from the sale of personal residences. 
Measures of the effectiveness of these provisions could include their 
effects on increasing the extent of home ownership and the quality of 
housing.. Similarly, analysis of the extent of accumulated inflationary 
gains is likely to be relevant to evaluation of the capital gains for 
home sales. Deductibility of State and local property taxes assists with 
making housing more affordable as well as easing the cost of providing 
community services through these 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

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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. A potentially negative outcome 
of this tax expenditure is that the subsidy may lead to excessive health 
care spending for these who are covered.
  Income security, Social Security, and veterans benefits and 
services.--Major tax expenditures in the income security function 
benefit retirement savings, through employer-provided pensions, 
individual retirement accounts, and Keogh plans. These provisions might 
be evaluated in terms of their effects on boosting retirement incomes, 
private savings, and national savings (which would include the effect on 
private savings as well as public savings or deficits). Interactions 
with other programs, including Social Security, also may merit analysis. 
As in the case of employer-provided health insurance, analysis of 
employer-provided pension programs requires imputing the value of 
benefits funded at the firm level to individuals.
  Other provisions principally affect the incomes of members of certain 
groups, rather than affecting incentives. For example, tax-favored 
treatment of Social Security benefits, certain veterans benefits, and 
deductions for the blind and elderly provide increased incomes to 
eligible parties. The earned-income tax credit, in contrast, should be 
evaluated for its effects on labor force participation as well as the 
income it provides lower-income workers.

  General purpose fiscal assistance and interest.--The tax-exemption for 
public purpose State and local bonds reduces the costs of borrowing for 
a variety of purposes (borrowing for non-public purposes is reflected 
under other budget functions). The deductibility of certain State and 
local taxes reflected under this function primarily relates to personal 
income taxes (property tax deductibility is reflected under the commerce 
and housing function). Tax preferences for Puerto Rico and other U.S. 
possessions are also included here. These provisions can be compared 
with other tax and spending policies as means of benefitting fiscal and 
economic conditions in the States, localities, and possessions. Finally, 
the tax deferral for interest on U.S. savings bonds benefits savers who 
invest in these instruments. The extent of these benefits and any 
effects on Federal borrowing costs could be evaluated.
  The above illustrative discussion, although broad, is nevertheless 
incomplete, omitting important details both for the provisions mentioned 
and the many that are not explicitly cited. Developing a framework that 
is sufficiently comprehensive, accurate, and flexible to reflect the 
objectives and effects of the wide range of tax expenditures will be a 
significant challenge. OMB, Treasury, and other agencies will work 
together, as appropriate, to address this challenge. As indicated above, 
over the next few years the Executive Branch's focus will be on the 
availability of the data needed to assess the effects of the tax 
expenditures designed to increase savings.

                  Descriptions of Income Tax Provisions

  Descriptions of the individual and corporate income tax expenditures 
reported upon in this chapter follow. These descriptions relate to 
current law as of December 31, 2002, and do not reflect proposals made 
elsewhere in the Budget.

                            National Defense

  1. Benefits and allowances to armed forces personnel.--The housing and 
meals provided military personnel, either in cash or in kind, as well as 
certain amounts of pay related to combat service, are excluded from 
income subject to tax.

                          International Affairs

  2. Income earned abroad.--U.S. citizens who lived abroad, worked in 
the private sector, and satisfied a foreign residency requirement in 
2002 may exclude up to $80,000 in foreign earned income from U.S. taxes.

[[Page 120]]

In addition, if these taxpayers receive a specific allowance for foreign 
housing from their employers, they may also exclude the value of that 
allowance. If they do not receive a specific allowance for housing 
expenses, they may deduct against their U.S. taxes that portion of such 
expenses that exceeds one-sixth the salary of a civil servant at grade 
GS-14, step 1 ($67,765 in 2002).
  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\ The determination of whether a provision is a tax expenditure is 
made on the basis of a broad concept of ``income'' that is larger in 
scope than is ``income'' as defined under general U.S. income tax 
principles. For 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.
---------------------------------------------------------------------------
  5. Sales source rule exceptions.--The worldwide income of U.S. persons 
is taxable by the United States and a credit for foreign taxes paid is 
allowed. The amount of foreign taxes that can be credited is limited to 
the pre-credit U.S. tax on the foreign source income. The sales source 
rules for inventory property allow U.S. exporters to use more foreign 
tax credits by allowing the exporters to attribute a larger portion of 
their earnings abroad than would be the case if the allocation of 
earnings was based on actual economic activity.
  6. Income of U.S.-controlled foreign corporations.--The income of 
foreign corporations controlled by U.S. shareholders is not subject to 
U.S. taxation. The income becomes taxable only when the controlling U.S. 
shareholders receive dividends or other distributions from their foreign 
stockholding. Under the normal tax method, the currently attributable 
foreign source pre-tax income from such a controlling interest is 
considered to be subject to U.S. taxation, whether or not distributed. 
Thus, the normal tax method considers the amount of controlled foreign 
corporation income not distributed to a U.S. shareholder as tax-deferred 
income.
  7. Exceptions under subpart F for active financing income.--Financial 
firms can defer taxes on income earned overseas in an active business. 
Taxes on income earned through December 31, 2006 can be deferred.

                 General Science, Space, and Technology

  8. Expensing R&E expenditures.--Research and experimentation (R&E) 
projects can be viewed as investments because, if successful, their 
benefits accrue for several years. It is often difficult, however, to 
identify whether a specific R&E project is successful and, if 
successful, what its expected life will be. Under the normal tax method, 
the expensing of R&E expenditures is viewed as a tax expenditure. The 
baseline assumed for the normal tax method is that all R&E expenditures 
are successful and have an expected life of five years.
  9. R&E credit.--The research and experimentation (R&E) credit is 20 
percent of qualified research expenditures in excess of a base amount. 
The base amount is generally determined by multiplying a ``fixed-base 
percentage'' by the average amount of the company's gross receipts for 
the prior four years. The taxpayer's fixed base percentage generally is 
the ratio of its research expenses to gross receipts for 1984 through 
1988. Taxpayers may also elect an alternative credit regime. Under the 
alternative credit regime the taxpayer is assigned a three-tiered fixed-
base percentage that is lower than the fixed-base percentage that would 
otherwise apply, and the credit rate is reduced (the rates range from 
2.65 percent to 3.75 percent). A 20-percent credit with a separate 
threshold is provided for a taxpayer's payments to universities for 
basic research. The credit applies to research conducted before July 1, 
2004 and extends to research conducted in Puerto Rico and the U.S. 
possessions.

                                 Energy

  10. Exploration and development costs.--For successful investments in 
domestic oil and gas wells, intangible drilling costs (e.g., wages, the 
costs of using machinery for grading and drilling, the cost of 
unsalvageable materials used in constructing wells) may be expensed 
rather than amortized over the productive life of the property. 
Integrated oil companies may deduct only 70 percent of such costs and 
must amortize the remaining 30 percent over five years. The same rule 
applies to the exploration and development costs of surface stripping 
and the construction of shafts and tunnels for other fuel minerals.
  11. Percentage depletion.--Independent fuel mineral producers and 
royalty owners are generally allowed to take percentage depletion 
deductions rather than cost depletion on limited quantities of output. 
Under cost depletion, outlays are deducted over the productive life of 
the property based on the fraction of the resource extracted. Under 
percentage depletion, taxpayers 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

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producers. Unlike depreciation or cost depletion, percentage depletion 
deductions can exceed the cost of the investment.
  12. Alternative fuel production credit.--A nontaxable credit of $3 per 
oil-equivalent barrel of production (in 1979 dollars) is provided for 
several forms of alternative fuels. The credit is generally available if 
the price of oil stays below $29.50 (in 1979 dollars). The credit 
generally expires on December 31, 2002.
  13. Oil and gas exception to passive loss limitation.--Owners of 
working interests in oil and gas properties are exempt from the 
``passive income'' limitations. As a result, the working interest-
holder, who manages on behalf of himself and all other owners the 
development of wells and incurs all the costs of their operation, may 
aggregate negative taxable income from such interests with his income 
from all other sources.
  14. Capital gains treatment of royalties on coal.--Sales of certain 
coal under royalty contracts can be treated as capital gains rather than 
ordinary income.
  15. Energy facility bonds.--Interest earned on State and local bonds 
used to finance construction of certain energy facilities is tax-exempt. 
These bonds are generally subject to the State private-activity bond 
annual volume cap.
  16. Enhanced oil recovery credit.--A credit is provided equal to 15 
percent of the taxpayer's costs for tertiary oil recovery on U.S. 
projects. Qualifying costs include tertiary injectant expenses, 
intangible drilling and development costs on a qualified enhanced oil 
recovery project, and amounts incurred for tangible depreciable 
property.
  17. New technology credits.--A credit of 10 percent is available for 
investment in solar and geothermal energy facilities. In addition, a 
credit of 1.5 cents is provided per kilowatt hour of electricity 
produced from renewable resources such as wind, biomass, and poultry 
waste facilities. The renewable resources credit applies only to 
electricity produced by a facility placed in service on or before 
December 31, 2004.
  18. Alcohol fuel credits.--An income tax credit is provided for 
ethanol that is derived from renewable sources and used as fuel. The 
credit equals 53 cents per gallon in 2001 and 2002; 52 cents per gallon 
in 2003 and 2004; and 51 cents per gallon in 2005, 2006, and 2007. To 
the extent that ethanol is mixed with taxable motor fuel to create 
gasohol, taxpayers may claim an exemption of the Federal excise tax 
rather than the income tax credit. In addition, small ethanol producers 
are eligible for a separate 10 cents per gallon credit.
  19. Credit and deduction for clean-fuel vehicles and property.--A tax 
credit of 10 percent (not to exceed $4,000) is provided for purchasers 
of electric vehicles. Purchasers of other clean-fuel burning vehicles 
and owners of clean-fuel refueling property may deduct part of their 
expenditures. The credit and deduction are phased out from 2004 through 
2007,.
  20. Exclusion of utility conservation subsidies.--Non-business 
customers can exclude from gross income subsidies received from public 
utilities for expenditures on energy conservation measures.

                    Natural Resources and Environment

  21. Exploration and development costs.--Certain capital outlays 
associated with exploration and development of nonfuel minerals may be 
expensed rather than depreciated over the life of the asset.
  22. Percentage depletion.--Most nonfuel mineral extractors may use 
percentage depletion rather than cost depletion, with percentage 
depletion rates ranging from 22 percent for sulfur to 5 percent for sand 
and gravel.
  23. Sewage, water, solid and hazardous waste facility bonds.--Interest 
earned on State and local bonds used to finance the construction of 
sewage, water, or hazardous waste facilities is tax-exempt. These bonds 
are generally subject to the State private-activity bond annual volume 
cap.
  24. Capital gains treatment of certain timber.--Certain timber sold 
under a royalty contract can be treated as a capital gain rather than 
ordinary income.
  25. Expensing multiperiod timber growing costs.--Most of the 
production costs of growing timber may be expensed rather than 
capitalized and deducted when the timber is sold. In most other 
industries, these costs are capitalized under the uniform capitalization 
rules.
  26. Historic preservation.--Expenditures to preserve and restore 
historic structures qualify for a 20-percent investment credit, but the 
depreciable basis must be reduced by the full amount of the credit 
taken.

