[Analytical Perspectives]
[Federal Receipts and Collections]
[18. Tax Expenditures]
[From the U.S. Government Printing Office, www.gpo.gov]
[[Page 285]]
18. 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 2003-2009 using three methods of
accounting: revenue effects, outlay equivalent, and present value. The
present value approach provides estimates of the revenue effects for tax
expenditures that generally involve deferrals of tax payments into the
future.
The section of the chapter on performance measures and economic
effects presents information related to assessment of the effect of tax
expenditures on the achievement of program performance goals. This
section is a complement to the Government-wide performance plan required
by the Government Performance and Results Act of 1993.
The 2004 Budget included a thorough review of important ambiguities in
the tax expenditure concept. In particular, this review focused on
defining tax expenditures relative to a comprehensive income tax
baseline, defining tax expenditures relative to a broad-based
consumption tax baseline, and defining negative tax expenditures, i.e.,
provisions of current law that over-tax certain items or activities.
This review has been updated and is presented in the Appendix.
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, 2003. Expired or repealed provisions
are not listed if their revenue effects result only from taxpayer
activity occurring before fiscal year 2003. 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 2003-
2009 are displayed according to the budget's functional categories in
Table 18-1. Descriptions of the specific tax expenditure provisions
follow the tables of estimates and the discussion of general features of
the tax expenditure concept.
As in prior years, two baseline concepts--the normal tax baseline and
the reference tax law baseline--are used to identify tax expenditures.
These baseline concepts are thoroughly discussed in Special Analysis G
of the 1985 Budget, where the former is referred to as the pre-1983
method, and the latter the post-1982 method. For the most part, the two
concepts coincide. However, items treated as tax expenditures under the
normal tax baseline, but not the reference tax law baseline, are
indicated by the designation ``normal tax method'' in the tables. The
revenue effects for these items are zero using the reference tax rules.
The alternative baseline concepts are discussed in detail following the
tables.
Table 18-2 reports the respective portions of the total revenue
effects that arise under the individual and corporate income taxes
separately. The location of the estimates under the individual and
corporate headings does not imply that these categories of filers
benefit from the special tax provisions in proportion to the respective
tax expenditure amounts shown. Rather, these breakdowns show the
specific tax accounts through which
[[Page 286]]
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 18-3 ranks the major tax expenditures by the size of their FY
2005-2009 revenue effect.
Interpreting Tax Expenditure Estimates
The estimates shown for individual tax expenditures in Tables 18-1,
18-2, and 18-3 do not necessarily equal the increase in Federal revenues
(or the change in the budget balance) that would result from repealing
these special provisions, for the following reasons:
Eliminating a tax expenditure may have incentive effects that alter
economic behavior. These incentives can affect the resulting magnitudes
of the activity or of other tax provisions or Government programs. For
example, if capital gains were taxed at ordinary rates, capital gain
realizations would be expected to decline, potentially resulting in a
decline in tax receipts. Such behavioral effects are not reflected in
the estimates.
Tax expenditures are interdependent even without incentive effects.
Repeal of a tax expenditure provision can increase or decrease the tax
revenues associated with other provisions. For example, even if behavior
does not change, repeal of an itemized deduction could increase the
revenue costs from other deductions because some taxpayers would be
moved into higher tax brackets. Alternatively, repeal of an itemized
deduction could lower the revenue cost from other deductions if
taxpayers are led to claim the standard deduction instead of itemizing.
Similarly, if two provisions were repealed simultaneously, the increase
in tax liability could be greater or less than the sum of the two
separate tax expenditures, because each is estimated assuming that the
other remains in force. In addition, the estimates reported in Table 18-
1 are the totals of individual and corporate income tax revenue effects
reported in Table 18-2 and do not reflect any possible interactions
between the individual and corporate income tax receipts. For this
reason, the estimates in Table 18-1 (as well as those in Table 18-5,
which are also based on summing individual and corporate estimates)
should be regarded as approximations.
Present-Value Estimates
The annual value of tax expenditures for tax deferrals is reported on
a cash basis in all tables except Table 18-4. Cash-based estimates
reflect the difference between taxes deferred in the current year and
incoming revenues that are received due to deferrals of taxes from prior
years. Although such estimates are useful as a measure of cash flows
into the Government, they do not accurately reflect the true economic
cost of these provisions. For example, for a provision where activity
levels have changed, so that incoming tax receipts from past deferrals
are greater than deferred receipts from new activity, the cash-basis tax
expenditure estimate can be negative, despite the fact that in present-
value terms current deferrals do have a real cost to the Government.
Alternatively, in the case of a newly enacted deferral provision, a
cash-based estimate can overstate the real effect on receipts to the
Government because the newly deferred taxes will ultimately be received.
Present-value estimates, which are a useful complement to the cash-basis
estimates for provisions involving deferrals, are discussed below.
Discounted present-value estimates of revenue effects are presented in
Table 18-4 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 2003 which cause the deferrals or other long-term revenue
effects. For instance, a pension contribution in 2003 would cause a
deferral of tax payments on wages in 2003 and on pension earnings on
this contribution (e.g., interest) in later years. In some future year,
however, the 2003 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.
[[Page 287]]
Table 18-1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Total from corporations and individuals
------------------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2005-09
----------------------------------------------------------------------------------------------------------------
National Defense
1 Exclusion of 2,210 2,240 2,260 2,290 2,310 2,330 2,350 11,540
benefits and
allowances to
armed forces
personnel........
International
Affairs
2 Exclusion of 2,620 2,680 2,750 2,810 2,940 3,100 3,270 14,870
income earned
abroad by U.S.
citizens.........
3 Exclusion of 770 800 840 880 920 960 1,010 4,610
certain
allowances for
Federal employees
abroad...........
4 Extraterritorial 5,150 5,510 5,890 6,290 6,730 7,200 7,700 33,810
income exclusion.
5 Inventory property 1,540 1,620 1,700 1,790 1,880 1,980 2,080 9,430
sales source
rules exception..
6 Deferral of income 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010
from controlled
foreign
corporations
(normal tax
method)..........
7 Deferred taxes for 2,050 2,130 2,190 2,260 960 ........ ........ 5,410
financial firms
on certain income
earned overseas..
General Science,
Space, and
Technology
8 Expensing of -1,980 -2,350 4,500 8,290 7,110 6,360 5,570 31,830
research and
experimentation
expenditures
(normal tax
method)..........
9 Credit for 4,960 4,400 2,550 1,090 460 150 60 4,310
increasing
research
activities.......
Energy
10 Expensing of 210 270 170 80 70 60 40 420
exploration and
development
costs, fuels.....
11 Excess of 640 620 580 590 610 610 610 3,000
percentage over
cost depletion,
fuels............
12 Alternative fuel 1,280 890 890 890 890 350 ........ 3,020
production credit
13 Exception from 20 20 20 20 20 20 20 100
passive loss
limitation for
working interests
in oil and gas
properties.......
14 Capital gains 100 110 120 120 130 130 140 640
treatment of
royalties on coal
15 Exclusion of 90 100 110 110 120 130 130 600
interest on
energy facility
bonds............
16 Enhanced oil 400 400 410 420 430 440 450 2,150
recovery credit..
17 New technology 280 350 370 370 370 370 370 1,850
credit...........
18 Alcohol fuel 30 30 30 30 30 30 30 150
credits \1\......
19 Tax credit and 70 60 10 -20 -70 -60 -70 -210
deduction for
clean-fuel
burning vehicles.
20 Exclusion from 80 80 80 80 80 80 80 400
income of
conservation
subsidies
provided by
public utilities.
Natural Resources
and Environment
21 Expensing of 10 10 10 10 10 10 10 50
exploration and
development
costs, nonfuel
minerals.........
22 Excess of 250 250 260 260 270 280 280 1,350
percentage over
cost depletion,
nonfuel minerals.
23 Exclusion of 450 490 530 570 590 630 650 2,970
interest on bonds
for water,
sewage, and
hazardous waste
facilities.......
24 Capital gains 100 110 120 120 130 130 140 640
treatment of
certain timber
income...........
25 Expensing of 340 340 350 370 380 400 410 1,910
multiperiod
timber growing
costs............
26 Tax incentives for 270 290 300 320 330 340 370 1,660
preservation of
historic
structures.......
Agriculture
27 Expensing of 120 130 130 130 140 150 160 710
certain capital
outlays..........
28 Expensing of 90 90 90 100 100 100 100 490
certain
multiperiod
production costs.
29 Treatment of loans 10 10 10 10 10 10 10 50
forgiven for
solvent farmers..
30 Capital gains 1,050 1,100 1,160 1,220 1,280 1,350 1,420 6,430
treatment of
certain income...
31 Income averaging 70 80 80 80 80 90 90 420
for farmers......
32 Deferral of gain 10 10 10 10 20 20 20 80
on sale of farm
refiners.........
Commerce and Housing
Financial
institutions and
insurance:
33 Exemption of 1,300 1,360 1,430 1,500 1,570 1,650 1,730 7,880
credit union
income..........
34 Excess bad debt 40 30 20 20 10 ........ ........ 50
reserves of
financial
institutions....
35 Exclusion of 18,900 20,500 22,130 24,010 26,050 28,260 30,660 131,110
interest on life
insurance
savings.........
36 Special 120 120 130 130 140 140 140 680
alternative tax
on small
property and
casualty
insurance
companies.......
37 Tax exemption of 190 210 220 240 250 260 280 1,250
certain
insurance
companies owned
by tax-exempt
organizations...
38 Small life 90 90 90 90 90 90 90 450
insurance
company
deduction.......
Housing:
39 Exclusion of 910 990 1,080 1,150 1,200 1,280 1,320 6,030
interest on
owner-occupied
mortgage subsidy
bonds...........
40 Exclusion of 280 310 350 370 380 400 410 1,910
interest on
rental housing
bonds...........
41 Deductibility of 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910
mortgage
interest on
owner-occupied
homes...........
42 Deductibility of 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
State and local
property tax on
owner-occupied
homes...........
43 Deferral of 1,080 1,100 1,120 1,140 1,160 1,190 1,200 5,810
income from post
1987 installment
sales...........
44 Capital gains 20,260 20,860 21,490 22,140 22,800 23,480 24,190 114,100
exclusion on
home sales......
45 Exception from 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120
passive loss
rules for
$25,000 of
rental loss.....
46 Credit for low- 6,210 6,550 6,860 7,180 7,470 7,830 8,210 37,550
income housing
investments.....
47 Accelerated 1,220 620 -170 -1,110 -2,330 -3,560 -4,900 -12,070
depreciation on
rental housing
(normal tax
method).........
Commerce:
48 Cancellation of 20 30 30 30 40 40 40 180
indebtedness....
49 Exceptions from 50 50 50 50 50 50 50 250
imputed interest
rules...........
50 Capital gains 25,730 27,300 30,190 32,930 36,410 48,930 29,210 177,670
(except
agriculture,
timber, iron
ore, and coal)
\2\.............
51 Capital gains 130 160 210 250 300 350 390 1,500
exclusion of
small
corporation
stock...........
52 Step-up basis of 14,880 16,280 18,240 20,240 22,240 24,190 26,010 110,920
capital gains at
death...........
53 Carryover basis 590 390 450 540 550 580 620 2,740
of capital gains
on gifts........
54 Ordinary income 40 50 50 50 50 50 50 250
treatment of
loss from small
business
corporation
stock sale......
55 Accelerated -2,290 -3,190 -4,060 -4,690 -6,810 -10,170 -14,430 -40,160
depreciation of
buildings other
than rental
housing (normal
tax method).....
[[Page 288]]
56 Accelerated 48,520 46,800 -10,920 -37,940 -31,040 -28,770 -27,590 -136,26
depreciation of 0
machinery and
equipment
(normal tax
method).........