                               Agriculture

  27. Expensing certain capital outlays.--Farmers, except for certain 
agricultural corporations and partnerships, are allowed to expense 
certain expenditures for feed and fertilizer, as well as for soil and 
water conservation measures. Expensing is allowed, even though these 
expenditures are for inventories held beyond the end of the year, or for 
capital improvements that would otherwise be capitalized.
  28. Expensing multiperiod livestock and crop production costs.--The 
production of livestock and crops with a production period of less than 
two years is exempt from the uniform cost capitalization rules. Farmers 
establishing orchards, constructing farm facilities for their own use, 
or producing any goods for sale with a production period of two years or 
more may elect not to capitalize costs. If they do, they must apply 
straight-line depreciation to all depreciable property they use in 
farming.
  29. Loans forgiven solvent farmers.--Farmers are forgiven the tax 
liability on certain forgiven debt. Normally, a debtor must include the 
amount of loan forgiveness as income or reduce his recoverable basis in 
the property to which the loan relates. If the debtor elects to reduce 
basis and the amount of forgiveness exceeds his basis in the property, 
the excess forgiveness is taxable. For insolvent (bankrupt) debtors, 
however,

[[Page 122]]

the amount of loan forgiveness reduces carryover losses, then unused 
credits, and then basis; any remainder of the forgiven debt is excluded 
from tax. Farmers with forgiven debt are considered insolvent for tax 
purposes, and thus qualify for income tax forgiveness.
  30. Capital gains treatment of certain income.--Certain agricultural 
income, such as unharvested crops, can be treated as capital gains 
rather than ordinary income.
  31. Income averaging for farmers.--Taxpayers can lower their tax 
liability by averaging, over the prior three-year period, their taxable 
income from farming.
  32. Deferral of gain on sales of farm refiners.--A taxpayer who sells 
stock in a farm refiner to a farmers' cooperative can defer recognition 
of gain if the taxpayer reinvests the proceeds in qualified replacement 
property.

                          Commerce and Housing

  This category includes a number of tax expenditure provisions that 
also affect economic activity in other functional categories. For 
example, provisions related to investment, such as accelerated 
depreciation, could be classified under the energy, natural resources 
and environment, agriculture, or transportation categories.
  33. Credit union income.--The earnings of credit unions not 
distributed to members as interest or dividends are exempt from income 
tax.
  34. Bad debt reserves.--Small (less than $500 million in assets) 
commercial banks, mutual savings banks, and savings and loan 
associations may deduct additions to bad debt reserves in excess of 
actually experienced losses.
  35. Deferral of income on life insurance and annuity contracts.--
Favorable tax treatment is provided for investment income within 
qualified life insurance and annuity contracts. Investment income earned 
on qualified life insurance contracts held until death is permanently 
exempt from income tax. Investment income distributed prior to the death 
of the insured is tax-deferred, if not tax-exempt. Investment income 
earned on annuities is treated less favorably than income earned on life 
insurance contracts, but it benefits from tax deferral without annual 
contribution or income limits generally applicable to other tax-favored 
retirement income plans.
  36. Small property and casualty insurance companies.--Insurance 
companies that have annual net premium incomes of less than $350,000 are 
exempt from tax; those with $350,000 to $2.1 million of net premium 
incomes may elect to pay tax only on the income earned by their 
investment portfolio.
  37. Insurance companies owned by exempt organizations.--Generally, the 
income generated by life and property and casualty insurance companies 
is subject to tax, albeit by special rules. Insurance operations 
conducted by such exempt organizations as fraternal societies and 
voluntary employee benefit associations, however, are exempt from tax.
  38. Small life insurance company deduction.--Small life insurance 
companies (gross assets of less than $500 million) can deduct 60 percent 
of the first $3 million of otherwise taxable income. The deduction 
phases out for otherwise taxable income between $3 million and $15 
million.
  39. Mortgage housing bonds.--Interest earned on State and local bonds 
used to finance homes purchased by first-time, low-to-moderate-income 
buyers is tax-exempt. The amount of State and local tax-exempt bonds 
that can be issued to finance these and other private activity is 
limited. The combined volume cap for private activity bonds, including 
mortgage housing bonds, rental housing bonds, student loan bonds, and 
industrial development bonds is $62.50 per capita ($187.5 million 
minimum) per State in 2001, and $75 per capita ($225 million minimum) in 
2002. The Community Renewal Tax Relief Act of 2000 accelerated the 
scheduled increase in the state volume cap and indexed the cap for 
inflation, beginning in 2003. States may issue mortgage credit 
certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home 
buyers to income tax credits for a specified percentage of interest on 
qualified mortgages. The total amount of MCCs issued by a State cannot 
exceed 25 percent of its annual ceiling for mortgage-revenue bonds.
  40. Rental housing bonds.--Interest earned on State and local 
government bonds used to finance multifamily rental housing projects is 
tax-exempt. At least 20 percent (15 percent in targeted areas) of the 
units must be reserved for families whose income does not exceed 50 
percent of the area's median income; or 40 percent for families with 
incomes of no more than 60 percent of the area median income. Other tax-
exempt bonds for multifamily rental projects are generally issued with 
the requirement that all tenants must be low or moderate income 
families. Rental housing bonds are subject to the volume cap discussed 
in the mortgage housing bond section above.
  41. Interest on owner-occupied homes.--Owner-occupants of homes may 
deduct mortgage interest on their primary and secondary residences as 
itemized nonbusiness deductions. The mortgage interest deduction is 
limited to interest on debt no greater than the owner's basis in the 
residence and, for debt incurred after October 13, 1987, it is limited 
to no more than $1 million. Interest on up to $100,000 of other debt 
secured by a lien on a principal or second residence is also deductible, 
irrespective of the purpose of borrowing, provided the debt does not 
exceed the fair market value of the residence. Mortgage interest 
deductions on personal residences are tax expenditures because the value 
of owner-occupied housing services is not included in a taxpayer's 
taxable income. The Appendix provides an alternative calculation of the 
tax expenditure based on the implicit rental income on owner-occupied 
housing, which is generally viewed as a more accurate measure of the tax 
expenditure relative to a comprehensive income tax base.

[[Page 123]]

  42. Taxes on owner-occupied homes.--Owner-occupants of homes may 
deduct property taxes on their primary and secondary residences even 
though they are not required to report the value of owner-occupied 
housing services as gross income.
  43. Installment sales.--Dealers in real and personal property (i.e., 
sellers who regularly hold property for sale or resale) cannot defer 
taxable income from installment sales until the receipt of the loan 
repayment. Nondealers (i.e., sellers of real property used in their 
business) are required to pay interest on deferred taxes attributable to 
their total installment obligations in excess of $5 million. Only 
properties with sales prices exceeding $150,000 are includable in the 
total. The payment of a market rate of interest eliminates the benefit 
of the tax deferral. The tax exemption for nondealers with total 
installment obligations of less than $5 million is, therefore, a tax 
expenditure.
  44. Capital gains exclusion on home sales.--A homeowner can exclude 
from tax up to $500,000 ($250,000 for singles) of the capital gains from 
the sale of a principal residence. The exclusion may not be used more 
than once every two years.
  45. Passive loss real estate exemption.--In general, passive losses 
may not offset income from other sources. Losses up to $25,000 
attributable to certain rental real estate activity, however, are exempt 
from this rule.
  46. Low-income housing credit.--Taxpayers who invest in certain low-
income housing are eligible for a tax credit. The credit rate is set so 
that the present value of the credit is equal to 70 percent for new 
construction and 30 percent for (1) housing receiving other Federal 
benefits (such as tax-exempt bond financing), or (2) substantially 
rehabilitated existing housing. The credit is allowed in equal amounts 
over 10 years. State agencies determine who receives the credit; States 
are limited in the amount of credit they may authorize annually. The 
Community Renewal Tax Relief Act of 2000 increased the per-resident 
limit to $1.50 in 2001 and to $1.75 in 2002 and indexed the limit for 
inflation, beginning in 2003. The Act also created a $2 million minimum 
annual cap for small States beginning in 2002; the cap is indexed for 
inflation, beginning in 2003.
  47. Accelerated depreciation of rental property.--The tax depreciation 
allowance provisions are part of the reference law rules, and thus do 
not give rise to tax expenditures under the reference method. Under the 
normal tax method, however, economic depreciation is assumed. This 
calculation is described in more detail in the Appendix.
  48. Cancellation of indebtedness.--Individuals are not required to 
report the cancellation of certain indebtedness as current income. If 
the canceled debt is not reported as current income, however, the basis 
of the underlying property must be reduced by the amount canceled.
  49. Imputed interest rules.--Holders (issuers) of debt instruments are 
generally required to report interest earned (paid) in the period it 
accrues, not when paid. In addition, the amount of interest accrued is 
determined by the actual price paid, not by the stated principal and 
interest stipulated in the instrument. In general, any debt associated 
with the sale of property worth less than $250,000 is excepted from the 
general interest accounting rules. This general $250,000 exception is 
not a tax expenditure under reference law but is under normal law. 
Exceptions above $250,000 are a tax expenditure under reference law; 
these exceptions include the following: (1) sales of personal residences 
worth more than $250,000, and (2) sales of farms and small businesses 
worth between $250,000 and $1 million.
  50. Capital gains (other than agriculture, timber, iron ore, and 
coal).--Capital gains on assets held for more than 1 year are taxed at a 
lower rate than ordinary income. The lower rate on capital gains is 
considered a tax expenditure under the normal tax method but not under 
the reference law method.
  For most assets held for more than 1 year, the top capital gains tax 
rate is 20 percent. For assets acquired after December 31, 2000, the top 
capital gains tax rate for assets held for more than 5 years is 18 
percent. On January 1, 2001, taxpayers were permitted to mark-to-market 
existing assets to start the 5-year holding period. Losses from the 
mark-to-market are not recognized. For assets held for more than 1 year 
by taxpayers in the 15-percent ordinary tax bracket, the top capital 
gains tax rate is 10 percent. After December 31, 2000, the top capital 
gains tax rate for assets held by these taxpayers for more than 5 years 
is 8 percent.
  51. Capital gains exclusion for small business stock.--An exclusion of 
50 percent is provided for capital gains from qualified small business 
stock held by individuals for more than 5 years. A qualified small 
business is a corporation whose gross assets do not exceed $50 million 
as of the date of issuance of the stock.
  52. Step-up in basis of capital gains at death.--Capital gains on 
assets held at the owner's death are not subject to capital gains taxes. 
The cost basis of the appreciated assets is adjusted upward to the 
market value at the owner's date of death. After repeal of the estate 
tax under EGTRRA for 2010, the basis for property acquired from a 
decedent will be the lesser of fair market value or the decedent's 
basis. Certain types of additions to basis will be allowed so that 
assets in most estates that are not currently subject to estate tax will 
not be subject to capital gains tax in the hands of the heirs.
  53. Carryover basis of capital gains on gifts.--When a gift is made, 
the donor's basis in the transferred property (the cost that was 
incurred when the transferred property was first acquired) carries-over 
to the donee. The carryover of the donor's basis allows a continued 
deferral of unrealized capital gains. Even though the estate tax is 
repealed for 2010 under EGTRRA, the gift tax is retained with a lifetime 
exemption of $1 million.

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  54. Ordinary income treatment of losses from sale of small business 
corporate stock shares.--Up to $100,000 in losses from the sale of small 
business corporate stock (capitalization less than $1 million) may be 
treated as ordinary losses. Such losses would, thus, not be subject to 
the $3,000 annual capital loss write-off limit.
  55. Accelerated depreciation of non-rental-housing buildings.--The tax 
depreciation allowance provisions are part of the reference law rules, 
and thus do not give rise to tax expenditures under reference law. Under 
normal law, however, economic depreciation is assumed. This calculation 
is described in more detail in the Appendix.
  56. Accelerated depreciation of machinery and equipment.--The tax 
depreciation allowance provisions are part of the reference law rules, 
and thus do not give rise to tax expenditures under reference law. Under 
the normal tax baseline, this tax depreciation allowance is measured 
relative to economic depreciation. This calculation is described in more 
detail in the Appendix.
  57. Expensing of certain small investments.--In 2002, qualifying 
investments in tangible property up to $24,000 can be expensed rather 
than depreciated over time. The expensing limit increases to $25,000 in 
2003. To the extent that qualifying investment during the year exceeds 
$200,000, the amount eligible for expensing is decreased. In 2002, the 
amount expensed is completely phased out when qualifying investments 
exceed $224,000.
  58. Business start-up costs.--When taxpayers enter into a new 
business, certain start-up expenses, such as the cost of legal services, 
are normally incurred. Taxpayers may elect to amortize these outlays 
over 60 months even though they are similar to other payments made for 
nondepreciable intangible assets that are not recoverable until the 
business is sold. The normal tax method treats this amortization as a 
tax expenditure; the reference tax method does not.
  59. Graduated corporation income tax rate schedule.--The corporate 
income tax schedule is graduated, with rates of 15 percent on the first 
$50,000 of taxable income, 25 percent on the next $25,000, and 34 
percent on the next $9.925 million. Compared with a flat 34-percent 
rate, the lower rates provide an $11,750 reduction in tax liability for 
corporations with taxable income of $75,000. This benefit is recaptured 
for corporations with taxable incomes exceeding $100,000 by a 5-percent 
additional tax on corporate incomes in excess of $100,000 but less than 
$335,000.
  The corporate tax rate is 35 percent on income over $10 million. 
Compared with a flat 35-percent tax rate, the 34-percent rate provides a 
$100,000 reduction in tax liability for corporations with taxable 
incomes of $10 million. This benefit is recaptured for corporations with 
taxable incomes exceeding $15 million by a 3-percent additional tax on 
income over $15 million but less than $18.33 million. Because the 
corporate rate schedule is part of reference tax law, it is not 
considered a tax expenditure under the reference method. A flat 
corporation income tax rate is taken as the baseline under the normal 
tax method; therefore the lower rates is considered a tax expenditure 
under this concept.
  60. Small issue industrial development bonds.--Interest earned on 
small issue industrial development bonds (IDBs) issued by State and 
local governments to finance manufacturing facilities is tax-exempt. 
Depreciable property financed with small issue IDBs must be depreciated, 
however, using the straight-line method. The annual volume of small 
issue IDBs is subject to the unified volume cap discussed in the 
mortgage housing bond section above.

                             Transportation

  61. Deferral of tax on U.S. shipping companies.--Certain companies 
that operate U.S. flag vessels can defer income taxes on that portion of 
their income used for shipping purposes, primarily construction, 
modernization and major repairs to ships, and repayment of loans to 
finance these investments. Once indefinite, the deferral has been 
limited to 25 years since January 1, 1987.
  62. Exclusion of employee parking expenses.--Employee parking expenses 
that are paid for by the employer or that are received in lieu of wages 
are excludable from the income of the employee. In 2002, the maximum 
amount of the parking exclusion is $185 (indexed) per month. The tax 
expenditure estimate does not include parking at facilities owned by the 
employer.
  63. Exclusion of employee transit pass expenses.--Transit passes, 
tokens, fare cards, and vanpool expenses paid for by an employer or 
provided in lieu of wages to defray an employee's commuting costs are 
excludable from the employee's income. In 2002, the maximum amount of 
the exclusion is $100 (indexed) per month.

                   Community and Regional Development

  64. Rehabilitation of structures.--A 10-percent investment tax credit 
is available for the rehabilitation of buildings that are used for 
business or productive activities and that were erected before 1936 for 
other than residential purposes. The taxpayer's recoverable basis must 
be reduced by the amount of the credit.
  65. Airport, dock, and similar facility bonds.--Interest earned on 
State and local bonds issued to finance high-speed rail facilities and 
government-owned airports, docks, wharves, and sport and convention 
facilities is tax-exempt. These bonds are not subject to a volume cap.
  66. Exemption of income of mutuals and cooperatives.--The incomes of 
mutual and cooperative telephone and electric companies are exempt from 
tax if at least 85 percent of their revenues are derived from patron 
service charges.
  67. Empowerment zones, enterprise communities, and renewal 
communities.--Qualifying businesses in designated economically depressed 
areas can receive tax

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benefits such as an employer wage credit, increased expensing of 
investment in equipment, special tax-exempt financing, accelerated 
depreciation, and certain capital gains incentives. The Job Creation and 
Worker Assistance Act of 2002 expanded the existing provisions by adding 
the ``New York City Liberty Zone.'' In addition, certain first-time 
buyers of a principal residence in the District of Columbia can receive 
a tax credit on homes purchased on or before December 31, 2003, and 
investors in certain D.C. property can receive a capital gains break. 
The Community Renewal Tax Relief Act of 2000 created the renewal 
communities tax benefits, which begin on January 1, 2002 and expire on 
December 31, 2009. The Act also created additional empowerment zones, 
increased the tax benefits for empowerment zones, and extended the 
expiration date of (1) empowerment zones from December 31, 2004 to 
December 31, 2009, and (2) the D.C. home-buyer credit from December 31, 
2001 to December 31, 2003.
  68. New markets tax credit.--Taxpayers who invest in a community 
development entity (CDE) after December 31, 2000 are eligible for a tax 
credit. The total equity investment available for the credit across all 
CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and 2003, $2.0 
billion in 2004 and 2005, and $3.5 billion in 2006 and 2007. The amount 
of the credit equals (1) 5 percent in the year of purchase and the 
following 2 years, and (2) 6 percent in the following 4 years. A CDE is 
any domestic firm whose primary mission is to serve or provide 
investment capital for low-income communities/individuals; a CDE must be 
accountable to residents of low-income communities. The Community 
Renewal Tax Relief Act of 2000 created the new markets tax credit.
  69. Expensing of environmental remediation costs.--Taxpayers who clean 
up certain hazardous substances at a qualified site may expense the 
clean-up costs, rather than capitalize the costs, even though the 
expenses will generally increase the value of the property significantly 
or appreciably prolong the life of the property. The expensing only 
applies to clean-up costs incurred on or before December 31, 2003. The 
Community Renewal Tax Relief Act of 2000 extended the expiration date 
from December 31, 2001 to December 31, 2003. The Act also expanded the 
number of qualified sites.

          Education, Training, Employment, and Social Services

  70. Scholarship and fellowship income.--Scholarships and fellowships 
are excluded from taxable income to the extent they pay for tuition and 
course-related expenses of the grantee. Similarly, tuition reductions 
for employees of educational institutions and their families are not 
included in taxable income. From an economic point of view, scholarships 
and fellowships are either gifts not conditioned on the performance of 
services, or they are rebates of educational costs. Thus, under the 
reference law method, this exclusion is not a tax expenditure because 
this method does not include either gifts or price reductions in a 
taxpayer's gross income. The exclusion, however, is considered a tax 
expenditure under the normal tax method, which includes gift-like 
transfers of government funds in gross income (many scholarships are 
derived directly or indirectly from government funding).
  71. HOPE tax credit.--The non-refundable HOPE tax credit allows a 
credit for 100 percent of an eligible student's first $1,000 of tuition 
and fees and 50 percent of the next $1,000 of tuition and fees. The 
credit only covers tuition and fees paid during the first two years of a 
student's post-secondary education. In 2002, the credit is phased out 
ratably for taxpayers with modified AGI between $82,000 and $102,000 
($41,000 and $51,000 for singles) (indexed beginning in 2002).
  72. Lifetime Learning tax credit.--The non-refundable Lifetime 
Learning tax credit allows a credit for 20 percent of an eligible 
student's tuition and fees. For tuition and fees paid before January 1, 
2003, the maximum credit per return is $1,000. For tuition and fees paid 
after December 31, 2002, the maximum credit per return is $2,000. The 
credit is phased out ratably for taxpayers with modified AGI between 
$82,000 and $102,000 ($41,000 and $51,000 for singles) (indexed 
beginning in 2002). The credit applies to both undergraduate and 
graduate students.
  73. Deduction for Higher Education Expenses.--The tax code provides a 
new above-the-line deduction for qualified higher education expenses. 
The maximum annual deduction is $3,000 beginning in 2002 for taxpayers 
with adjusted gross income up to $130,000 on a joint return ($65,000 for 
singles). The maximum deduction increases to $4,000 in 2004. Taxpayers 
with adjusted gross income up to $160,000 on a joint return ($80,000 for 
singles) may deduct up to $2,000 beginning in 2004. No deduction is 
allowed for expenses paid after December 31, 2005.
  74. Education Individual Retirement Accounts.--Contributions to an 
education IRA are not tax-deductible. Investment income earned by 
education IRAs is not taxed when earned, and investment income from an 
education IRA is tax-exempt when withdrawn to pay for a student's 
tuition and fees. The maximum contribution is $2,000 and the phase-out 
range for joint filers is $190,000 through $220,000 of modified AGI, 
double the range of singles. Elementary and secondary school expenses 
may also be paid tax-free from such accounts.
  75. Student-loan interest.--Taxpayers may claim an above-the-line 
deduction of up to $2,500 on interest paid on an education loan. 
Interest may only be deducted for the first five years in which interest 
payments are required.
  76. State prepaid tuition plans.--Some States have adopted prepaid 
tuition plans and prepaid room and board plans, which allow persons to 
pay in advance for college expenses for designated beneficiaries. 
Beginning in 2002, investment income is not taxed when earned, and is 
tax-exempt when withdrawn to pay for qualified expenses.