57 Expensing of 1,030 1,590 4,850 1,650 -490 -30 130 6,110
certain small
investments
(normal tax
method).........
58 Amortization of 110 120 130 150 160 160 160 760
start-up costs
(normal tax
method).........
59 Graduated 3,030 3,090 3,910 4,650 4,800 4,890 5,040 23,290
corporation
income tax rate
(normal tax
method).........
60 Exclusion of 390 430 470 490 520 550 570 2,600
interest on
small issue
bonds...........
Transportation
61 Deferral of tax on 20 20 20 20 20 20 20 100
shipping
companies........
62 Exclusion of 2,130 2,240 2,360 2,490 2,610 2,740 2,880 13,080
reimbursed
employee parking
expenses.........
63 Exclusion for 320 380 450 520 590 660 730 2,950
employer-provided
transit passes...
Community and
Regional
Development
64 Investment credit 30 30 30 30 30 30 30 150
for
rehabilitation of
structures (other
than historic)...
65 Exclusion of 770 840 910 970 1,020 1,080 1,110 5,090
interest for
airport, dock,
and similar bonds
66 Exemption of 60 60 70 70 70 70 70 350
certain mutuals'
and cooperatives'
income...........
67 Empowerment zones, 1,070 1,080 1,120 1,210 1,320 1,470 1,730 6,850
Enterprise
communities, and
Renewal
communities......
68 New markets tax 190 290 430 610 830 870 790 3,530
credit...........
69 Expensing of 80 20 -10 -10 -10 -10 -10 -50
environmental
remediation costs
Education, Training,
Employment, and
Social Services
Education:
70 Exclusion of 1,260 1,260 1,340 1,400 1,410 1,420 1,420 6,990
scholarship and
fellowship
income (normal
tax method).....
71 HOPE tax credit.. 3,290 3,420 3,510 3,290 3,330 3,320 3,310 16,760
72 Lifetime Learning 1,910 2,250 2,180 2,120 2,320 2,320 2,300 11,240
tax credit......
73 Education 70 110 140 190 240 300 370 1,240
Individual
Retirement
Accounts........
74 Deductibility of 730 760 780 800 820 830 840 4,070
student-loan
interest........
75 Deduction for 1,730 1,810 2,580 2,610 ........ ........ ........ 5,190
higher education
expenses........
76 State prepaid 50 150 320 430 510 590 660 2,510
tuition plans...
77 Exclusion of 260 280 310 320 340 360 380 1,710
interest on
student-loan
bonds...........
78 Exclusion of 780 850 930 990 1,030 1,100 1,130 5,180
interest on
bonds for
private
nonprofit
educational
facilities......
79 Credit for 80 90 110 130 130 140 140 650
holders of zone
academy bonds...
80 Exclusion of 10 10 10 10 20 20 20 80
interest on
savings bonds
redeemed to
finance
educational
expenses........
81 Parental personal 3,140 3,130 2,550 2,000 1,760 1,580 1,430 9,320
exemption for
students age 19
or over.........
82 Deductibility of 3,670 3,390 3,660 4,000 4,230 4,510 4,830 21,230
charitable
contributions
(education).....
83 Exclusion of 500 530 560 590 620 660 690 3,120
employer-
provided
educational
assistance......
84 Special deduction 140 140 ........ ........ ........ ........ ........ .......
for teacher
expenses........
Training,
employment, and
social services:
85 Work opportunity 430 370 170 70 30 ........ ........ 270
tax credit......
86 Welfare-to-work 60 60 40 30 20 ........ ........ 90
tax credit......
87 Employer provided 590 620 770 870 920 960 1,010 4,530
child care
exclusion.......
88 Employer-provided 90 130 140 150 160 170 180 800
child care
credit..........
89 Assistance for 250 290 330 380 430 480 540 2,160
adopted foster
children........
90 Adoption credit 220 450 500 540 560 570 580 2,750
and exclusion...
91 Exclusion of 780 810 850 890 930 970 1,000 4,640
employee meals
and lodging
(other than
military).......
92 Child credit \3\. 37,970 24,340 29,860 24,810 24,680 24,480 25,430 129,260
93 Credit for child 2,720 2,950 2,690 2,210 2,030 1,900 1,780 10,610
and dependent
care expenses...
94 Credit for 50 50 60 60 60 60 60 300
disabled access
expenditures....
95 Deductibility of 30,020 27,370 29,670 32,550 34,500 36,790 39,410 172,920
charitable
contributions,
other than
education and
health..........
96 Exclusion of 430 430 440 450 460 470 570 2,390
certain foster
care payments...
97 Exclusion of 380 400 420 450 480 510 540 2,400
parsonage
allowances......
Health
98 Exclusion of 101,920 106,720 112,990 120,940 129,820 139,620 150,300 653,670
employer
contributions for
medical insurance
premiums and
medical care.....
99 Deductibility of 2,550 3,740 3,780 4,090 4,370 4,750 5,150 22,140
self-employed
medical insurance
premiums.........
100 Medical Savings -30 -140 -570 -960 -1,380 -1,920 -2,180 -7,010
Accounts/Health
Savings Accounts.
101 Deductibility of 6,240 6,880 7,900 8,480 9,180 10,200 10,990 46,750
medical expenses.
102 Exclusion of 1,620 1,780 1,930 2,060 2,160 2,290 2,360 10,800
interest on
hospital
construction
bonds............
103 Deductibility of 3,390 3,090 3,350 3,670 3,890 4,150 4,450 19,510
charitable
contributions
(health).........
104 Tax credit for 160 180 200 220 250 280 310 1,260
orphan drug
research.........
105 Special Blue Cross/ 350 320 310 280 310 260 290 1,450
Blue Shield
deduction........
106 Tax credit for ........ 50 60 60 70 70 80 340
health insurance
purchased by
certain displaced
and retired
individuals \4\..
Income Security
107 Exclusion of 400 400 400 400 400 400 400 2,000
railroad
retirement system
benefits.........
108 Exclusion of 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710
workers'
compensation
benefits.........
109 Exclusion of 400 410 430 450 470 490 510 2,350
public assistance
benefits (normal
tax method)......
110 Exclusion of 60 60 50 50 50 40 40 230
special benefits
for disabled coal
miners...........
111 Exclusion of 100 110 110 110 110 120 120 570
military
disability
pensions
Net exclusion of
pension
contributions and
earnings:........
112 Employer plans... 59,480 59,380 61,740 66,340 62,650 58,360 60,440 309,530
[[Page 289]]
113 401(k) plans..... 51,560 56,740 58,910 61,340 65,750 71,080 75,440 332,520
114 Individual 20,060 19,810 20,090 20,610 20,150 19,710 19,490 100,050
Retirement
Accounts........
115 Low and moderate 880 960 1,100 1,210 730 ........ ........ 3,040
income savers
credit..........
116 Keogh plans...... 6,020 8,730 9,260 9,860 10,530 11,480 12,500 53,630
Exclusion of other
employee
benefits:
117 Premiums on group 1,800 1,830 1,860 1,890 1,920 1,950 1,990 9,610
term life
insurance.......
118 Premiums on 230 240 250 260 270 280 290 1,350
accident and
disability
insurance.......
119 Small business 40 80 100 130 140 150 150 670
retirement plan
credit...........
120 Income of trusts 30 30 30 30 30 30 30 .......
to finance
supplementary
unemployment
benefits.........
121 Special ESOP rules 1,780 1,920 2,060 2,220 2,400 2,580 2,780 12,040
122 Additional 40 30 40 40 40 40 40 200
deduction for the
blind............
123 Additional 1,840 1,710 1,800 1,900 1,960 1,920 1,940 9,520
deduction for the
elderly..........
124 Tax credit for the 20 10 10 10 10 10 10 50
elderly and
disabled.........
125 Deductibility of 500 690 670 680 640 600 630 3,220
casualty losses..
126 Earned income tax 5,099 4,884 5,006 5,477 5,515 5,603 5,780 27,381
credit \5\.......
Social Security
Exclusion of
social security
benefits:
127 Social Security 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420
benefits for
retired workers.
128 Social Security 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420
benefits for
disabled........
129 Social Security 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730
benefits for
dependents and
survivors.......
Veterans Benefits
and Services
130 Exclusion of 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560
veterans death
benefits and
disability
compensation.....
131 Exclusion of 100 100 100 110 110 110 120 550
veterans pensions
132 Exclusion of GI 110 120 130 130 160 170 170 760
bill benefits....
133 Exclusion of 40 50 50 50 60 60 60 280
interest on
veterans housing
bonds............
General Purpose
Fiscal Assistance
134 Exclusion of 25,480 25,980 26,370 26,440 26,150 26,940 27,750 133,650
interest on
public purpose
State and local
bonds............
135 Deductibility of 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
nonbusiness State
and local taxes
other than on
owner-occupied
homes............
136 Tax credit for 1,200 1,150 1,100 800 ........ ........ ........ 1,900
corporations
receiving income
from doing
business in U.S.
possessions......
Interest
137 Deferral of 30 40 40 40 40 40 50 210
interest on U.S.
savings bonds....
Addendum: Aid to
State and local
governments:
Deductibility of:
Property taxes on 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
owner-occupied
homes...........
Nonbusiness State 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
and local taxes
other than on
owner-occupied
homes...........
Exclusion of
interest on State
and local bonds
for:
Public purposes.. 25,480 25,980 26,370 26,440 26,150 26,940 27,750 133,650
Energy facilities 90 100 110 110 120 130 130 600
Water, sewage, 450 490 530 570 590 630 650 2,970
and hazardous
waste disposal
facilities......
Small-issues..... 390 430 470 490 520 550 570 2,600
Owner-occupied 910 990 1,080 1,150 1,200 1,280 1,320 6,030
mortgage
subsidies.......
Rental housing... 280 310 350 370 380 400 410 1,910
Airports, docks, 770 840 910 970 1,020 1,080 1,110 5,090
and similar
facilities......
Student loans.... 260 280 310 320 340 360 380 1,710
Private nonprofit 780 850 930 990 1,030 1,100 1,130 5,180
educational
facilities......
Hospital 1,620 1,780 1,930 2,060 2,160 2,290 2,360 10,800
construction....
Veterans' housing 40 50 50 50 60 60 60 280
Credit for holders 80 90 110 130 130 140 140 650
of zone academy
bonds............
----------------------------------------------------------------------------------------------------------------
\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: 2003 $1,100; 2004 $1,260; 2005 $1,370; 2006 $1,430; 2007
$1,470; 2008 $1,510; and 2009 $1,550.
\2\ If corporate equity were to be included, the revenue loss estimates would be $48,540 in 2003, $51,510 in
2004, $56,970 in 2005, $62,140 in 2006, $68,690 in 2007, $92,320 in 2008, and $55,110 in 2009. Similarly, if
the reduced tax rate on dividends were to be included, the revenue loss estimates would be $1,810 in 2003,
$16,720 in 2004, $13,280 in 2005, $13,880 in 2006, $14,480 in 2007, $15,970 in 2008, and $8,540 in 2009.
\3\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit
on outlays (in millions of dollars) is as follows: 2003 $6,435; 2004 $7,447; 2005 $11,486; 2006 $8,440; 2007
$8,237; 2008 $7,956; and 2009 $7,909
\4\ In addition to the receipts shown outlays of $60 million in 2004, $90 million in 2005, $100 million in
2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected.
\5\ 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: 2003 $31,961; 2004 $33,551; 2005 $34,148; 2006
$34,488; 2007 $34,338; 2008 $34,359; and 2009 $35,161.
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 290]]
Table 18-2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Corporations Individuals
-------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2005-09 2003 2004 2005 2006 2007 2008 2009 2005-09
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
National Defense
1 Exclusion of benefits and allowances to armed ....... ....... ....... ......... ......... ......... ......... ......... 2,210 2,240 2,260 2,290 2,310 2,330 2,350 11,540
forces personnel..............................
International Affairs
2 Exclusion of income earned abroad by U.S. ....... ....... ....... ......... ......... ......... ......... ......... 2,620 2,680 2,750 2,810 2,940 3,100 3,270 14,870
citizens......................................
3 Exclusion of certain allowances for Federal ....... ....... ....... ......... ......... ......... ......... ......... 770 800 840 880 920 960 1,010 4,610
employees abroad..............................
4 Extraterritorial income exclusion.............. 5,150 5,510 5,890 6,290 6,730 7,200 7,700 33,810 ......... ......... ......... ......... ......... ......... ......... .........
5 Inventory property sales source rules exception 1,540 1,620 1,700 1,790 1,880 1,980 2,080 9,430 ......... ......... ......... ......... ......... ......... ......... .........
6 Deferral of income from controlled foreign 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010 ......... ......... ......... ......... ......... ......... ......... .........
corporations (normal tax method)..............
7 Deferred taxes for financial firms on certain 2,050 2,130 2,190 2,260 960 ......... ......... 5,410 ......... ......... ......... ......... ......... ......... ......... .........
income earned overseas........................
General Science, Space, and Technology
8 Expensing of research and experimentation -1,940 -2,300 4,400 8,130 6,970 6,240 5,460 31,200 -40 -50 100 160 140 120 110 630
expenditures (normal tax method)..............
9 Credit for increasing research activities...... 4,910 4,360 2,530 1,090 460 150 60 4,290 50 40 20 ......... ......... ......... ......... 20
Energy
10 Expensing of exploration and development costs, 180 240 150 70 60 50 30 360 30 30 20 10 10 10 10 60
fuels.........................................
11 Excess of percentage over cost depletion, fuels 530 510 480 490 510 510 510 2,500 110 110 100 100 100 100 100 500
12 Alternative fuel production credit............. 1,230 850 850 850 850 340 ......... 2,890 50 40 40 40 40 10 ......... 130
13 Exception from passive loss limitation for ....... ....... ....... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
working interests in oil and gas properties...
14 Capital gains treatment of royalties on coal... ....... ....... ....... ......... ......... ......... ......... ......... 100 110 120 120 130 130 140 640
15 Exclusion of interest on energy facility bonds. 20 20 20 20 20 20 20 100 70 80 90 90 100 110 110 500
16 Enhanced oil recovery credit................... 360 360 370 380 390 400 410 1,950 40 40 40 40 40 40 40 200
17 New technology credit.......................... 280 350 370 370 370 370 370 1,850 ......... ......... ......... ......... ......... ......... ......... .........
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 40 10 -20 -60 -50 -60 -180 20 20 ......... ......... -10 -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, 10 10 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
nonfuel minerals..............................
22 Excess of percentage over cost depletion, 230 230 240 240 250 260 260 1,250 20 20 20 20 20 20 20 100
nonfuel minerals..............................
23 Exclusion of interest on bonds for water, 100 100 100 110 110 110 120 550 350 390 430 460 480 520 530 2,420
sewage, and hazardous waste facilities........
24 Capital gains treatment of certain timber ....... ....... ....... ......... ......... ......... ......... ......... 100 110 120 120 130 130 140 640
income........................................
25 Expensing of multiperiod timber growing costs.. 230 230 240 250 260 280 290 1,320 110 110 110 120 120 120 120 590
26 Tax incentives for preservation of historic 210 230 240 250 260 270 290 1,310 60 60 60 70 70 70 80 350
structures....................................
Agriculture
27 Expensing of certain capital outlays........... 20 20 20 20 20 30 30 120 100 110 110 110 120 120 130 590
28 Expensing of certain multiperiod production 20 20 20 20 20 20 20 100 70 70 70 80 80 80 80 390
costs.........................................
29 Treatment of loans forgiven for solvent farmers ....... ....... ....... ......... ......... ......... ......... ......... 10 10 10 10 10 10 10 50
30 Capital gains treatment of certain income...... ....... ....... ....... ......... ......... ......... ......... ......... 1,050 1,100 1,160 1,220 1,280 1,350 1,420 6,430
31 Income averaging for farmers................... ....... ....... ....... ......... ......... ......... ......... ......... 70 80 80 80 80 90 90 420
32 Deferral of gain on sale of farm refiners...... 10 10 10 10 20 20 20 80 ......... ......... ......... ......... ......... ......... ......... .........
Commerce and Housing
Financial institutions and insurance:
33 Exemption of credit union income.............. 1,300 1,360 1,430 1,500 1,570 1,650 1,730 7,880 ......... ......... ......... ......... ......... ......... ......... .........
34 Excess bad debt reserves of financial 40 30 20 20 10 ......... ......... 50 ......... ......... ......... ......... ......... ......... ......... .........
institutions.................................
35 Exclusion of interest on life insurance 2,090 2,250 2,410 2,590 2,780 2,980 3,200 13,960 16,810 18,250 19,720 21,420 23,270 25,280 27,460 117,150
savings......................................
36 Special alternative tax on small property and 120 120 130 130 140 140 140 680 ......... ......... ......... ......... ......... ......... ......... .........
casualty insurance companies.................
37 Tax exemption of certain insurance companies 190 210 220 240 250 260 280 1,250 ......... ......... ......... ......... ......... ......... ......... .........
owned by tax-exempt organizations............
38 Small life insurance company deduction........ 90 90 90 90 90 90 90 450 ......... ......... ......... ......... ......... ......... ......... .........
Housing:
39 Exclusion of interest on owner-occupied 200 200 210 220 220 230 240 1,120 710 790 870 930 980 1,050 1,080 4,910
mortgage subsidy bonds.......................
40 Exclusion of interest on rental housing bonds. 60 60 70 70 70 70 70 350 220 250 280 300 310 330 340 1,560
41 Deductibility of mortgage interest on owner- ....... ....... ....... ......... ......... ......... ......... ......... 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910
occupied homes...............................
[[Page 291]]
42 Deductibility of State and local property tax ....... ....... ....... ......... ......... ......... ......... ......... 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
on owner-occupied homes......................
43 Deferral of income from post 1987 installment 280 290 290 300 300 310 310 1,510 800 810 830 840 860 880 890 4,300
sales........................................
44 Capital gains exclusion on home sales......... ....... ....... ....... ......... ......... ......... ......... ......... 20,260 20,860 21,490 22,140 22,800 23,480 24,190 114,100
45 Exception from passive loss rules for $25,000 ....... ....... ....... ......... ......... ......... ......... ......... 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120
of rental loss...............................
46 Credit for low-income housing investments..... 3,450 3,640 3,810 3,990 4,150 4,350 4,560 20,860 2,760 2,910 3,050 3,190 3,320 3,480 3,650 16,690
47 Accelerated depreciation on rental housing 50 -10 -50 -110 -180 -260 -340 -940 1,170 630 -120 -1,000 -2,150 -3,300 -4,560 -11,130
(normal tax method)..........................
Commerce:
48 Cancellation of indebtedness.................. ....... ....... ....... ......... ......... ......... ......... ......... 20 30 30 30 40 40 40 180
49 Exceptions from imputed interest rules........ ....... ....... ....... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
50 Capital gains (except agriculture, timber, ....... ....... ....... ......... ......... ......... ......... ......... 25,730 27,300 30,190 32,930 36,410 48,930 29,210 177,670
iron ore, and coal) \2\......................
51 Capital gains exclusion of small corporation ....... ....... ....... ......... ......... ......... ......... ......... 130 160 210 250 300 350 390 1,500
stock........................................
52 Step-up basis of capital gains at death....... ....... ....... ....... ......... ......... ......... ......... ......... 14,880 16,280 18,240 20,240 22,240 24,190 26,010 110,920
53 Carryover basis of capital gains on gifts..... ....... ....... ....... ......... ......... ......... ......... ......... 590 390 450 540 550 580 620 2,740
54 Ordinary income treatment of loss from small ....... ....... ....... ......... ......... ......... ......... ......... 40 50 50 50 50 50 50 250
business corporation stock sale..............
55 Accelerated depreciation of buildings other -2,190 -2,920 -3,740 -4,250 -6,060 -9,050 -12,360 -35,460 -100 -270 -320 -440 -750 -1,120 -2,070 -4,700
than rental housing (normal tax method)......
56 Accelerated depreciation of machinery and 40,600 38,830 -8,720 -32,980 -26,580 -23,990 -22,400 -114,670 7,920 7,970 -2,200 -4,960 -4,460 -4,780 -5,190 -21,590
equipment (normal tax method)................
57 Expensing of certain small investments (normal 420 710 1,790 680 -390 -140 -30 1,910 610 880 3,060 970 -100 110 160 4,200
tax method)..................................
58 Amortization of start-up costs (normal tax 100 110 120 130 140 140 140 670 10 10 10 20 20 20 20 90
method)......................................
59 Graduated corporation income tax rate (normal 3,030 3,090 3,910 4,650 4,800 4,890 5,040 23,290 ......... ......... ......... ......... ......... ......... ......... .........
tax method)..................................
60 Exclusion of interest on small issue bonds.... 80 90 90 90 100 100 100 480 310 340 380 400 420 450 470 2,120
Transportation
61 Deferral of tax on shipping companies.......... 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
62 Exclusion of reimbursed employee parking ....... ....... ....... ......... ......... ......... ......... ......... 2,130 2,240 2,360 2,490 2,610 2,740 2,880 13,080
expenses......................................
63 Exclusion for employer-provided transit passes. ....... ....... ....... ......... ......... ......... ......... ......... 320 380 450 520 590 660 730 2,950
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 170 170 180 180 190 190 200 940 600 670 730 790 830 890 910 4,150
similar bonds.................................
66 Exemption of certain mutuals' and cooperatives' 60 60 70 70 70 70 70 350 ......... ......... ......... ......... ......... ......... ......... .........
income........................................
67 Empowerment zones, Enterprise communities, and 280 280 290 310 330 370 420 1,720 790 800 830 900 990 1,100 1,310 5,130
Renewal communities...........................
68 New markets tax credit......................... 50 70 110 150 210 220 200 890 140 220 320 460 620 650 590 2,640
69 Expensing of environmental remediation costs... 70 20 -10 -10 -10 -10 -10 -50 10 ......... ......... ......... ......... ......... ......... .........
Education, Training, Employment, and Social
Services
Education:
70 Exclusion of scholarship and fellowship income ....... ....... ....... ......... ......... ......... ......... ......... 1,260 1,260 1,340 1,400 1,410 1,420 1,420 6,990
(normal tax method)..........................
71 HOPE tax credit............................... ....... ....... ....... ......... ......... ......... ......... ......... 3,290 3,420 3,510 3,290 3,330 3,320 3,310 16,760
72 Lifetime Learning tax credit.................. ....... ....... ....... ......... ......... ......... ......... ......... 1,910 2,250 2,180 2,120 2,320 2,320 2,300 11,240
73 Education Individual Retirement Accounts...... ....... ....... ....... ......... ......... ......... ......... ......... 70 110 140 190 240 300 370 1,240
74 Deductibility of student-loan interest........ ....... ....... ....... ......... ......... ......... ......... ......... 730 760 780 800 820 830 840 4,070
75 Deduction for higher education expenses....... ....... ....... ....... ......... ......... ......... ......... ......... 1,730 1,810 2,580 2,610 ......... ......... ......... 5,190
76 State prepaid tuition plans................... ....... ....... ....... ......... ......... ......... ......... ......... 50 150 320 430 510 590 660 2,510
77 Exclusion of interest on student-loan bonds... 60 60 60 60 60 60 70 310 200 220 250 260 280 300 310 1,400
78 Exclusion of interest on bonds for private 170 170 180 190 190 200 200 960 610 680 750 800 840 900 930 4,220
nonprofit educational facilities.............