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  77. Student-loan bonds.--Interest earned on State and local bonds 
issued to finance student loans is tax-exempt. The volume of all such 
private activity bonds that each State may issue annually is limited.
  78. Bonds for private nonprofit educational institutions.--Interest 
earned on State and local government bonds issued to finance the 
construction of facilities used by private nonprofit educational 
institutions is not taxed.
  79. Credit for holders of zone academy bonds.--Financial institutions 
that own zone academy bonds receive a non-refundable tax credit (at a 
rate set by the Treasury Department) rather than interest. The credit is 
included in gross income. Proceeds from zone academy bonds may only be 
used to renovate, but not construct, qualifying schools and for certain 
other school purposes. The total amount of zone academy bonds that may 
be issued is limited to $1.6 billion--$400 million in each year from 
1998 to 2003.
  80. U.S. savings bonds for education.--Interest earned on U.S. savings 
bonds issued after December 31, 1989 is tax-exempt if the bonds are 
transferred to an educational institution to pay for educational 
expenses. The tax exemption is phased out for taxpayers with AGI between 
$86,400 and $116,400 ($57,600 and $72,600 for singles) in 2002.
  81. Dependent students age 19 or older.--Taxpayers may claim personal 
exemptions for dependent children age 19 or over who (1) receive 
parental support payments of $1,000 or more per year, (2) are full-time 
students, and (3) do not claim a personal exemption on their own tax 
returns.
  82. Charitable contributions to educational institutions.--Taxpayers 
may deduct contributions to nonprofit educational institutions. 
Taxpayers who donate capital assets to educational institutions can 
deduct the assets' current value without being taxed on any appreciation 
in value. An individual's total charitable contribution generally may 
not exceed 50 percent of adjusted gross income; a corporation's total 
charitable contributions generally may not exceed 10 percent of pre-tax 
income.
  83. Employer-provided educational assistance.--Employer-provided 
educational assistance is excluded from an employee's gross income even 
though the employer's costs for this assistance are a deductible 
business expense.
  84. Work opportunity tax credit.--Employers can claim a tax credit for 
qualified wages paid to individuals who begin work on or before December 
31, 2004 and who are certified as members of various targeted groups. 
The amount of the credit that can be claimed is 25 percent for 
employment of less than 400 hours and 40 percent for employment of 400 
hours or more. The maximum credit per employee is $2,400 and can only be 
claimed on the first year of wages an individual earns from an employer. 
Employers must reduce their deduction for wages paid by the amount of 
the credit claimed.
  85. Welfare-to-work tax credit.--An employer is eligible for a tax 
credit on the first $20,000 of eligible wages paid to qualified long-
term family assistance recipients during the first two years of 
employment. The credit is 35 percent of the first $10,000 of wages in 
the first year of employment and 50 percent of the first $10,000 of 
wages in the second year of employment. The maximum credit is $8,500 per 
employee. The credit applies to wages paid to employees who are hired on 
or before December 31, 2004.
  86. Employer-provided child care exclusion.--Employer-provided child 
care is excluded from an employee's gross income even though the 
employer's costs for the child care are a deductible business expense.
  87. Employer-provided child care credit.--Employers can deduct 
expenses for supporting child care or child care resource and referral 
services. A tax credit to employers for qualified expenses began in 
2002. The credit is equal to 25 percent of qualified expenses for 
employee child care and 10 percent of qualified expenses for child care 
resource and referral services. Employer deductions for such expenses 
are reduced by the amount of the credit. The maximum total credit is 
limited to $150,000 per taxable year.
  88. Assistance for adopted foster children.--Taxpayers who adopt 
eligible children from the public foster care system can receive monthly 
payments for the children's significant and varied needs and a 
reimbursement of up to $2,000 for nonrecurring adoption expenses. These 
payments are excluded from gross income.
  89. Adoption credit and exclusion.--Taxpayers can receive a 
nonrefundable tax credit for qualified adoption expenses. The maximum 
credit is $5,000 per child ($6,000 for special needs adoptions) for 
2001. The credit is phased-out ratably for taxpayers with modified AGI 
between $150,000 and $190,000 in 2002. EGTRRA increased the maximum 
credit for non-special needs children to $10,000, set a flat credit 
amount of $10,000 for special needs children, and increased the start 
point of the phase-out to $150,000 beginning in 2002. The credit amounts 
and the phase-out thresholds are indexed for inflation beginning in 
2003. Unused credits may be carried forward and used during the five 
subsequent years. Taxpayers may also exclude qualified adoption expenses 
from income, subject to the same maximum amounts and phase-out as the 
credit. The same expenses cannot qualify for tax benefits under both 
programs; however, a taxpayer may use the benefits of the exclusion and 
the tax credit for different expenses. Stepchild adoptions are not 
eligible for either benefit. Both the credit and the exclusion were made 
permanent by EGTRRA.
  90. Employer-provided meals and lodging.--Employer-provided meals and 
lodging are excluded from an employee's gross income even though the 
employer's costs for these items are a deductible business expense.
  91. Child credit.--Taxpayers with children under age 17 can qualify 
for a $600 refundable per child credit. The maximum credit is increased 
to $700 in 2005,

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$800 in 2009, and $1,000 in 2010. The credit is phased out for taxpayers 
at the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 
for singles).
  92. Child and dependent care expenses.--Married couples with child and 
dependent care expenses may claim a tax credit when one spouse works 
full time and the other works at least part time or goes to school. The 
credit may also be claimed by single parents and by divorced or 
separated parents who have custody of children. Expenditures up to a 
maximum $2,400 for one dependent and $4,800 for two or more dependents 
are eligible for the credit. EGTRRA increased the maximum expenditure 
limit to $3,000 for one dependent and $6,000 for two or more dependents 
beginning in 2003. The credit is equal to 30 percent of qualified 
expenditures (35 percent beginning in 2003) for taxpayers with incomes 
of $10,000 or less ($15,000 or less beginning in 2003). The credit is 
reduced to a minimum of 20 percent by one percentage point for each 
$2,000 of income in excess of $10,000 ($15,000 beginning in 2003).
  93. Disabled access expenditure credit.--Small businesses (less than 
$1 million in gross receipts or fewer than 31 full-time employees) can 
claim a 50-percent credit for expenditures in excess of $250 to remove 
access barriers for disabled persons. The credit is limited to $5,000.
  94. Charitable contributions, other than education and health.--
Taxpayers may deduct contributions to charitable, religious, and certain 
other nonprofit organizations. Taxpayers who donate capital assets to 
charitable organizations can deduct the assets' current value without 
being taxed on any appreciation in value. An individual's total 
charitable contribution generally may not exceed 50 percent of adjusted 
gross income; a corporation's total charitable contributions generally 
may not exceed 10 percent of pre-tax income.
  95. Foster care payments.--Foster parents provide a home and care for 
children who are wards of the State, under contract with the State. 
Compensation received for this service is excluded from the gross 
incomes of foster parents; the expenses they incur are nondeductible.
  96. Parsonage allowances.--The value of a minister's housing allowance 
and the rental value of parsonages are not included in a minister's 
taxable income.

                                 Health

  97. Employer-paid medical insurance and expenses.--Employer-paid 
health insurance premiums and other medical expenses (including long-
term care) are deducted as a business expense by employers, but they are 
not included in employee gross income. The self-employed also may deduct 
part of their family health insurance premiums.
  98. Self-employed medical insurance premiums.--Self-employed taxpayers 
may deduct a percentage of their family health insurance premiums. 
Taxpayers without self-employment income are not eligible for the 
special percentage deduction. The deductible percentage is 60 percent in 
2001, 70 percent in 2002, and 100 percent in 2003 and thereafter.
  99. Workers compensation insurance premiums.--Workers compensation 
insurance premiums are paid by employers and deducted as a business 
expense, but the premiums are not included in employee gross income.
  100. Medical savings accounts.--Some employees may deduct annual 
contributions to a medical savings account (MSA); employer contributions 
to MSAs (except those made through cafeteria plans) for qualified 
employees are also excluded from income. An employee may contribute to 
an MSA in a given year only if the employer does not contribute to the 
MSA in that year. MSAs are only available to self-employed individuals 
or employees covered under an employer-sponsored high deductible health 
plan of a small employer. The maximum annual MSA contribution is 75 
percent of the deductible under the high deductible plan for family 
coverage (65 percent for individual coverage). Earnings from MSAs are 
excluded from taxable income. Distributions from an MSA for medical 
expenses are not taxable. The number of taxpayers who may benefit 
annually from MSAs is generally limited to 750,000. No new MSAs may be 
established after December 31, 2003.
  101. Medical care expenses.--Personal expenditures for medical care 
(including the costs of prescription drugs) exceeding 7.5 percent of the 
taxpayer's adjusted gross income are deductible.
  102. Hospital construction bonds.--Interest earned on State and local 
government debt issued to finance hospital construction is excluded from 
income subject to tax.
  103. Charitable contributions to health institutions.--Individuals and 
corporations may deduct contributions to nonprofit health institutions. 
Tax expenditures resulting from the deductibility of contributions to 
other charitable institutions are listed under the education, training, 
employment, and social services function.
  104. Orphan drugs.--Drug firms can claim a tax credit of 50 percent of 
the costs for clinical testing required by the Food and Drug 
Administration for drugs that treat rare physical conditions or rare 
diseases.
  105. Blue Cross and Blue Shield.--Blue Cross and Blue Shield health 
insurance providers in existence on August 16, 1986 and certain other 
nonprofit health insurers are provided exceptions from otherwise 
applicable insurance company income tax accounting rules that 
substantially reduce (or even eliminate) their tax liabilities.
  106. Tax credit for health insurance purchased by ceratin displaced 
and retired individuals.--The Trade Act of 2002 provided a refundable 
tax credit of 65 percent for the purchase of health insurance covergae 
by individuals eligible for Trade Adjustment Assitance and certain PBGC 
pension recipients.

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                             Income Security

  107. Railroad retirement benefits.--Railroad retirement benefits are 
not generally subject to the income tax unless the recipient's gross 
income reaches a certain threshold. The threshold is discussed more 
fully under the Social Security function.
  108. Workers' compensation benefits.--Workers compensation provides 
payments to disabled workers. These benefits, although income to the 
recipients, are not subject to the income tax.
  109. Public assistance benefits.--Public assistance benefits are 
excluded from tax. The normal tax method considers cash transfers from 
the government as taxable and, thus, treats the exclusion for public 
assistance benefits as a tax expenditure.
  110. Special benefits for disabled coal miners.--Disability payments 
to former coal miners out of the Black Lung Trust Fund, although income 
to the recipient, are not subject to the income tax.
  111. Military disability pensions.--Most of the military pension 
income received by current disabled retired veterans is excluded from 
their income subject to tax.
  112. Employer-provided pension contributions and earnings.--Certain 
employer contributions to pension plans are excluded from an employee's 
gross income even though the employer can deduct the contributions. In 
addition, the tax on the investment income earned by the pension plans 
is deferred until the money is withdrawn.
  113. 401(k) plans.--Individual taxpayers can make tax-preferred 
contributions to certain types of employer-provided 401(k) plans (and 
401(k)-type plans like 403(b) plans and the Federal government's Thrift 
Savings Plan). In 2001, an employee could exclude up to $10,500 
(indexed) of wages from AGI under a qualified arrangement with an 
employer's 401(k) plan. EGTRRA increases the exclusion amount to $11,000 
in 2002, $12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and $15,000 
in 2006 (indexed thereafter). The tax on the investment income earned by 
401(k)-type plans is deferred until withdrawn.
  EGTRRA also allows employees to make after-tax contributions to 401(k) 
and 401(k)-type plans beginning in 2002. These contributions are not 
excluded from AGI, but the investment income of such after-tax 
contributions is not taxed when earned or withdrawn.
  114. Individual Retirement Accounts.--Individual taxpayers can take 
advantage of several different Individual Retirement Accounts (IRAs): 
deductible IRAs, non-deductible IRAs, and Roth IRAs. Employees can make 
annual contributions to an IRA up to $3,000 (or 100 percent of 
compensation, if less). The annual contributions limit applies to the 
total of a taxpayer's deductible, non-deductible, and Roth IRAs 
contributions. The IRA contribution limit increases to $4,000 in 2005, 
and $5,000 in 2008 (indexed thereafter) and allows taxpayers over age 50 
to make additional ``catch-up'' contributions of $1,000 (by 2006).
  Taxpayers whose AGI is below $54,000 ($34,000 for non-joint filers) in 
2002 can claim a deduction for IRA contributions. In 2002, the IRA 
deduction is phased out for taxpayers with AGI between $54,000 and 
$64,000 ($34,000 and $44,000 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 $150,000 ($95,000 for nonjoint filers) 
can make contributions to Roth IRAs. The maximum contribution to a Roth 
IRA is phased out for taxpayers with AGI between $150,000 and $160,000 
($95,000 and $110,000 for singles). Investment income of a Roth IRA is 
not taxed when earned nor when withdrawn. Withdrawals from a Roth IRA 
are penalty free if: (1) the Roth IRA was opened at least 5 years before 
the withdrawal, and (2) the taxpayer either (a) is at least 59-1/2, (b) 
dies, (c) is disabled, or (d) purchases a first-time house.
  Taxpayers can contribute to a non-deductible IRA regardless of their 
income and whether they are an active participant in an employer-
provided retirement plan. The tax on investment income earned by non-
deductible IRAs is deferred until the money is withdrawn.
  115. Low and moderate income savers' credit.--EGTRRA provides an 
additional incentive for lower-income taxpayers to save through a 
nonrefundable credit of up to 50 percent on IRA contributions. This 
credit is in addition to any deduction or exclusion. The credit is 
completely phased out by $50,000 for joint filers and $25,000 for single 
filers. This temporary credit is in effect from 2002 through 2006.
  116. Keogh plans.--Self-employed individuals can make deductible 
contributions to their own retirement (Keogh) plans equal to 25 percent 
of their income, up to a maximum of $40,000 in 2002. The tax on the 
investment income earned by Keogh plans is deferred until withdrawn.
  117. Employer-provided life insurance benefits.--Employer-provided 
life insurance benefits are excluded from an employee's gross income 
even though the employer's costs for the insurance are a deductible 
business expense.
  118. Small business retirement plan credit.--Businesses with 100 or 
fewer employees may receive 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.

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  119. Employer-provided accident and disability benefits.--Employer-
provided accident and disability benefits are excluded from an 
employee's gross income even though the employer's costs for the 
benefits are a deductible business expense.
  120. Employer-provided supplementary unemployment benefits.--Employers 
may establish trusts to pay supplemental unemployment benefits to 
employees separated from employment. Interest payments to such trusts 
are exempt from taxation.
  121. Employer Stock Ownership Plan (ESOP) provisions.--ESOPs are a 
special type of tax-exempt employee benefit plan. Employer-paid 
contributions (the value of stock issued to the ESOP) are deductible by 
the employer as part of employee compensation costs. They are not 
included in the employees' gross income for tax purposes, however, until 
they are paid out as benefits. The following special income tax 
provisions for ESOPs are intended to increase ownership of corporations 
by their employees: (1) annual employer contributions are subject to 
less restrictive limitations; (2) ESOPs may borrow to purchase employer 
stock, guaranteed by their agreement with the employer that the debt 
will be serviced by his payment (deductible by him) of a portion of 
wages (excludable by the employees) to service the loan; (3) employees 
who sell appreciated company stock to the ESOP may defer any taxes due 
until they withdraw benefits; and (4) dividends paid to ESOP-held stock 
are deductible by the employer.
  122. Additional deduction for the blind.--Taxpayers who are blind may 
take an additional $1,150 standard deduction if single, or $900 if 
married in 2002.
  123. Additional deduction for the elderly.--Taxpayers who are 65 years 
or older may take an additional $1,150 standard deduction if single, or 
$900 if married in 2002.
  124. Tax credit for the elderly and disabled.--Individuals who are 65 
years of age or older, or who are permanently disabled, can take a tax 
credit equal to 15 percent of the sum of their earned and retirement 
income. Income is limited to no more than $5,000 for single individuals 
or married couples filing a joint return where only one spouse is 65 
years of age or older, and up to $7,500 for joint returns where both 
spouses are 65 years of age or older. These limits are reduced by one-
half of the taxpayer's adjusted gross income over $7,500 for single 
individuals and $10,000 for married couples filing a joint return.
  125. Casualty losses.--Neither the purchase of property nor insurance 
premiums to protect its value are deductible as costs of earning income; 
therefore, reimbursement for insured loss of such property is not 
reportable as a part of gross income. Taxpayers, however, may deduct 
uninsured casualty and theft losses of more than $100 each, but only to 
the extent that total losses during the year exceed 10 percent of AGI.
  126. Earned income tax credit (EITC).--The EITC may be claimed by low 
income workers. For a family with one qualifying child, the credit is 34 
percent of the first $7,370 of earned income in 2002. The credit is 40 
percent of the first $10,350 of income for a family with two or more 
qualifying children. The credit is phased out beginning when the 
taxpayer's income exceeds $13,520 at the rate of 15.98 percent (21.06 
percent if two or more qualifying children are present). It is 
completely phased out when the taxpayer's modified adjusted gross income 
reaches $29,201 ($33,178 if two or more qualifying children are 
present).
  The credit may also be claimed by workers who do not have children 
living with them. Qualifying workers must be at least age 25 and may not 
be claimed as a dependent on another taxpayer's return. The credit is 
not available to workers age 65 or older. In 2002, the credit is 7.65 
percent of the first $4,910 of earned income. When the taxpayer's income 
exceeds $6,150, the credit is phased out at the rate of 7.65 percent. It 
is completely phased out at $11,060 of modified adjusted gross income.
  For workers with or without children, the income levels at which the 
credit begins to phase-out and the maximum amounts of income on which 
the credit can be taken are adjusted for inflation. For married 
taxpayers filing a joint return, EGTRRA increases the base amount for 
the phase-out by $1,000 in 2002 through 2004, $2,000 in 2005 through 
2007, and $3,000 in 2008 (indexed thereafter).
  Earned income tax credits in excess of tax liabilities owed through 
the individual income tax system are refundable to individuals. This 
portion of the credit is shown as an outlay, while the amount that 
offsets tax liabilities is shown as a tax expenditure.

                             Social Security

  127. Social Security benefits for retired workers.--Social Security 
benefits that exceed the beneficiary's contributions out of taxed income 
are deferred employee compensation and the deferral of tax on that 
compensation is a tax expenditure. These additional retirement benefits 
are paid for partly by employers' contributions that were not included 
in employees' taxable compensation. Portions (reaching as much as 85 
percent) of recipients' Social Security and Tier 1 Railroad Retirement 
benefits are included in the income tax base, however, if the 
recipient's provisional income exceeds certain base amounts. Provisional 
income is equal to adjusted gross income plus foreign or U.S. possession 
income and tax-exempt interest, and one half of Social Security and tier 
1 railroad retirement benefits. The tax expenditure is limited to the 
portion of the benefits received by taxpayers who are below the base 
amounts at which 85 percent of the benefits are taxable.
  128. Social Security benefits for the disabled.--Benefit payments from 
the Social Security Trust Fund, for disability and for dependents and 
survivors, are partially excluded from a beneficiary's gross incomes.
  129. Social Security benefits for dependents and survivors.--Benefit 
payments from the Social Security

[[Page 130]]

Trust Fund for dependents and survivors are partially excluded from a 
beneficiary's gross income.

                     Veterans Benefits and Services

  130. Veterans death benefits and disability compensation.--All 
compensation due to death or disability paid by the Veterans 
Administration is excluded from taxable income.
  131. Veterans pension payments.--Pension payments made by the Veterans 
Administration are excluded from gross income.
  132. G.I. Bill benefits.--G.I. Bill benefits paid by the Veterans 
Administration are excluded from gross income.
  133. Tax-exempt mortgage bonds for veterans.--Interest earned on 
general obligation bonds issued by State and local governments to 
finance housing for veterans is excluded from taxable income. The 
issuance of such bonds is limited, however, to five pre-existing State 
programs and to amounts based upon previous volume levels for the period 
January 1, 1979 to June 22, 1984. Furthermore, future issues are limited 
to veterans who served on active duty before 1977.

                           General Government

  134. Public purpose State and local bonds.--Interest earned on State 
and local government bonds issued to finance public-purpose construction 
(e.g., schools, roads, sewers), equipment acquisition, and other public 
purposes is tax-exempt. Interest on bonds issued by Indian tribal 
governments for essential governmental purposes is also tax-exempt.
  135. Deductibility of certain nonbusiness State and local taxes.--
Taxpayers may deduct State and local income taxes and property taxes 
even though these taxes primarily pay for services that, if purchased 
directly by taxpayers, would not be deductible.
  136. Business income earned in U.S. possessions.--U.S. corporations 
operating in a U.S. possession (e.g., Puerto Rico) can claim a credit 
against some or all of their U.S. tax liability on possession business 
income. The credit expires December 31, 2005.

                                Interest

  137. U.S. savings bonds.--Taxpayers may defer paying tax on interest 
earned on U.S. savings bonds until the bonds are redeemed.

                                Appendix:

           TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION

  This appendix provides an initial presentation of the Treasury 
Department review of the tax expenditure budget first described in the 
2003 Budget. As previously described, the review focuses in particular 
on three issues: (1) using comprehensive income as a baseline tax 
system, (2) using a consumption tax as a baseline tax system, and (3) 
defining negative tax expenditures (provisions that cause taxpayers to 
pay too much tax).
  The first section of this appendix compares major tax expenditures in 
the current budget to those implied by a comprehensive income baseline. 
This comparison includes a discussion of negative tax expenditures. The 
second section compares the major tax expenditures in the current budget 
to those implied by a consumption tax baseline, and also discusses 
negative tax expenditures. The final section addresses concerns that 
have been raised over the measurement of some current tax expenditures 
by describing a new estimate of the tax expenditure caused by 
accelerated depreciation and an alternative estimate of the tax 
expenditure resulting from the tax exemption of the return earned on 
owner-occupied housing. The final section also provides an estimate of 
the negative tax expenditure caused by the double tax on corporate 
profits.

    DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON 
                          COMPREHENSIVE INCOME

  As discussed in the main body of this chapter, traditional tax 
expenditures are measured relative to normal law or reference law 
baselines that deviate from a comprehensive concept of income. 
Consequently, tax expenditures identified in the budget can differ from 
those that would be identified if comprehensive income were chosen as 
the baseline tax system. This appendix addresses this issue by comparing 
major tax expenditures listed in the current tax expenditure budget with 
those implied by a comprehensive income baseline. Most large tax 
expenditures would continue to be tax expenditures were the baseline 
taken to be comprehensive income, although some would not. 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, it gives a 
one-sided picture of the ways in which current law deviates from the 
baseline tax system. Relative to a comprehensive income baseline, a 
number of current tax provisions would be negative tax expenditures. 
Some of these might also be negative tax expenditures under the 
reference law or normal law baselines, expanded to admit negative tax 
expenditures.