79 Credit for holders of zone academy bonds...... 80 90 110 130 130 140 140 650 ......... ......... ......... ......... ......... ......... ......... .........
80 Exclusion of interest on savings bonds ....... ....... ....... ......... ......... ......... ......... ......... 10 10 10 10 20 20 20 80
redeemed to finance educational expenses.....
81 Parental personal exemption for students age ....... ....... ....... ......... ......... ......... ......... ......... 3,140 3,130 2,550 2,000 1,760 1,580 1,430 9,320
19 or over...................................
82 Deductibility of charitable contributions 490 510 540 560 590 620 660 2,970 3,180 2,880 3,120 3,440 3,640 3,890 4,170 18,260
(education)..................................
83 Exclusion of employer-provided educational ....... ....... ....... ......... ......... ......... ......... ......... 500 530 560 590 620 660 690 3,120
assistance...................................
84 Special deduction for teacher expenses........ ....... ....... ....... ......... ......... ......... ......... ......... 140 140 ......... ......... ......... ......... ......... .........
[[Page 292]]
Training, employment, and social services:
85 Work opportunity tax credit................... 370 310 140 60 20 ......... ......... 220 60 60 30 10 10 ......... ......... 50
86 Welfare-to-work tax credit.................... 50 50 30 20 10 ......... ......... 60 10 10 10 10 10 ......... ......... 30
87 Employer provided child care exclusion........ ....... ....... ....... ......... ......... ......... ......... ......... 590 620 770 870 920 960 1,010 4,530
88 Employer-provided child care credit........... ....... ....... ....... ......... ......... ......... ......... ......... 90 130 140 150 160 170 180 800
89 Assistance for adopted foster children........ ....... ....... ....... ......... ......... ......... ......... ......... 250 290 330 380 430 480 540 2,160
90 Adoption credit and exclusion................. ....... ....... ....... ......... ......... ......... ......... ......... 220 450 500 540 560 570 580 2,750
91 Exclusion of employee meals and lodging (other ....... ....... ....... ......... ......... ......... ......... ......... 780 810 850 890 930 970 1,000 4,640
than military)...............................
92 Child credit \3\.............................. ....... ....... ....... ......... ......... ......... ......... ......... 37,970 24,340 29,860 24,810 24,680 24,480 25,430 129,260
93 Credit for child and dependent care expenses.. ....... ....... ....... ......... ......... ......... ......... ......... 2,720 2,950 2,690 2,210 2,030 1,900 1,780 10,610
94 Credit for disabled access expenditures....... 10 10 20 20 20 20 20 100 40 40 40 40 40 40 40 200
95 Deductibility of charitable contributions, 1,110 1,170 1,230 1,290 1,360 1,430 1,500 6,810 28,910 26,200 28,440 31,260 33,140 35,360 37,910 166,110
other than education and health..............
96 Exclusion of certain foster care payments..... ....... ....... ....... ......... ......... ......... ......... ......... 430 430 440 450 460 470 570 2,390
97 Exclusion of parsonage allowances............. ....... ....... ....... ......... ......... ......... ......... ......... 380 400 420 450 480 510 540 2,400
Health
98 Exclusion of employer contributions for medical ....... ....... ....... ......... ......... ......... ......... ......... 101,920 106,720 112,990 120,940 129,820 139,620 150,300 653,670
insurance premiums and medical care...........
99 Deductibility of self-employed medical ....... ....... ....... ......... ......... ......... ......... ......... 2,550 3,740 3,780 4,090 4,370 4,750 5,150 22,140
insurance premiums............................
100 Medical Savings Accounts/Health Savings ....... ....... ....... ......... ......... ......... ......... ......... -30 -140 -570 -960 -1,380 -1,920 -2,180 -7,010
Accounts......................................
101 Deductibility of medical expenses.............. ....... ....... ....... ......... ......... ......... ......... ......... 6,240 6,880 7,900 8,480 9,180 10,200 10,990 46,750
102 Exclusion of interest on hospital construction 350 360 370 390 400 410 420 1,990 1,270 1,420 1,560 1,670 1,760 1,880 1,940 8,810
bonds.........................................
103 Deductibility of charitable contributions 140 150 160 160 170 180 190 860 3,250 2,940 3,190 3,510 3,720 3,970 4,260 18,650
(health)......................................
104 Tax credit for orphan drug research............ 160 180 200 220 250 280 310 1,260 ......... ......... ......... ......... ......... ......... ......... .........
105 Special Blue Cross/Blue Shield deduction....... 350 320 310 280 310 260 290 1,450 ......... ......... ......... ......... ......... ......... ......... .........
106 Tax credit for health insurance purchased by ....... ....... ....... ......... ......... ......... ......... ......... ......... 50 60 60 70 70 80 340
certain displaced and retired individuals \4\.
Income Security
107 Exclusion of railroad retirement system ....... ....... ....... ......... ......... ......... ......... ......... 400 400 400 400 400 400 400 2,000
benefits......................................
108 Exclusion of workers' compensation benefits.... ....... ....... ....... ......... ......... ......... ......... ......... 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710
109 Exclusion of public assistance benefits (normal ....... ....... ....... ......... ......... ......... ......... ......... 400 410 430 450 470 490 510 2,350
tax method)...................................
110 Exclusion of special benefits for disabled coal ....... ....... ....... ......... ......... ......... ......... ......... 60 60 50 50 50 40 40 230
miners........................................
111 Exclusion of military disability pensions...... ....... ....... ....... ......... ......... ......... ......... ......... 100 110 110 110 110 120 120 570
Net exclusion of pension contributions and
earnings:
112 Employer plans................................ ....... ....... ....... ......... ......... ......... ......... ......... 59,480 59,380 61,740 66,340 62,650 58,360 60,440 309,530
113 401(k) plans.................................. ....... ....... ....... ......... ......... ......... ......... ......... 51,560 56,740 58,910 61,340 65,750 71080 75440 332,520
114 Individual Retirement Accounts................ ....... ....... ....... ......... ......... ......... ......... ......... 20,060 19,810 20,090 20,610 20,150 19,710 19,490 100,050
115 Low and moderate income savers credit......... ....... ....... ....... ......... ......... ......... ......... ......... 880 960 1,100 1,210 730 ......... ......... 3,040
116 Keogh plans................................... ....... ....... ....... ......... ......... ......... ......... ......... 6,020 8,730 9,260 9,860 10,530 11,480 12,500 53,630
Exclusion of other employee benefits:
117 Premiums on group term life insurance......... 1,800 1,830 1,860 1,890 1,920 1,950 1,990 9,610 ......... ......... ......... ......... ......... ......... ......... .........
118 Premiums on accident and disability insurance. ....... ....... ....... ......... ......... ......... ......... ......... 230 240 250 260 270 280 290 1,350
119 Small business retirement plan credit.......... 20 40 50 70 70 80 80 350 20 40 50 60 70 70 70 320
120 Income of trusts to finance supplementary ....... ....... ....... ......... ......... ......... ......... ......... 30 30 30 30 30 30 30 .........
unemployment benefits.........................
121 Special ESOP rules............................. 1460 1570 1690 1820 1970 2120 2280 9,880 320 350 370 400 430 460 500 2,160
122 Additional deduction for the blind............. ....... ....... ....... ......... ......... ......... ......... ......... 40 30 40 40 40 40 40 200
123 Additional deduction for the elderly........... ....... ....... ....... ......... ......... ......... ......... ......... 1,840 1,710 1,800 1,900 1,960 1,920 1,940 9,520
124 Tax credit for the elderly and disabled........ ....... ....... ....... ......... ......... ......... ......... ......... 20 10 10 10 10 10 10 50
125 Deductibility of casualty losses............... ....... ....... ....... ......... ......... ......... ......... ......... 500 690 670 680 640 600 630 3,220
126 Earned income tax credit \5\................... ....... ....... ....... ......... ......... ......... ......... ......... 5,099 4,884 5,006 5,477 5,515 5,603 5,780 27,381
Social Security
Exclusion of social security benefits:
127 Social Security benefits for retired workers.. ....... ....... ....... ......... ......... ......... ......... ......... 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420
128 Social Security benefits for disabled......... ....... ....... ....... ......... ......... ......... ......... ......... 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420
129 Social Security benefits for dependents and ....... ....... ....... ......... ......... ......... ......... ......... 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730
survivors....................................
Veterans Benefits and Services
130 Exclusion of veterans death benefits and ....... ....... ....... ......... ......... ......... ......... ......... 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560
disability compensation.......................
131 Exclusion of veterans pensions................. ....... ....... ....... ......... ......... ......... ......... ......... 100 100 100 110 110 110 120 550
132 Exclusion of GI bill benefits.................. ....... ....... ....... ......... ......... ......... ......... ......... 110 120 130 130 160 170 170 760
133 Exclusion of interest on veterans housing bonds 10 10 10 10 10 10 10 50 30 40 40 40 50 50 50 230
[[Page 293]]
General Purpose Fiscal Assistance
134 Exclusion of interest on public purpose State 5,710 5,880 6,060 6,240 6,420 6,620 6,820 32,160 19,770 20,100 20,310 20,200 19,730 20,320 20,930 101,490
and local bonds...............................
135 Deductibility of nonbusiness State and local ....... ....... ....... ......... ......... ......... ......... ......... 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
taxes other than on owner-occupied homes......
136 Tax credit for corporations receiving income 1,200 1,150 1,100 800 ......... ......... ......... 1,900 ......... ......... ......... ......... ......... ......... ......... .........
from doing business in U.S. possessions.......
Interest
137 Deferral of interest on U.S. savings bonds..... ....... ....... ....... ......... ......... ......... ......... ......... 30 40 40 40 40 40 50 210
Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes........ ....... ....... ....... ......... ......... ......... ......... ......... 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
Nonbusiness State and local taxes other than ....... ....... ....... ......... ......... ......... ......... ......... 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
on owner-occupied homes......................
Exclusion of interest on State and local bonds
for:
Public purposes............................... 5,710 5,880 6,060 6,240 6,420 6,620 6,820 32,160 19,770 20,100 20,310 20,200 19,730 20,320 20,930 101,490
Energy facilities............................. 20 20 20 20 20 20 20 100 70 80 90 90 100 110 110 500
Water, sewage, and hazardous waste disposal 100 100 100 110 110 110 120 550 350 390 430 460 480 520 530 2,420
facilities...................................
Small-issues.................................. 80 90 90 90 100 100 100 480 310 340 380 400 420 450 470 2,120
Owner-occupied mortgage subsidies............. 200 200 210 220 220 230 240 1,120 710 790 870 930 980 1,050 1,080 4,910
Rental housing................................ 60 60 70 70 70 70 70 350 220 250 280 300 310 330 340 1,560
Airports, docks, and similar facilities....... 170 170 180 180 190 190 200 940 600 670 730 790 830 890 910 4,150
Student loans................................. 60 60 60 60 60 60 70 310 200 220 250 260 280 300 310 1,400
Private nonprofit educational facilities...... 170 170 180 190 190 200 200 960 610 680 750 800 840 900 930 4,220
Hospital construction......................... 350 360 370 390 400 410 420 1,990 1,270 1,420 1,560 1,670 1,760 1,880 1,940 8,810
Veterans' housing............................. 10 10 10 10 10 10 10 50 30 40 40 40 50 50 50 230
Credit for holders of zone academy bonds....... 80 90 110 130 130 140 140 650 ......... ......... ......... ......... ......... ......... ......... .........
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\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: 2003 $1,100; 2004 $1,260; 2005 $1,370; 2006 $1,430; 2007 $1,470; 2008
$1,510; and 2009 $1,550.
\2\ If corporate equity were to be included, the revenue loss estimates would be $48,540 in 2003, $51,510 in 2004, $56,970 in 2005, $62,140 in 2006, $68,690 in 2007, $92,320 in 2008, and $55,110 in 2009. Similarly, if the reduced
tax rate on dividends were to be included, the revenue loss estimates would be $1,810 in 2003, $16,720 in 2004, $13,280 in 2005, $13,880 in 2006, $14,480 in 2007, $15,970 in 2008, and $8,540 in 2009.
\3\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2003 $6,435; 2004 $7,447; 2005 $11,486; 2006 $8,440; 2007 $8,237;
2008 $7,956; and 2009 $7,909
\4\ In addition to the receipts shown outlays of $60 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected.
\5\ 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: 2003 $31,961; 2004 $33,551; 2005 $34,148; 2006 $34,488; 2007
$34,338; 2008 $34,359; and 2009 $35,161.
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 294]]
Table 18-3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2005-2009 PROJECTED REVENUE EFFECT
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Provision 2005 2005-2009
----------------------------------------------------------------------------------------------------------------
Exclusion of employer contributions for medical insurance premiums and medical 112,990 653,670
care.........................................................................
Deductibility of mortgage interest on owner-occupied homes.................... 69,740 393,910
Net exclusion of pension contributions and earnings: 401(k) plans............. 58,910 332,520
Net exclusion of pension contributions and earnings: Employer plans........... 61,740 309,530
Deductibility of nonbusiness state and local taxes other than on owner- 46,180 190,290
occupied homes...............................................................
Capital gains (except agriculture, timber, iron ore, and coal)................ 30,190 177,670
Deductibility of charitable contributions, other than education and health.... 29,670 172,920
Exclusion of interest on public purpose State and local bonds................. 26,370 133,650
Exclusion of interest on life insurance savings............................... 22,130 131,110
Child credit.................................................................. 29,860 129,260
Capital gains exclusion on home sales......................................... 21,490 114,100
Step-up basis of capital gains at death....................................... 18,240 110,920
Net exclusion of pension contributions and earnings: Individual Retirement 20,090 100,050
Accounts.....................................................................
Social Security benefits for retired workers.................................. 19,040 98,420
Deductibility of State and local property tax on owner-occupied homes......... 19,410 76,850
Net exclusion of pension contributions and earnings: Keough Plans............. 9,260 53,630
Deferral of income from controlled foreign corporations (normal tax method)... 8,400 48,010
Deductibility of medical expenses............................................. 7,900 46,750
Exclusion of workers' compensation benefits................................... 6,850 38,710
Credit for low-income housing investments..................................... 6,860 37,550
Extraterritorial income exclusion............................................. 5,890 33,810
Expensing of research and experimentation expenditures (normal tax method).... 4,500 31,830
Earned income tax credit...................................................... 5,006 27,381
Graduated corporation income tax rate (normal tax method)..................... 3,910 23,290
Deductibility of self-employed medical insurance premiums..................... 3,780 22,140
Social Security benefits for dependents and survivors......................... 4,310 20,730
Deductibility of charitable contributions (education)......................... 3,660 21,230
Exclusion of veterans death benefits and disability compensation.............. 3,600 20,560
Social Security benefits for disabled......................................... 3,720 20,420
Exception from passive loss rules for $25,000 of rental loss.................. 4,390 20,120
Deductibility of charitable contributions (health)............................ 3,350 19,510
HOPE tax credit............................................................... 3,510 16,760
Exclusion of income earned abroad by U.S. citizens............................ 2,750 14,870
Exclusion of reimbursed employee parking expenses............................. 2,360 13,080
Special ESOP rules............................................................ 2,060 12,040
Exclusion of benefits and allowances to armed forces personnel................ 2,260 11,540
Lifetime Learning tax credit.................................................. 2,180 11,240
Exclusion of interest on hospital construction bonds.......................... 1,930 10,800
Credit for child and dependent care expenses.................................. 2,690 10,610
Premiums on group term life insurance......................................... 1,860 9,610
Additional deduction for the elderly.......................................... 1,800 9,520
Inventory property sales source rules exception............................... 1,700 9,430
Parental personal exemption for students age 19 or over....................... 2,550 9,320
Exemption of credit union income.............................................. 1,430 7,880
Exclusion of scholarship and fellowship income (normal tax method)............ 1,340 6,990
Empowerment zones, Enterprise communities, and Renewal communities............ 1,120 6,850
Capital gains treatment of certain income..................................... 1,160 6,430
Expensing of certain small investments (normal tax method).................... 4,850 6,110
Exclusion of interest on owner-occupied mortgage subsidy bonds................ 1,080 6,030
Deferral of income from post 1987 installment sales........................... 1,120 5,810
Deferred taxes for financial firms on certain income earned overseas.......... 2,190 5,410
Deduction for higher education expenses....................................... 2,580 5,190
Exclusion of interest on bonds for private nonprofit educational facilities... 930 5,180
Exclusion of interest for airport, dock, and similar bonds.................... 910 5,090
Exclusion of employee meals and lodging (other than military)................. 850 4,640
Exclusion of certain allowances for Federal employees abroad.................. 840 4,610
Employer provided child care exclusion........................................ 770 4,530
Credit for increasing research activities..................................... 2,550 4,310
Deductibility of student-loan interest........................................ 780 4,070
New markets tax credit........................................................ 430 3,530
Deductibility of casualty losses.............................................. 670 3,220
Exclusion of employer-provided educational assistance......................... 560 3,120
Low and moderate income savers credit......................................... 1,100 3,040
Alternative fuel production credit............................................ 890 3,020
Excess of percentage over cost depletion, fuels............................... 580 3,000
Exclusion of interest on bonds for water, sewage, and hazardous waste 530 2,970
facilities...................................................................
Exclusion for employer-provided transit passes................................ 450 2,950
Adoption credit and exclusion................................................. 500 2,750
Carryover basis of capital gains on gifts..................................... 450 2,740
[[Page 295]]
Exclusion of interest on small issue bonds.................................... 470 2,600
State prepaid tuition plans................................................... 320 2,510
Exclusion of parsonage allowances............................................. 420 2,400
Exclusion of certain foster care payments..................................... 440 2,390
Exclusion of public assistance benefits (normal tax method)................... 430 2,350
Assistance for adopted foster children........................................ 330 2,160
Enhanced oil recovery credit.................................................. 410 2,150
Exclusion of railroad retirement system benefits.............................. 400 2,000
Expensing of multiperiod timber growing costs................................. 350 1,910
Exclusion of interest on rental housing bonds................................. 350 1,910
Tax credit for corporations receiving income from doing business in U.S. 1,100 1,900
possessions..................................................................
New technology credit......................................................... 370 1,850
Exclusion of interest on student-loan bonds................................... 310 1,710
Tax incentives for preservation of historic structures........................ 300 1,660
Capital gains exclusion of small corporation stock............................ 210 1,500
Special Blue Cross/Blue Shield deduction...................................... 310 1,450
Excess of percentage over cost depletion, nonfuel minerals.................... 260 1,350
Premiums on accident and disability insurance................................. 250 1,350
Tax credit for orphan drug research........................................... 200 1,260
Tax exemption of certain insurance companies owned by tax-exempt organizations 220 1,250
Education Individual Retirement Accounts...................................... 140 1,240
Employer-provided child care credit........................................... 140 800
Exclusion of GI bill benefits................................................. 130 760
Amortization of start-up costs (normal tax method)............................ 130 760
Expensing of certain capital outlays.......................................... 130 710
Special alternative tax on small property and casualty insurance companies.... 130 680
Small business retirement plan credit......................................... 100 670
Credit for holders of zone academy bonds...................................... 110 650
Capital gains treatment of royalties on coal.................................. 120 640
Capital gains treatment of certain timber income.............................. 120 640
Exclusion of interest on energy facility bonds................................ 110 600
Exclusion of military disability pensions..................................... 110 570
Exclusion of veterans pensions................................................ 100 550
Expensing of certain multiperiod production costs............................. 90 490
Small life insurance company deduction........................................ 90 450
Income averaging for farmers.................................................. 80 420
Expensing of exploration and development costs, fuels......................... 170 420
Exclusion from income of conservation subsidies provided by public utilities.. 80 400
Exemption of certain mutuals' and cooperatives' income........................ 70 350
Tax credit for health insurance purchased by certain displaced and retired 60 340
individuals..................................................................
Credit for disabled access expenditures....................................... 60 300
Exclusion of interest on veterans housing bonds............................... 50 280
Work opportunity tax credit................................................... 170 270
Exceptions from imputed interest rules........................................ 50 250
Ordinary income treatment of loss from small business corporation stock sale.. 50 250
Exclusion of special benefits for disabled coal miners........................ 50 230
Deferral of interest on U.S. savings bonds.................................... 40 210
Additional deduction for the blind............................................ 40 200
Cancellation of indebtedness.................................................. 30 180
Alcohol fuel credits \1\...................................................... 30 150
Investment credit for rehabilitation of structures (other than historic)...... 30 150
Deferral of tax on shipping companies......................................... 20 100
Exception from passive loss limitation for working interests in oil and gas 20 100
properties...................................................................
Welfare-to-work tax credit.................................................... 40 90
Exclusion of interest on savings bonds redeemed to finance educational 10 80
expenses.....................................................................
Deferral of gain on sale of farm refiners..................................... 10 80
Expensing of exploration and development costs, nonfuel minerals.............. 10 50
Tax credit for the elderly and disabled....................................... 10 50
Treatment of loans forgiven for solvent farmers............................... 10 50
Income of trusts to finance supplementary unemployment benefits............... 30 ...............
Expensing of environmental remediation costs.................................. -10 -50
Tax credit and deduction for clean-fuel burning vehicles...................... 10 -210
Medical Savings Accounts...................................................... -570 -7,010
Accelerated depreciation on rental housing (normal tax method)................ -170 -12,070
Accelerated depreciation of buildings other than rental housing (normal tax -4,060 -40,160
method)......................................................................
Accelerated depreciation of machinery and equipment (normal tax method)....... -10,920 -136,260
----------------------------------------------------------------------------------------------------------------
[[Page 296]]
Table 18-4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2003
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Present
Provision Value of
Revenue Loss
----------------------------------------------------------------------------------------------------------------
1 Deferral of income from controlled foreign corporations (normal tax method).......... 7,630
2 Deferred taxes for financial firms on income earned overseas......................... 2,080
3 Expensing of research and experimentation expenditures (normal tax method)........... 2,000
4 Expensing of exploration and development costs--fuels................................ 120
5 Expensing of multiperiod timber growing costs........................................ 200
6 Expensing of certain multiperiod production costs--agriculture....................... 170
7 Expensing of certain capital outlays--agriculture.................................... 200
8 Deferral of income on life insurance and annuity contracts........................... 25,060
9 Expensing of certain small investments (normal tax method)........................... 690
10 Amortization of start-up costs (normal tax method)................................... 70
11 Deferral of tax on shipping companies................................................ 20
12 Credit for holders of zone academy bonds............................................. 110
13 Credit for low-income housing investments............................................ 3,470
14 Deferral for state prepaid tuition plans............................................. 1,510
15 Exclusion of pension contributions--employer plans................................... 102,470
16 Exclusion of 401(k) contributions.................................................... 81,610
17 Exclusion of IRA contributions and earnings.......................................... 11,030
18 Exclusion of contributions and earnings for Keogh plans.............................. 9,530
19 Exclusion of interest on public-purpose bonds........................................ 19,440
20 Exclusion of interest on non-public purpose bonds.................................... 6,120
21 Deferral of interest on U.S. savings bonds........................................... 440
----------------------------------------------------------------------------------------------------------------
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 18-5.