[[Page 131]]

  Treatment of Major Tax Expenditures From the Current Budget Under a 
                      Comprehensive Income 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 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. 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 housing or consumer durable 
goods, including automobiles and major appliances.
---------------------------------------------------------------------------
  \6\ See, 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.
---------------------------------------------------------------------------
  Furthermore, comprehensive income represents an ideal tax base only in 
the tautological sense that the base of an income tax is, or should be, 
income. Comprehensive income does not necessarily represent the 
economically most desirable tax base; efficiency or equity might be 
improved by deviating from comprehensive income as a tax base, e.g., by 
reducing the taxation of capital income in order to spur economic growth 
or by subsidizing certain types of activities in order to correct for 
market failures or to improve the after-tax distribution of income. In 
addition, some elements of comprehensive income would be difficult or 
impossible to include in a tax system that is administrable.
  Table 1 shows the thirty largest tax expenditures from the 2004 Budget 
classified according to whether they would be considered a tax 
expenditure under a comprehensive income tax. Thirteen of the thirty 
items would be tax expenditures under a comprehensive tax base (those in 
panel A). \7\ 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, especially in consideration of the potential for capital 
income to be subject to two layers of tax given the absence of 
integration between the corporate and individual income tax systems.
---------------------------------------------------------------------------
  \7\ Not all of the items are properly specified and measured if the 
intent is to compare current law with a comprehensive income tax. 
Nonetheless, they all deal with items whose treatment differs 
fundamentally from that required by a comprehensive income tax.
---------------------------------------------------------------------------
  Panel B deals with items that potentially are tax expenditures, but 
that raise more difficult conceptual issues or raise inconsistencies. 
The first of these is the deduction of nonbusiness State and local taxes 
other than on owner-occupied homes. These taxes include both income 
taxes and property taxes. The stated justification for this tax 
expenditure is that ``Taxpayers may deduct State and local income taxes 
and property taxes even though these taxes primarily pay for services 
that, if purchased directly by taxpayers, would not be deductible.'' \8\ 
The idea is that these taxes represent consumption expenditures, and so 
are elements of income.
---------------------------------------------------------------------------
  \8\ Fiscal Year 2003 Budget of the United States Government, 
Analytical Perspectives (Washington, D.C.: U.S. Government Printing 
Office, 2002) p. 127
---------------------------------------------------------------------------
  In contrast to the view in the budget, the deduction for State and 
local taxes might not be a tax expenditure if the baseline were 
comprehensive income. Properly measured comprehensive income would 
include the imputed value of State and local government benefits 
received, but would allow a deduction for State and local taxes paid. 
\9\ Thus, in this sense the deductibility of State and local taxes is 
consistent with comprehensive income principles; it should not be a tax 
expenditure. However, imputing the value of State and local services may 
be difficult and, as a rough correction, the tax system might disallow 
the deduction for State and local taxes. \10\ So, if the value of 
services from State and local governments is excluded from the tax base, 
as it generally is under current law, a deduction for taxes might be 
viewed as a tax expenditure relative to a comprehensive income baseline. 
\11\
---------------------------------------------------------------------------
  \9\ U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: 
U.S. Government Printing Office, 1977) p. 92.
  \10\ Home mortgage interest and property taxes on owner-occupied 
housing raise the same ambiguity. Classifying them as probably not tax 
expenditures arguably is inconsistent. It reflects the judgment that no 
comprehensive tax is likely to tax the value of State and local 
services, while it appears somewhat easier to impute and tax the rental 
income from owner-occupied housing.
  \11\ 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.
---------------------------------------------------------------------------
  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 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 retirement benefits also 
is listed in panel B. To the extent that Social Security is viewed as a 
pension, a comprehensive income tax would include in income all 
contributions to Social Security retirement funds (payroll taxes) and 
tax accretions to value as they arise (inside build-up). \12\ Benefits 
paid out of prior contributions and the inside

[[Page 132]]

build-up, 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.
---------------------------------------------------------------------------
  \12\ 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.
---------------------------------------------------------------------------
  In contrast to either of these treatments, current law excludes one-
half of contributions (employer-paid payroll taxes) from the base of the 
income tax, makes no attempt to tax accretions, and subjects some, but 
not all, benefits to taxation. The difference between the current law 
treatment of Social Security retirement 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 
current budget.
  The tax expenditures in the current budget \13\ reflect exemptions for 
lower income beneficiaries from the tax on 85 percent of Social Security 
benefits. \14\ Historically, payroll taxes paid by the employee 
represented no more than 15 percent of the expected value of the 
benefits received by a lower-earnings Social Security beneficiary. The 
85 percent inclusion rate is therefore intended to tax the remaining 
amount of the benefit payment arising from the payroll tax contributions 
made by employers and the implicit return on the employee and employer 
contributions. Thus, the tax expenditure conceived and measured in the 
current budget is not intended to capture the deviation from a 
comprehensive income baseline, which would additionally account for the 
deferral of tax on these components (less an inflation adjustment 
attributable to the employee's payroll tax contributions). Rather, it is 
intended to approximate the taxation of private pensions with employee 
contributions made from after-tax income, \15\ on the assumption that 
Social Security is comparable to such pensions. Hence, the official tax 
expenditure understates the tax advantage accorded Social Security 
benefits relative to a comprehensive income baseline.
---------------------------------------------------------------------------
  \13\ This includes both the tax expenditure for benefits paid to 
workers and that for benefits paid to survivors and dependents.
  \14\ The 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.
  \15\ Private 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 
build-up 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.
---------------------------------------------------------------------------
  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 consumption value, then the child care credit and the 
earned income tax credit would be tax expenditures. In contrast, a 
competing perspective views these credits as appropriate modifications 
that account for differing taxpaying capacity. Since comprehensive 
income is equal to the sum of consumption and one's change in wealth, 
expenditures on items that are viewed as not yielding consumption value 
reduce income, and, hence taxpaying capacity under this interpretation.
  The tax expenditures related to workers' compensation benefits raise 
double counting issues. The official tax expenditure list counts as a 
tax expenditure both the failure to tax premiums and the failure to tax 
benefits. This is inappropriate treatment if the baseline is 
comprehensive income. Under comprehensive income tax principles, if the 
taxpayer 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 the benefit when paid (since it represents an increase in net-
worth). \16\ If the employer paid 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. 
Equivalently, the employee could be required to take the premium into 
income and ignore the proceeds, on the argument that the premium has the 
same expected value as the proceeds of the policy, as explained in 
Blueprints. \17\ But in no circumstances should the employee be taxed on 
both the premium and the proceeds. One of the two current tax 
expenditures would be eliminated if the baseline were comprehensive 
income. \18\
---------------------------------------------------------------------------
  \16\ Suppose he buys the unemployment insurance policy at the 
beginning of the year. He exchanges one asset, cash, for another, the 
policy, so there is no change in net worth. But, at the end of the year, 
the policy expires and so is worthless, hence he has a reduction in net 
worth equal to the amount he paid for the policy, which of course is the 
premium. If the policy pays off (i.e., a work related injury prevents 
his employment), then he would include the proceeds in his income 
because they represent an increase in net worth.
  \17\ U.S. Treasury, Blueprints for Basic Tax Reform, pp. 59-61.
  \18\ This might also be double counting under the normal and reference 
law baselines.
---------------------------------------------------------------------------
  The next category (panel C) includes items whose treatment under a 
comprehensive income tax is widely acknowledged to be ambiguous. \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\
---------------------------------------------------------------------------
  \19\ See, for example, Goode, The Economic Definition of Income, pp. 
16-17, and Bradford, Untangling the Income Tax, pp. 19-21, and pp.30-31.
  \20\ The 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.
---------------------------------------------------------------------------
  The treatment of charitable donations, however, is ambiguous under a 
comprehensive income tax. If charitable contributions are a consumption 
item for the giver, then they are properly included in his taxable 
income; a deduction for contributions would then be a tax expenditure 
relative to a comprehensive income tax baseline. In contrast, charitable 
contributions could represent a transfer of purchasing power from the 
giver to the receiver. As such, they would represent a reduction in the 
giver's net worth, not an item of consumption, and so properly would be 
deductible, implying that current law's treatment is not a tax 
expenditure. At the same time, the value of the charitable benefits 
received is income to the recipient. Under current law, such income 
generally is not taxed, and so represents a tax expenditure whose size 
might be approximated by the size of the donor's contribution. \21\
---------------------------------------------------------------------------
  \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.

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

[[Page 133]]

  Medical expenditures may or may not be an element of income (or 
consumption), depending on one's point of view. Some argue that medical 
expenditures don't represent discretionary spending, and so are not 
consumption. Instead, they are a reduction of net worth and should be 
excluded from the tax base. Others argue that there is no way to 
logically distinguish medical care from other consumption items. 
Moreover, clearly there is choice in health care decisions, e.g., 
whether to go to the best doctor, whether to have voluntary surgical 
procedures, and whether to exercise and eat nutritiously so as to 
improve and maintain one's health and minimize medical expenditures.
  The final category (panel D) includes items that probably are not tax 
expenditures under a comprehensive income tax base. But even these raise 
some issues. Mortgage interest would be deductible from the base of a 
comprehensive income tax, because comprehensive income would include 
implicit rental income on owner-occupied housing. Similarly, property 
taxes on owner-occupied housing would be deductible, since they 
represent a reduction in net worth. \22\ One could argue, however, that 
because current law fails to impute rental income, the home mortgage 
interest deduction and the deduction for property taxes constitute tax 
expenditures. Alternatively, they might be viewed as proxies for the 
correct tax expenditure. They are, however, extremely crude proxies for 
the implicit rental income earned on owner-occupied housing. The 
interest deduction proxy, for example, ignores implicit rental income 
earned on a house that is unencumbered by any mortgage.
---------------------------------------------------------------------------
  \22\ Of course, the value of government services would be included in 
net income.
---------------------------------------------------------------------------
  A comprehensive income tax would assign all income tax liability to 
individuals. There would be no separate corporation income tax. Hence, 
the issue of graduated corporate tax rates would not come up. \23\ Under 
some views, graduated individual income tax rates might result in a tax 
expenditure or in a negative tax expenditure, depending on the decision 
regarding the general tax rate.
---------------------------------------------------------------------------
  \23\ As discussed below, the double tax on corporate profits would be 
a major negative tax expenditure.
---------------------------------------------------------------------------
  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. \24\
---------------------------------------------------------------------------
  \24\ 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.
---------------------------------------------------------------------------

    Major Tax Expenditures Under a Comprehensive Income Tax That Are 
                    Excluded from the Current Budget

  While most of the major tax expenditures in the current budget also 
would be tax expenditures under a comprehensive income base, there also 
are tax expenditures relative to a comprehensive income base that are 
not found on the existing tax expenditure list. These additional tax 
expenditures include the imputed return from consumer durables and 
owner-occupied housing, the difference between capital gains as they 
accrue and capital gains as they are realized, private gifts and 
inheritances received, in-kind benefits from such government programs as 
food-stamps, Medicaid, and public housing, the value of payouts from 
insurance policies, \25\ 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 or as necessary 
expenditures that are not items of voluntary consumption. The foreign 
tax credit also might be a tax expenditure, since it could be argued 
that a deduction for foreign taxes, rather than a credit, would seem to 
measure the income of U.S. residents properly.
---------------------------------------------------------------------------
  \25\ To the extent that premiums are deductible.
---------------------------------------------------------------------------

                        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 defined to be similar to government spending 
programs.
  If attention is expanded 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, which would be eliminated 
under a comprehensive income tax applied to individuals as discussed 
later in the Appendix. 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. \26\ 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. \27\
---------------------------------------------------------------------------
  \26\ Current law offers favorable treatment to some education costs, 
thereby creating (positive) tax expenditures. Current law allows 
expensing of that part of the cost of education and career training that 
is related to foregone earnings and this would be a tax expenditure 
under a comprehensive income baseline. In addition, some education has 
consumption value, and under a comprehensive income definition would be 
taxable to that extent, but is not taxable under current law.
  \27\ See Bradford, Untangling the Income Tax, p. 41.
---------------------------------------------------------------------------
  Current tax law fails to index for inflation interest receipts, 
capital gains, depreciation, and inventories. These provisions are 
negative tax expenditures because

[[Page 134]]

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 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. \28\
---------------------------------------------------------------------------
  \28\ 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 Expenditures and the Tax Rate Structure

  Under some views, the graduated personal income tax rate structure 
might result in a tax expenditure or in a negative tax expenditure. To 
the extent that one views a single tax rate as most compatible with a 
comprehensive income base, tax rates above the appropriate single rate 
would yield a negative tax expenditure. To the extent that one views a 
graduated tax rate structure as most desirable, then differences between 
the appropriate graduated tax rate structure and the actual tax rate 
structure would lead to tax expenditures or negative tax expenditures.