Table 18-5. OUTLAY EQUVALENT ESTIMATES FOR TAX EXPENDITURES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2005-09
----------------------------------------------------------------------------------------------------------------
National Defense
1 Exclusion of 2,570 2,600 2,620 2,650 2,680 2,710 2,740 13,400
benefits and
allowances to
armed forces
personnel........
International
Affairs
2 Exclusion of 3,470 3,530 3,640 3,700 3,880 4,100 4,320 19,640
income earned
abroad by U.S.
citizens.........
3 Exclusion of 980 1,030 1,070 1,120 1,180 1,230 1,290 5,890
certain
allowances for
Federal employees
abroad...........
4 Extraterritorial 7,920 8,480 9,060 9,680 10,350 11,080 11,850 52,020
income exclusion.
5 Inventory property 2,370 2,490 2,620 2,750 2,890 3,050 3,200 14,510
sales source
rules exception..
6 Deferral of income 7,450 7,900 8,400 8,930 9,550 10,210 10,920 48,010
from controlled
foreign
corporations
(normal tax
method)..........
7 Deferred taxes for 2,050 2,130 2,190 2,260 960 ........ ........ 5,410
financial firms
on certain income
earned overseas..
General Science,
Space, and
Technology
8 Expensing of -1,980 -2,350 4,500 8,290 7,110 6,360 5,570 31,830
research and
experimentation
expenditures
(normal tax
method)..........
9 Credit for 7,620 6,760 3,930 1,680 700 230 90 6,630
increasing
research
activities.......
Energy
10 Expensing of 230 290 190 80 70 70 50 460
exploration and
development
costs, fuels.....
11 Excess of 910 780 760 810 820 810 820 4,020
percentage over
cost depletion,
fuels............
12 Alternative fuel 1,720 1,190 1,190 1,190 1,190 470 ........ 4,040
production credit
13 Exception from 20 20 20 20 20 20 20 100
passive loss
limitation for
working interests
in oil and gas
properties.......
14 Capital gains 140 150 150 160 170 180 190 850
treatment of
royalties on coal
15 Exclusion of 130 150 160 160 170 190 190 870
interest on
energy facility
bonds............
16 Enhanced oil 620 630 650 660 680 700 720 3,410
recovery credit..
17 New technology 380 470 490 490 490 500 500 2,470
credit...........
18 Alcohol fuel 30 30 30 30 30 30 30 150
credits \1\......
19 Tax credit and 90 80 20 -30 -90 -90 -100 -290
deduction for
clean-fuel
burning vehicles.
20 Exclusion from 110 110 110 110 100 100 100 520
income of
conservation
subsidies
provided by
public utilities.
Natural Resources
and Environment
21 Expensing of 10 10 10 10 10 10 10 50
exploration and
development
costs, nonfuel
minerals.........
22 Excess of 320 330 330 360 370 370 390 1,820
percentage over
cost depletion,
nonfuel minerals.
23 Exclusion of 650 700 760 820 850 900 940 4,270
interest on bonds
for water,
sewage, and
hazardous waste
facilities.......
[[Page 297]]
24 Capital gains 140 150 150 160 170 180 190 850
treatment of
certain timber
income...........
25 Expensing of 450 450 460 470 490 520 530 2,470
multiperiod
timber growing
costs............
26 Tax incentives for 270 290 300 320 330 340 370 1,660
preservation of
historic
structures.......
Agriculture
27 Expensing of 150 160 160 160 170 180 190 860
certain capital
outlays..........
28 Expensing of 110 110 110 110 110 120 110 560
certain
multiperiod
production costs.
29 Treatment of loans 10 10 10 10 10 10 10 50
forgiven for
solvent farmers..
30 Capital gains 1,400 1,470 1,550 1,630 1,710 1,800 1,890 8,580
treatment of
certain income...
31 Income averaging 90 90 90 100 100 100 110 500
for farmers......
32 Deferral of gain 10 20 20 20 20 20 20 100
on sale of farm
refiners.........
Commerce and Housing
Financial
institutions and
insurance:
33 Exemption of 1,650 1,730 1,820 1,910 2,000 2,100 2,210 10,040
credit union
income..........
34 Excess bad debt 50 38 25 25 13 ........ ........ 63
reserves of
financial
institutions....
35 Exclusion of 22,000 23,840 25,730 27,920 30,290 32,860 35,650 152,450
interest on life
insurance
savings.........
36 Special 170 170 180 180 200 200 200 960
alternative tax
on small
property and
casualty
insurance
companies.......
37 Tax exemption of 270 300 310 340 350 370 390 1,760
certain
insurance
companies owned
by tax-exempt
organizations...
38 Small life 120 120 120 120 120 120 120 600
insurance
company
deduction.......
Housing:
39 Exclusion of 1,310 1,420 1,550 1,660 1,730 1,840 1,890 8,670
interest on
owner-occupied
mortgage subsidy
bonds...........
40 Exclusion of 400 440 510 530 550 580 590 2,760
interest on
rental housing
bonds...........
41 Deductibility of 61,160 62,590 69,740 74,800 78,420 83,030 87,920 393,910
mortgage
interest on
owner-occupied
homes...........
42 Deductibility of 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
State and local
property tax on
owner-occupied
homes...........
43 Deferral of 1,060 1,080 1,100 1,120 1,140 1,170 1,190 5,720
income from post
1987 installment
sales...........
44 Capital gains 26,570 27,367 28,188 29,034 29,905 30,802 31,726 149,655
exclusion on
home sales......
45 Exception from 5,710 4,570 4,390 4,210 4,020 3,840 3,660 20,120
passive loss
rules for
$25,000 of
rental loss.....
46 Credit for low- 4,670 4,920 5,160 5,390 5,620 5,880 6,170 28,220
income housing
investments.....
47 Accelerated 1,220 620 -170 -1,110 -2,330 -3,560 -4,900 -12,070
depreciation on
rental housing
(normal tax
method).........
Commerce:
48 Cancellation of 20 30 30 30 40 40 40 180
indebtedness....
49 Exceptions from 50 50 50 50 50 50 50 250
imputed interest
rules...........
50 Capital gains 34,310 36,400 40,260 43,910 48,540 65,240 38,950 236,900
(except
agriculture,
timber, iron
ore, and coal)..
51 Capital gains 170 220 270 340 400 460 530 2,000
exclusion of
small
corporation
stock...........
52 Step-up basis of 19,840 21,710 24,320 26,990 29,650 32,260 34,680 147,900
capital gains at
death...........
53 Carryover basis 590 390 450 540 550 580 620 2,740
of capital gains
on gifts........
54 Ordinary income 50 60 60 60 60 60 60 300
treatment of
loss from small
business
corporation
stock sale......
55 Accelerated -2,290 -3,190 -4,060 -4,690 -6,810 -10,170 -14,430 -40,160
depreciation of
buildings other
than rental
housing (normal
tax method).....
56 Accelerated 48,520 46,800 -10,920 -37,940 -31,040 -28,770 -27,590 -136,26
depreciation of 0
machinery and
equipment
(normal tax
method).........
57 Expensing of 1,030 1,590 4,850 1,650 -490 -30 130 6,110
certain small
investments
(normal tax
method).........
58 Amortization of 110 120 130 150 160 160 160 760
start-up costs
(normal tax
method).........
59 Graduated 4,670 4,760 6,020 7,150 7,390 7,520 7,760 35,840
corporation
income tax rate
(normal tax
method).........
60 Exclusion of 560 610 670 700 750 790 820 3,730
interest on
small issue
bonds...........
Transportation
61 Deferral of tax on 20 20 20 20 20 20 20 100
shipping
companies........
62 Exclusion of 2,750 2,900 3,050 3,210 3,370 3,540 3,710 16,880
reimbursed
employee parking
expenses.........
63 Exclusion for 400 480 560 650 740 820 910 3,680
employer-provided
transit passes...
Community and
Regional
Development
64 Investment credit 30 30 30 30 30 30 30 150
for
rehabilitation of
structures (other
than historic)...
65 Exclusion of 1,110 1,210 1,310 1,390 1,460 1,550 1,600 7,310
interest for
airport, dock,
and similar bonds
66 Exemption of 70 80 80 80 80 80 90 410
certain mutuals'
and cooperatives'
income...........
67 Empowerment zones, 1,070 1,080 1,120 1,210 1,320 1,470 1,730 6,850
Enterprise
communities, and
Renewal
communities......
68 New markets tax 190 290 430 610 830 870 790 3,530
credit...........
69 Expensing of 110 40 -20 -10 -10 -10 -10 -60
environmental
remediation costs
Education, Training,
Employment, and
Social Services
Education:
70 Exclusion of 1,390 1,380 1,480 1,540 1,550 1,560 1,560 7,690
scholarship and
fellowship
income (normal
tax method).....
71 HOPE tax credit.. 4,210 4,390 4,500 4,210 4,270 4,250 4,250 21,480
72 Lifetime Learning 2,440 2,890 2,800 2,720 2,970 2,970 2,950 14,410
tax credit......
73 Education 90 130 180 240 310 390 470 1,590
Individual
Retirement
Accounts........
74 Deductibility of 870 900 930 960 980 990 990 4,850
student-loan
interest........
75 Deduction for 2,210 2,320 3,310 3,340 ........ ........ ........ 6,650
higher education
expenses........
76 State prepaid 50 150 320 430 510 590 660 2,510
tuition plans...
77 Exclusion of 370 400 440 460 490 510 550 2,450
interest on
student-loan
bonds...........
78 Exclusion of 1,120 1,220 1,340 1,420 1,480 1,580 1,630 7,450
interest on
bonds for
private
nonprofit
educational
facilities......
79 Credit for 110 130 160 180 190 200 200 930
holders of zone
academy bonds...
80 Exclusion of 20 20 20 20 20 20 20 100
interest on
savings bonds
redeemed to
finance
educational
expenses........
81 Parental personal 3,480 3,470 2,820 2,220 1,950 1,750 1,580 10,320
exemption for
students age 19
or over.........
[[Page 298]]
82 Deductibility of 3,670 3,390 3,660 4,000 4,230 4,510 4,830 21,230
charitable
contributions
(education).....
83 Exclusion of 620 660 690 730 770 810 860 3,860
employer-
provided
educational
assistance......
84 Special deduction 180 170 ........ ........ ........ ........ ........ .......
for teacher
expenses........
Training,
employment, and
social services:
85 Work opportunity 430 370 170 70 30 ........ ........ 270
tax credit......
86 Welfare-to-work 60 60 40 30 20 ........ ........ 90
tax credit......
87 Employer provided 790 830 1,030 1,160 1,230 1,280 1,350 6,050
child care
exclusion.......
88 Employer-provided 120 170 190 200 220 230 240 1,080
child care
credit..........
89 Assistance for 280 330 370 420 480 540 610 2,420
adopted foster
children........
90 Adoption credit 280 570 640 690 710 730 750 3,520
and exclusion...
91 Exclusion of 950 990 1,030 1,080 1,130 1,180 1,210 5,630
employee meals
and lodging
(other than
military).......
92 Child credit \2\. 50,520 25,950 39,010 32,280 31,960 31,450 31,450 166,150
93 Credit for child 3,630 3,930 3,590 2,950 2,710 2,530 2,370 14,150
and dependent
care expenses...
94 Credit for 70 70 70 70 70 80 80 370
disabled access
expenditures....