   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 
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 baseline, concluding that about one-half of the top 
thirty official tax expenditures would remain tax expenditures under a 
consumption 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 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 
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 more obvious, for the consumption tax 
baseline.
  It is not always clear how to treat certain items under a consumption 
tax. One problem is determining whether a particular expenditure is an 
item of consumption. Spending on medical care and charitable donations 
are two examples. Another problem is related to foreign source income. 
It is sometimes argued that a credit for foreign income taxes is 
inappropriate against the base of a consumption tax. Does that mean that 
the current foreign tax credit is a tax expenditure for a consumption 
tax base? The classification below includes medical spending and 
charitable contributions in the definition of consumption, but also 
considers an alternative view. It makes no judgment about the treatment 
of foreign taxes, but provides a brief discussion of the issue.
  There may be more than one way to treat various items under a 
consumption tax. For example, a consumption tax might ignore borrowing 
and lending by excluding from the borrower's tax base the proceeds from 
loans, denying the borrower a deduction for payments of interest and 
principal, and excluding interest and principal payments received from 
the lender's tax base. On the other hand, a consumption tax might 
include borrowing and lending in the tax base by requiring the borrower 
to add the proceeds from loans in his tax base, allowing the lender to 
deduct loans from his tax base, allowing the borrower to deduct payments 
of principal and interest, and requiring the lender to include receipt 
of principal and interest payments. In present value terms, the two 
approaches are equivalent for both the borrower and the lender; in 
particular both allow the tax base to measure consumption and both 
impose a zero effective tax rate on interest income. But which approach 
is taken obviously has different implications (at least on an annual 
flow basis) for the treatment of many important items of income and 
expense, such as the home mortgage interest deduction. The 
classification below suggests that the deduction for home mortgage 
interest probably should be a tax expenditure, but takes note of 
alternative views.

[[Page 135]]

  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 generally takes a broad view of this 
equivalence and considers tax provisions that reduce or eliminate the 
tax on capital income to be consistent with a broad-based consumption 
tax.
  Looking at provisions one at a time can be misleading. The hybrid 
character of the existing tax system leads to many provisions that might 
make good sense in the context of a consumption tax, but that generate 
inefficiencies because of the problem of the ``uneven playing field'' 
when evaluated within the context of the existing tax rules. It is not 
clear how these should be classified. For example, many saving 
incentives are targeted to specific tax-favored sources of capital 
income, and so potentially distort economic choices in ways that would 
not occur under a broad-based consumption tax. As another example, under 
a consumption value added tax (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 generally views 
savings incentives, even if targeted, as consistent with a broad based 
consumption tax.
  Capital gains would not be a part of a comprehensive consumption tax 
base. Proceeds from asset sales and sometimes borrowing would be part of 
the cash-flow tax base, but, for transactions between domestic investors 
at a flat tax rate, would cancel out in the economy as a whole. How 
should existing tax expenditures related to capital gains be classified? 
The classification below generally views available capital gains tax 
breaks as consistent with a broad-based consumption tax because they 
lower the tax rate on capital income toward the zero rate that is 
consistent with a consumption-based tax. By implication, this also means 
that capital gains taxes paid under a broad-based consumption tax are 
negative tax expenditures.
  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, Table 2 attempts a 
classification based on the criteria outlined above.

 Treatment of Major Tax Expenditures Under a Comprehensive Consumption 
                                Baseline

  As noted above, the major difference between a comprehensive 
consumption tax and a comprehensive income tax is in the treatment of 
saving, or in the taxation of capital income. Consequently, many current 
tax expenditures related to preferential taxation of capital income 
would not be tax expenditures under a consumption tax. However, 
preferential treatment of items of income unrelated to fairly broad-
based saving incentives would remain tax expenditures under a 
consumption baseline.
  Table 2 shows the thirty largest tax expenditures from the 2004 Budget 
classified according to whether they would be considered a tax 
expenditure under a consumption tax. Four of the thirty items clearly 
would be tax expenditures (those in panel A).
  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

[[Page 136]]

would correspond to including 50 percent of Social Security benefits in 
the recipient's tax base.
  Exclusion of workers' compensation benefits allows an exclusion from 
income that is unrelated to investment, and so should be included in the 
base of a comprehensive consumption tax.
  The credit for increasing research activities gives a negative 
effective tax rate because the cost of investment in research can be 
deducted immediately. As discussed above, expensing reduces to zero the 
effective tax rate on the income from an investment. Giving a tax credit 
on top of expensing leads to a negative effective tax rate; it gives 
better than consumption tax treatment to the income earned by the 
qualifying investment. A tax subsidy for research might be justified to 
the extent that the full social return from an investment is not 
captured by the investor, because, e.g., others can freely learn from 
the results of the research. Nonetheless, such a subsidy is inconsistent 
with a broad-based consumption tax.
  An additional twelve items (panel B) probably would be tax 
expenditures under a consumption base. Each of these twelve, however, 
comes with some ambiguity. Several of these items relate to the costs of 
medical care or to charitable contributions. As discussed in the 
previous section of the appendix, there is disagreement within the tax 
policy community over the extent to which medical care and charitable 
giving represent consumption items. While widely held to be consumption, 
a competing view is that they represent reductions in net worth that 
should be excluded from the tax base because they do not yield direct 
satisfaction to taxpayer who makes the expenditure.
  There also is the issue of how to tax employer-provided medical 
insurance. Under current law, employees do not have to include insurance 
premiums paid for by employers in their income. The self-employed also 
may exclude (via a deduction) medical insurance premiums from their 
taxable income. Assume first that medical spending is consumption. 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 the 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.
  Ambiguity also surrounds the deductibility of home mortgage interest. 
A consumption tax seeks to tax the consumption value of housing services 
consumed no matter how the house is financed. From this perspective, 
home mortgage interest should not be deductible. However, what governs 
the proper treatment of interest under a consumption tax is whether 
financial flows are in or out of the consumption tax base. A result 
equivalent to disallowing the interest deduction would require that the 
loan be taken into income and would permit the associated interest and 
principal payments to be deducted. If the loans are taken into income 
(as they would be under some types of consumption taxes), then the 
associated interest and principal payments should be deductible, 
otherwise not. Without specifying how financial flows are treated, it is 
unclear how to treat the home mortgage interest deduction. Nonetheless, 
given that loans are not taken into income under current law, and this 
treatment's equivalency to disallowing the interest deduction, 
classifying the deduction of home mortgage interest as a tax expenditure 
might be reasonable.
  Ambiguities arise about the proper treatment of State and local taxes, 
as they do under an income tax. These taxes are not of themselves 
consumption items, but might serve as proxies for the value of 
government services consumed.
  The child credit and the earned income tax credit can be viewed as 
social welfare programs unrelated to measuring and taxing consumption. 
As such, they would be tax expenditures relative to a consumption 
baseline. Yet, from another perspective, these credits look similar to a 
personal or dependent deduction that many would see as appropriate under 
a broad-based consumption tax.
  The extraterritorial income exclusion replaces the previous Foreign 
Sales Corporation program. It provides an exclusion from income for 
certain exports. To the extent that the program is viewed as a component 
of a destination-based VAT it might not be a tax expenditure. In 
addition, to the extent that the exclusion is an investment subsidy, it 
might be consistent with consumption tax principles (i.e., a low tax 
rate on capital income).
  The remaining items in the table (panels C and D) are not likely to be 
tax expenditures under a consumption base. Exemption of workers' 
compensation insurance premiums would not be a tax expenditure because 
it represents double counting, given that the exemption of benefits 
already is a tax expenditure, as discussed in the previous section of 
the appendix.
  Most of the other items that would not be tax expenditures 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

[[Page 137]]

  The graduated corporate income tax rates would not be a tax 
expenditure under a comprehensive consumption baseline. A consumption 
tax would have no tax on corporate income or profits, hence the issue of 
whether the rate structure on corporate income provides a special 
benefit to corporations with low income would not arise.
  The exception from the passive loss rules probably would not be a tax 
expenditure because proper measurement of income, and hence of 
consumption, requires full deduction of losses.

 Major Tax Expenditures under a Consumption Tax That Are Excluded from 
                           the Current Budget

  Several differences between current law and a consumption tax are left 
off the official tax expenditure list. Additional tax expenditures 
include the imputed consumption value from consumer durables and owner-
occupied housing, 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 if they were 
not imputed to the tax base.
  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.
  The foreign tax credit also might be a tax expenditure relative to a 
consumption baseline, but the argument for this is not air-tight. From a 
formalistic perspective, the foreign tax credit would be a tax 
expenditure because it applies against income tax and there would be no 
income tax under a consumption baseline. In addition, it is sometimes 
argued that a deduction for foreign taxes, rather than a credit, is 
appropriate under a comprehensive consumption tax because the taxpayer's 
increase in net worth properly is measured after payment of foreign 
taxes. Nonetheless, simply eliminating the credit for foreign taxes 
would subject the return earned by U.S. residents on overseas investment 
to double taxation, and would disfavor foreign investment relative to 
domestic investment.

                        Negative Tax Expenditures

  Importantly, current law also deviates from a consumption tax norm in 
ways that increase, rather than decrease, tax liability. These could be 
called negative tax expenditures. The official budget excludes negative 
tax expenditures on the theory that tax expenditures are intended to 
substitute for government spending programs. Yet excluding negative tax 
expenditures would give a very one-sided look at the differences between 
the existing tax system and a consumption tax.
  A large item on this list would be the inclusion of capital income in 
the current individual income tax base. The revenue from the corporation 
income tax also would be a negative tax expenditure. Depreciation 
allowances, even if accelerated, would be a negative tax expenditure 
since consumption tax treatment generally would require expensing. 
Depending on the treatment of loans, the borrower's inability to deduct 
payments of principal and the lender's inability to deduct loans might 
be a negative tax expenditure. The passive loss rules, restrictions on 
the deductibility of capital losses, and NOL carryforward provisions 
also would generate negative tax expenditures, because the change in net 
worth requires a deduction for losses. If human capital were considered 
an asset, then its cost (e.g., certain education and training expenses, 
including perhaps costs of college and professional school) should be 
expensed, but it is not under current law. Certain restrictions under 
the individual AMT as well as the phase-out of personal exemptions and 
of itemized deductions also might be considered negative tax 
expenditures.