95 Deductibility of 30,020 27,370 29,670 32,550 34,500 36,790 39,410 172,920
charitable
contributions,
other than
education and
health..........
96 Exclusion of 490 500 510 520 530 540 650 2,750
certain foster
care payments...
97 Exclusion of 460 490 520 550 580 620 660 2,930
parsonage
allowances......
Health
98 Exclusion of 129,010 133,400 141,590 151,940 163,510 176,320 190,300 823,660
employer
contributions for
medical insurance
premiums and
medical care.....
99 Deductibility of 3,170 4,640 4,610 4,990 5,310 5,770 6,250 26,930
self-employed
medical insurance
premiums.........
100 Medical Savings -40 -180 -730 -1,230 -1,780 -2,460 -2,800 -9,000
Accounts/Health
Savings Accounts.
101 Deductibility of 6,700 7,400 8,540 9,170 9,930 11,060 11,930 50,630
medical expenses.
102 Exclusion of 2,330 2,560 2,770 2,960 3,110 3,290 3,390 15,520
interest on
hospital
construction
bonds............
103 Deductibility of 3,390 3,090 3,350 3,670 3,890 4,150 4,450 19,510
charitable
contributions
(health).........
104 Tax credit for 240 270 300 330 370 420 470 1,890
orphan drug
research.........
105 Special Blue Cross/ 440 400 390 350 390 330 360 1,820
Blue Shield
deduction........
106 Tax credit for ........ 60 80 80 90 90 100 440
health insurance
purchased by
certain displaced
and retired
individuals \3\..
Income Security
107 Exclusion of 400 400 400 400 400 400 400 2,000
railroad
retirement system
benefits.........
108 Exclusion of 6,100 6,460 6,850 7,270 7,710 8,190 8,690 38,710
workers'
compensation
benefits.........
109 Exclusion of 400 410 430 450 470 490 510 2,350
public assistance
benefits (normal
tax method)......
110 Exclusion of 60 60 50 50 50 40 40 230
special benefits
for disabled coal
miners...........
111 Exclusion of 100 110 110 110 110 120 120 570
military
disability
pensions.........
Net exclusion of
pension
contributions and
earnings:
112 Employer plans... 72980 72410 75290 80900 76400 71170 73710 377,470
113 401(k) plans..... 63260 69200 71840 74800 80180 86680 92000 405,500
114 Individual 26220 26390 26910 27530 27010 26640 26320 134,410
Retirement
Accounts........
115 Low and moderate 880 960 1100 1210 730 ........ ........ 3,040
income savers
credit..........
116 Keogh plans...... 7640 11040 11660 12360 13140 14320 15600 67,080
Exclusion of other
employee
benefits:
117 Premiums on group 2,400 2,440 2,480 2,520 2,560 2,600 2,650 12,810
term life
insurance.......
118 Premiums on 310 320 330 350 360 370 390 1,800
accident and
disability
insurance.......
119 Small business 60 110 140 190 200 210 210 950
retirement plan
credit...........
120 Income of trusts 30 30 30 30 30 30 30 150
to finance
supplementary
unemployment
benefits.........
121 Special ESOP rules 2,850 3,060 3,280 3,520 3,800 4,080 4,360 19,040
122 Additional 40 40 40 40 40 40 50 210
deduction for the
blind............
123 Additional 2,220 2,070 2,180 2,290 2,380 2,330 2,350 11,530
deduction for the
elderly..........
124 Tax credit for the 30 20 20 20 10 10 10 70
elderly and
disabled.........
125 Deductibility of 550 760 740 750 640 600 630 3,360
casualty losses..
126 Earned income tax 5,666 5,427 5,562 6,085 6,127 6,226 6,422 30,422
credit \4\.......
Social Security
Exclusion of
social security
benefits:
127 Social Security 18,600 19,620 19,040 19,370 20,390 19,710 19,910 98,420
benefits for
retired workers.
128 Social Security 3,230 3,570 3,720 3,840 4,080 4,280 4,500 20,420
benefits for
disabled........
129 Social Security 4,060 4,380 4,310 4,160 4,190 4,030 4,040 20,730
benefits for
dependents and
survivors.......
Veterans Benefits
and Services
130 Exclusion of 3,320 3,330 3,600 3,930 4,170 4,300 4,560 20,560
veterans death
benefits and
disability
compensation.....
131 Exclusion of 100 100 100 110 110 110 120 550
veterans pensions
132 Exclusion of GI 110 120 130 130 160 170 170 760
bill benefits....
133 Exclusion of 50 70 70 70 80 80 80 380
interest on
veterans housing
bonds............
General Purpose
Fiscal Assistance
134 Exclusion of 36,550 37,270 37,830 37,920 37,490 38,620 39,770 191,630
interest on
public purpose
State and local
bonds............
135 Deductibility of 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
nonbusiness State
and local taxes
other than on
owner-occupied
homes............
136 Tax credit for 1,710 1,640 1,570 1,140 ........ ........ ........ 2,710
corporations
receiving income
from doing
business in U.S.
possessions......
Interest
137 Deferral of 30 40 40 40 40 40 50 210
interest on U.S.
savings bonds....
[[Page 299]]
Addendum: Aid to
State and local
governments:
Deductibility of:
Property taxes on 22,090 21,740 19,410 16,110 14,580 13,640 13,110 76,850
owner-occupied
homes...........
Nonbusiness State 49,770 49,470 46,180 39,100 35,930 34,710 34,370 190,290
and local taxes
other than on
owner-occupied
homes...........
Exclusion of
interest on State
and local bonds
for:
Public purposes.. 36,550 37,270 37,830 37,920 37,490 38,620 39,770 191,630
Energy facilities 130 150 160 160 170 190 190 870
Water, sewage, 650 700 760 820 850 900 940 4,270
and hazardous
waste disposal
facilities......
Small-issues..... 560 610 670 700 750 790 820 3,730
Owner-occupied 1,310 1,420 1,550 1,660 1,730 1,840 1,890 8,670
mortgage
subsidies.......
Rental housing... 400 440 510 530 550 580 590 2,760
Airports, docks, 1,110 1,210 1,310 1,390 1,460 1,550 1,600 7,310
and similar
facilities......
Student loans.... 370 400 440 460 490 510 550 2,450
Private nonprofit 1,120 1,220 1,340 1,420 1,480 1,580 1,630 7,450
educational
facilities......
Hospital 2,330 2,560 2,770 2,960 3,110 3,290 3,390 15,520
construction....
Veterans' housing 50 70 70 70 80 80 80 380
Credit for holders 110 130 160 180 190 200 200 930
of zone academy
bonds............
----------------------------------------------------------------------------------------------------------------
\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\ In addition to the outlay equivalents shown outlays of $60 million in 2004, $90 million in 2005, $100
million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 are projected.
\4\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the
credit on outlays (in millions of dollars) is as follows: 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, most of this
year's tax expenditure estimates are presented using two baselines: the
normal tax baseline and the reference tax law baseline. An exception is
provided for the reduction in the tax rate on dividends and capital
gains on corporate shares by the Jobs and Growth Tax Relief
Reconciliation Act of 2003 (JGTRRA), as dicussed below.
The normal tax baseline is patterned on a comprehensive income tax,
which defines income as the sum of consumption and the change in net
wealth in a given period of time. The normal tax baseline allows
personal exemptions, a standard deduction, and deductions of the
expenses incurred in earning income. It is not limited to a particular
structure of tax rates, or by a specific definition of the taxpaying
unit.
The reference tax law baseline is also patterned on a comprehensive
income tax, but it is closer to existing law. Tax expenditures under the
reference law baseline are generally tax expenditures under the normal
tax baseline, but the reverse is not always true.
Both the normal and reference tax baselines allow several major
departures from a pure comprehensive income tax. For example:
Income is taxable only when it is realized in exchange.
Thus, neither the deferral of tax on unrealized capital gains
nor the tax exclusion of imputed income (such as the rental
value of owner-occupied housing or farmers' consumption of
their own produce) is regarded as a tax expenditure. Both
accrued and imputed income would be taxed under a
comprehensive income tax.
A comprehensive income tax would generally not exclude from
the tax base amounts for personal exemptions or a standard
deduction, except perhaps to ease tax administration.
There generally is a separate corporate income tax.
Values of assets and debt are not generally adjusted for
inflation. A comprehensive income tax would adjust the cost
basis of capital assets and debt for changes in the price
level during the time the assets or debt are held. Thus, under
a comprehensive income tax baseline, the failure to take
account of inflation in measuring depreciation, capital gains,
and interest income would be regarded as a negative tax
expenditure (i.e., a tax penalty), and failure to take account
of inflation in measuring interest costs would be regarded as
a positive tax expenditure (i.e., a tax subsidy).
Although the reference law and normal tax baselines are generally
similar, areas of difference include:
Tax rates. The separate schedules applying to the various
taxpaying units are included in the reference law baseline.
Thus, corporate tax rates below the maximum statutory rate do
not give rise to a tax expenditure. The normal tax baseline is
similar, except that, by convention, it specifies the current
maximum rate as the baseline for the corporate income tax. The
lower tax rates applied to the first $10 million of corporate
income are thus regarded as a tax expenditure. Again by
convention, the alternative minimum tax is treated
[[Page 300]]
as part of the baseline rate structure under both the
reference and normal tax methods.
Income subject to the tax. Income subject to tax is defined
as gross income less the costs of earning that income. The
Federal income tax defines gross income to include: (1)
consideration received in the exchange of goods and services,
including labor services or property; and (2) the taxpayer's
share of gross or net income earned and/or reported by another
entity (such as a partnership). Under the reference tax rules,
therefore, gross income does not include gifts--defined as
receipts of money or property that are not consideration in an
exchange--or most transfer payments, which can be thought of
as gifts from the Government.\1\ The normal tax baseline also
excludes gifts between individuals from gross income. Under
the normal tax baseline, however, all cash transfer payments
from the Government to private individuals are counted in
gross income, and exemptions of such transfers from tax are
identified as tax expenditures. The costs of earning income
are generally deductible in determining taxable income under
both the reference and normal tax baselines.\2\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
Capital recovery. Under the reference tax law baseline no
tax expenditures arise from accelerated depreciation. Under
the normal tax baseline, the depreciation allowance for
property is computed using estimates of economic depreciation.
The latter represents a change in the calculation of the tax
expenditure under normal law first made in the 2004 Budget.
The Appendix provides further details on the new methodology
and how it differs from the prior methodology.
Treatment of foreign income. Both the normal and reference
tax baselines allow a tax credit for foreign income taxes paid
(up to the amount of U.S. income taxes that would otherwise be
due), which prevents double taxation of income earned abroad.
Under the normal tax method, however, controlled foreign
corporations (CFCs) are not regarded as entities separate from
their controlling U.S. shareholders. Thus, the deferral of tax
on income received by CFCs is regarded as a tax expenditure
under this method. In contrast, except for tax haven
activities, the reference law baseline follows current law in
treating CFCs as separate taxable entities whose income is not
subject to U.S. tax until distributed to U.S. taxpayers. Under
this baseline, deferral of tax on CFC income is not a tax
expenditure because U.S. taxpayers generally are not taxed on
accrued, but unrealized, income.
In addition to these areas of difference, the Joint Committee on
Taxation considers a somewhat broader set of tax expenditures under its
normal tax baseline than is considered here.