               Tax Expenditures and the Tax Rate Structure

  Under some views, the graduated personal income tax rate structure 
might result in a tax expenditure or in a negative tax expenditure when 
compared with a consumption tax base. To the extent that one views a 
single tax rate as most compatible with a consumption tax base, tax 
rates above the appropriate single rate would yield a negative tax 
expenditure. To the extent that one views a graduated tax rate structure 
as most desirable, then differences between the appropriate graduated 
tax rate structure and the actual tax rate structure would lead to tax 
expenditures or negative tax expenditures.

             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

[[Page 138]]

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.
  In this year's 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. \29\ The revised estimates are 
intended to approximate the degree of acceleration provided by current 
law over a baseline determined by real, inflation adjusted, economic 
depreciation. Current law depreciation allowances for machinery and 
equipment include the benefits of the temporary 30 percent expensing 
provision. \30\ The estimates are shown in tables in the body of the 
main text, e.g., Table 6-1.
---------------------------------------------------------------------------
  \29\ See 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.
  \30\ The 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. 
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.
---------------------------------------------------------------------------
  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. \31\ In part 
this is because the new baseline uses depreciation allowances that are 
faster than those in the old baseline. In addition, the new baseline 
calculates depreciation on a replacement cost basis rather on the 
historic cost basis previously used; this translates into larger 
depreciation allowances to the extent that asset prices rise over time. 
In many years the new tax expenditures are negative, indicating that 
current law's tax depreciation allowances are smaller than those implied 
by economic depreciation. Because these estimates are on a cash flow, 
rather than a present value, basis, the negative value does not 
necessarily indicate that tax depreciation is decelerated relative to 
economic depreciation over the life of an investment. Even when tax 
depreciation is accelerated over the life of an investment, negative 
annual cash flow estimates could obtain in the later years of an 
investment's economic life. This type of vintage effect contributes 
importantly to the negative tax expenditures calculated for equipment in 
2005-2008 because the temporary expensing provision expires in 2004. 
Calculations that compare the present value of tax depreciation (without 
30 percent 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. \32\
---------------------------------------------------------------------------
  \31\ Estimates under the old methodology are no longer shown in the 
tables.
  \32\ 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.
---------------------------------------------------------------------------

                         Owner-Occupied Housing

  A homeowner receives a flow of housing services equal in gross value 
to the rent that could have been earned had the owner chosen to rent the 
house to others. Comprehensive income would include in its base the 
implicit net rental income earned on investment in owner-occupied 
housing. Current law, however, excludes from its tax base such net 
rental income. This exclusion is a tax expenditure relative to a 
comprehensive income base.
  In contrast to a comprehensive income baseline, the official list of 
tax expenditures does not include the exclusion of implicit rental 
income on owner-occupied housing. Instead, it includes as tax 
expenditures deductions for home mortgage interest and for property 
taxes. These are poor proxies for the exclusion of implicit net rental 
income. To the extent that a homeowner owns his house outright, 
unencumbered by a mortgage, he would have no home mortgage interest 
deduction, yet he still would enjoy the benefits of receiving tax free 
the implicit rental income earned on his house. When measuring the net 
income from an investment in owner-occupied housing, mortgage interest 
and property taxes generally would be deductible. The official tax 
expenditures do not allow for depreciation and other costs incurred by 
the homeowner that must be deducted in determining his net rental 
income.
  Table 3 shows an estimate of the tax expenditure caused by the 
exclusion of implicit net rental income from investment in owner-
occupied housing. This estimate starts with the NIPA calculated value of 
gross rent on owner-occupied housing, and subtracts interest, taxes, 
economic depreciation, and other costs in arriving at an estimate of 
net-rental income from owner-occupied housing. \33\
---------------------------------------------------------------------------
  \33\ National Income and Production Accounts, Table 2.4.
---------------------------------------------------------------------------
  The tax expenditure estimate is substantial, growing from $20 billion 
in 1994 to $31 billion in 2008. Nonetheless, it is only about one-third 
as large as the official tax expenditure for the deduction of home 
mortgage interest. In part this discrepancy reflects depreciation and 
other expenses that must be subtracted from gross rents in arriving at 
net rental income. In part, it also might reflect homeowners' ability to 
borrow against their homes to fund other spending, leading to a 
relatively high debt/equity ratio for housing.

                     Double Tax on Corporate Profits

  A comprehensive income tax would tax all sources of income once at a 
tax rate appropriate for the particular taxpayer. Taxes would not vary 
by type or source of income.
  In contrast to this benchmark, current law may tax 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

[[Page 139]]

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 beings distributed to noncorporate shareholders. 
Corporate level taxes cascade because corporations and 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. The President 
has proposed in this Budget to remove the double taxation of corporate 
profits.
  Table 3 provides an estimate of the negative tax expenditure caused by 
the multiple levels of tax on corporate profits. This negative tax 
expenditure includes the shareholder level tax on dividends paid and 
capital gains realized out of earnings that have been 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 negative tax expenditure is large in magnitude; it grows from $25 
billion in 2004 to $33 billion in 2008. It is comparable in size (but 
opposite in sign) to all but the largest official tax expenditures.

                                     

                     Appendix Table 1.  COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX \1\

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                          Revenue Effect
                                                              Description                                                                     (2004)
--------------------------------------------------------------------------------------------------------------------------------------------------------
A.  Tax Expenditure Under a Comprehensive Income Tax
Net exclusion of pension contributions and earnings: Employer plans....................................................................      67,870
Net exclusion of pension contributions and earnings: 401(k) plans......................................................................      55,290
Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method).....................................................      53,930
Exclusion of interest on public purpose State and local bonds..........................................................................      27,310
Net exclusion of pension contributions and earnings: Individual Retirement Accounts....................................................      23,130
Capital gains exclusion on home sales..................................................................................................      20,860
Exclusion of interest on life insurance savings........................................................................................      20,740
Accelerated depreciation of machinery and equipment (normal tax method)................................................................      16,670
Deferral of income from controlled foreign corporations (normal tax method)............................................................       7,900
Net exclusion of pension contributions and earnings: Keogh plans.......................................................................       7,616
Extraterritorial income exclusion......................................................................................................       5,510
Credit for increasing research activities..............................................................................................       4,990
Exclusion of Social security benefits of dependents and survivors......................................................................       4,140

B.  Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications
 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes.................................................      50,910
 Step-up basis of capital gains at death...............................................................................................      28,500
 Child credit..........................................................................................................................      21,310
 Exclusion of Social Security benefits for retired workers.............................................................................      18,930
 Exclusion of workers' compensation benefits...........................................................................................       6,460
 Workers' compensation insurance premiums..............................................................................................       6,190
 Earned income tax credit..............................................................................................................       5,090

C.  Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care....................................................     120,160
Deductibility of charitable contributions, other than education and health.............................................................      33,990
Deductibility of medical expenses......................................................................................................       6,340
Deductibility of charitable contributions (health).....................................................................................       4,580
Deductibility of charitable contributions (education)..................................................................................       4,350
Deductibility of self-employed medical insurance premiums..............................................................................       3,690

D.  Probably Not a Tax Expenditure Under a Comprehensive Income Tax
 Deductibility of mortgage interest on owner-occupied homes............................................................................      68,440
 Deductibility of State and local property tax on owner-occupied homes.................................................................      22,160
 Graduated corporation income tax rate (normal tax method).............................................................................       5,700
 Exception from passive loss rules for $25,000 of rental loss..........................................................................       4,920
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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 6-2, Tax Expenditure Budget.


[[Page 140]]


                   Appendix Table 2.  COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX \1\

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                          Revenue Effect
                                                              Description                                                                     (2004)
--------------------------------------------------------------------------------------------------------------------------------------------------------
A.  Tax Expenditure Under a Consumption Base
Exclusion of Social Security benefits for retired workers..............................................................................      18,930
Exclusion of workers' compensation benefits............................................................................................       6,460
Credit for increasing research activities..............................................................................................       4,990
Exclusion of Social Security benefits of dependents and survivors......................................................................       4,140

B.  Probably a Tax Expenditure Under a Consumption Base
Exclusion of employer contributions for medical insurance premiums and medical care....................................................     120,160
Deductibility of mortgage interest on owner-occupied homes.............................................................................      68,440
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes..................................................      50,910
Deductibility of charitable contributions, other than education and health.............................................................      33,990
Deductibility of State and local property tax on owner-occupied homes..................................................................      22,160
Child credit...........................................................................................................................      21,310
Deductibility of medical expenses......................................................................................................       6,340
Extraterritorial income exclusion......................................................................................................       5,510
Earned income tax credit...............................................................................................................       5,090
Deductibility of charitable contributions (health).....................................................................................       4,580
Deductibility of charitable contributions (education)..................................................................................       4,350
Deductibility of self-employed medical insurance premiums..............................................................................       3,690

C.  Probably Not a Tax Expenditure Under a Consumption Base
Workers' compensation insurance premiums...............................................................................................       6,190

D.   Not a Tax Expenditure Under a Consumption Base
Net exclusion of pension contributions and earnings: Employer plans....................................................................      67,870
Net exclusion of pension contributions and earnings: 401(k) plans......................................................................      55,290
Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method).....................................................      53,930
Step-up basis of capital gains at death................................................................................................      28,500
Exclusion of interest on public purpose State and local bonds..........................................................................      27,310
Net exclusion of pension contributions and earnings: Individual Retirement Accounts....................................................      23,130
Capital gains exclusion on home sales..................................................................................................      20,860
Exclusion of interest on life insurance savings........................................................................................      20,740
Accelerated depreciation of machinery and equipment (normal tax method)................................................................      16,663
Deferral of income from controlled foreign corporations (normal tax method)............................................................       7,900
Net exclusion of pension contributions and earnings: Keogh plans.......................................................................       7,616
Graduated corporation income tax rate (normal tax method)..............................................................................       5,700
Exception from passive loss rules for $25,000 of rental loss...........................................................................       4,920
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even when the provision
  would be a tax expenditure under both baselines.

Source: Table 6-2, Tax Expenditure Budget.


                  Appendix Table 3.  POSSIBLE FUTURE ADDITIONS TO TAX EXPENDITURE ESTIMATES \1\

----------------------------------------------------------------------------------------------------------------
                                                                  2004      2005      2006      2007      2008
----------------------------------------------------------------------------------------------------------------
Imputed Rent On Owner-Occupied Housing........................    20,517    24,064    25,092    28,052    31,002
Double Tax on Corporate Profits \2\...........................   -25,373   -32,723   -31,590   -32,022   -33,096
----------------------------------------------------------------------------------------------------------------
\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.