Treatment of JGTRRA's Cut in the Tax Rates on Dividends and Capital
Gains
Although not in line with previous reference tax law or normal tax law
baselines, our tables exclude from the list of tax expenditures JGTRRA's
reductions in the tax rate on dividends. Reference law used for the FY
2005 Budget includes capital gains as tax expenditure, but only to the
extent capital gains have not previously been taxed under the corporate
income tax. Similarly, the lower tax rate on dividends is not included
as a tax expenditure under reference law because dividends have
generally already been taxed under the corporate income tax. This
exception was made as part of Treasury's ongoing reevaluation of the tax
expenditure concept and to consider gradually changes in the baseline
tax system to conform more closely with a comprehensive income tax that
excludes double tax on corporate income. The same treatment is extended
to the tax rate differential applied to capital gains on corporate
shares, including JGTRRA's increase in this differential.
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
[[Page 301]]
effect of tax expenditures designed to increase savings. Other efforts
by OMB, Treasury, and other agencies to improve data available for the
analysis of savings tax expenditures will continue over the next several
years.
Comparison of tax expenditure, spending, and regulatory policies. Tax
expenditures by definition work through the tax system and,
particularly, the income tax. Thus, they may be relatively advantageous
policy approaches when the benefit or incentive is related to income and
is intended to be widely available.\4\ Because there is an existing
public administrative and private compliance structure for the tax
system, the incremental administrative and compliance costs for a tax
expenditure may be low in many cases. In addition, some tax expenditures
actually simplify the tax system, (for example, the exclusion for up to
$500,000 of capital gains on home sales). Tax expenditures also
implicitly subsidize certain activities. Spending, regulatory or tax-
disincentive policies can also modify behavior, but may have different
economic effects. Finally, a variety of tax expenditure tools can be
used--e.g., deductions; credits; exemptions; deferrals; floors;
ceilings; phase-ins; phase-outs; dependent on income, expenses, or
demographic characteristics (age, number of family members, etc.). This
wide range means that tax expenditures can be flexible and can have very
different economic effects.
---------------------------------------------------------------------------
\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 limitations. In many cases they add to the
complexity of the tax system, which raises both administrative and
compliance costs. For example, targeting personal exemptions and credits
can complicate filing and decisionmaking. The income tax system may have
little or no contact with persons who have no or very low incomes, and
does not require information on certain characteristics of individuals
used in some spending programs, such as wealth. These features may
reduce the effectiveness of tax expenditures for addressing certain
income-transfer objectives. Tax expenditures also generally do not
enable the same degree of agency discretion as an outlay program. For
example, grant or direct Federal service delivery programs can
prioritize activities to be addressed with specific resources in a way
that is difficult to emulate with tax expenditures. Finally, tax
expenditures may not receive the same level of scrutiny afforded to
other programs.
Outlay programs have advantages where direct Government service
provision is particularly warranted--such as equipping and providing the
armed forces or administering the system of justice. Outlay programs may
also be specifically designed to meet the needs of low-income families
who would not otherwise be subject to income taxes or need to file a tax
return. Outlay programs may also receive more year-to-year oversight and
fine tuning, through the legislative and executive budget process. In
addition, many different types of spending programs--including direct
Government provision; credit programs; and payments to State and local
governments, the private sector, or individuals in the form of grants or
contracts--provide flexibility for policy design. On the other hand,
certain outlay programs--such as direct Government service provision--
may rely less directly on economic incentives and private-market
provision than tax incentives, which may reduce the relative efficiency
of spending programs for some goals. Spending programs also require
resources to be raised via taxes, user charges, or Government borrowing,
which can impose further costs by diverting resources from their most
efficient uses. Finally, spending programs, particularly on the
discretionary side, may respond less readily to changing activity levels
and economic conditions than tax expenditures.
Regulations have more direct and immediate effects than outlay and
tax-expenditure programs because regulations apply directly and
immediately to the regulated party (i.e., the intended actor)--generally
in the private sector. Regulations can also be fine-tuned more quickly
than tax expenditures, because they can generally be changed by the
executive branch without legislation. Like tax expenditures, regulations
often rely largely upon voluntary compliance, rather than detailed
inspections and policing. As such, the public administrative costs tend
to be modest, relative to the private resource costs associated with
modifying activities. Historically, regulations have tended to rely on
proscriptive measures, as opposed to economic incentives. This reliance
can diminish their economic efficiency, although this feature can also
promote full compliance where (as in certain safety-related cases)
policymakers believe that trade-offs with economic considerations are
not of paramount importance. Also, regulations generally do not directly
affect Federal outlays or receipts. Thus, like tax expenditures, they
may escape the type of scrutiny that outlay programs receive. However,
major regulations are subjected to a formal regulatory analysis that
goes well beyond the analysis required for outlays and tax-expenditures.
To some extent, the GPRA requirement for performance evaluation will
address this lack of formal analysis.
Some policy objectives are achieved using multiple approaches. For
example, minimum wage legislation, the earned income tax credit, and the
food stamp program are regulatory, tax expenditure, and direct outlay
programs, respectively, all having the objective of improving the
economic welfare of low-wage workers.
Tax expenditures, like spending and regulatory programs, have a
variety of objectives and effects. 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.
[[Page 302]]
Also, many tax expenditures, including those cited above, may have more
than one objective. For example, accelerated depreciation may encourage
investment. In addition, the economic effects of particular provisions
can extend beyond their intended objectives (e.g., a provision intended
to promote an activity or raise certain incomes may have positive or
negative effects on tax neutrality).
Performance measurement is generally concerned with inputs, outputs,
and outcomes. In the case of tax expenditures, the principal input is
usually the revenue effect. Outputs are quantitative or qualitative
measures of goods and services, or changes in income and investment,
directly produced by these inputs. Outcomes, in turn, represent the
changes in the economy, society, or environment that are the ultimate
goals of programs.
Thus, for a provision that reduces taxes on certain investment
activity, an increase in the amount of investment would likely be a key
output. The resulting production from that investment, and, in turn, the
associated improvements in national income, welfare, or security, could
be the outcomes of interest. For other provisions, such as those
designed to address a potential inequity or unintended consequence in
the tax code, an important performance measure might be how they change
effective tax rates (the discounted present-value of taxes owed on new
investments or incremental earnings) or excess burden (an economic
measure of the distortions caused by taxes). Effects on the incomes of
members of particular groups may be an important measure for certain
provisions.
An overview of evaluation issues by budget function. The discussion
below considers the types of measures that might be useful for some
major programmatic groups of tax expenditures. The discussion is
intended to be illustrative and not all encompassing. However, it is
premised on the assumption that the data needed to perform the analysis
are available or can be developed. In practice, data availability is
likely to be a major challenge, and data constraints may limit the
assessment of the effectiveness of many provisions. In addition, such
assessments can raise significant challenges in economic modeling.
National defense.--Some tax expenditures are intended to assist
governmental activities. For example, tax preferences for military
benefits reflect, among other things, the view that benefits such as
housing, subsistence, and moving expenses are intrinsic aspects of
military service, and are provided, in part, for the benefit of the
employer, the U.S. Government. Tax benefits for combat service are
intended to reduce tax burdens on military personnel undertaking
hazardous service for the Nation. A portion of the tax expenditure
associated with foreign earnings is targeted to benefit U.S. Government
civilian personnel working abroad by offsetting the living costs that
can be higher than those in the United States. These tax expenditures
should be considered together with direct agency budget costs in making
programmatic decisions.
International affairs.--Tax expenditures are also aimed at goals such
as tax neutrality. These include the exclusion for income earned abroad
by nongovernmental employees and exclusions for income of U.S.-
controlled foreign corporations. Measuring the effectiveness of these
provisions raises challenging issues.
General science, space and technology; energy; natural resources and
the environment; agriculture; and commerce and housing.--A series of tax
expenditures reduces the cost of investment, both in specific
activities--such as research and experimentation, extractive industries,
and certain financial activities--and more generally, through
accelerated depreciation for plant and equipment. These provisions can
be evaluated along a number of dimensions. For example, it could be
useful to consider the strength of the incentives by measuring their
effects on the cost of capital (the interest rate which investments must
yield to cover their costs) and effective tax rates. The impact of these
provisions on the amounts of corresponding forms of investment (e.g.,
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
[[Page 303]]
taxes. Provisions intended to promote investment in rental housing could
be evaluated for their effects on making such housing more available and
affordable. These provisions should then be compared with alternative
programs that address housing supply and demand.
Transportation.--Employer-provided parking is a fringe benefit that,
for the most part, is excluded from taxation. The tax expenditure
estimates reflect the cost of parking that is leased by employers for
employees; an estimate is not currently available for the value of
parking owned by employers and provided to their employees. The
exclusion for employer-provided transit passes is intended to promote
use of this mode of transportation, which has environmental and
congestion benefits. The tax treatments of these different benefits
could be compared with alternative transportation policies.
Community and regional development.--A series of tax expenditures is
intended to promote community and regional development by reducing the
costs of financing specialized infrastructure, such as airports, docks,
and stadiums. Empowerment zone and enterprise community provisions are
designed to promote activity in disadvantaged areas. These provisions
can be compared with grants and other policies designed to spur economic
development.
Education, training, employment, and social services.--Major
provisions in this function are intended to promote post-secondary
education, to offset costs of raising children, and to promote a variety
of charitable activities. The education incentives can be compared with
loans, grants, and other programs designed to promote higher education
and training. The child credits are intended to adjust the tax system
for the costs of raising children; as such, they could be compared to
other Federal tax and spending policies, including related features of
the tax system, such as personal exemptions (which are not defined as a
tax expenditure). Evaluation of charitable activities requires
consideration of the beneficiaries of these activities, who are
generally not the parties receiving the tax reduction.
Health.--Individuals also benefit from favorable treatment of
employer-provided health insurance. Measures of these benefits could
include increased coverage and pooling of risks. The effects of
insurance coverage on final outcome measures of actual health (e.g.,
infant mortality, days of work lost due to illness, or life expectancy)
or intermediate outcomes (e.g., use of preventive health care or health
care costs) could also be investigated.
Income security, Social Security, and veterans benefits and
services.--Major tax expenditures in the income security function
benefit retirement savings, through employer-provided pensions,
individual retirement accounts, and Keogh plans. These provisions might
be evaluated in terms of their effects on boosting retirement incomes,
private savings, and national savings (which would include the effect on
private savings as well as public savings or deficits). Interactions
with other programs, including Social Security, also may merit analysis.
As in the case of employer-provided health insurance, analysis of
employer-provided pension programs requires imputing the value of
benefits funded at the firm level to individuals.
Other provisions principally affect the incomes of members of certain
groups, rather than affecting incentives. For example, tax-favored
treatment of Social Security benefits, certain veterans benefits, and
deductions for the blind and elderly provide increased incomes to
eligible parties. The earned-income tax credit, in contrast, should be
evaluated for its effects on labor force participation as well as the
income it provides lower-income workers.
General purpose fiscal assistance and interest.--The tax-exemption for
public purpose State and local bonds reduces the costs of borrowing for
a variety of purposes (borrowing for non-public purposes is reflected
under 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, 2003, 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.
[[Page 304]]
International Affairs
2. Income earned abroad.-- U.S. citizens who lived abroad, worked in
the private sector, and satisfied a foreign residency requirement in
2001 may exclude up to $78,000 in foreign earned income from U.S. taxes.
The exclusion increases to $80,000 in 2002 (and thereafter). In
addition, if these taxpayers receive a specific allowance for foreign
housing from their employers, they may also exclude the value of that
allowance. If they do not receive a specific allowance for housing
expenses, they may deduct against their U.S. taxes that portion of such
expenses that exceeds one-sixth the salary of a civil servant at grade
GS-14, step 1 ($72,381 in 2003).
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 yet distributed to a U.S. shareholder as tax-
deferred income.
7. Exceptions under subpart F for active financing income.--Financial
firms can defer taxes on income earned overseas in an active business.
Taxes on income earned through December 31, 2006 can be deferred.
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 de
[[Page 305]]
duct a percentage of gross income from mineral production at rates of 22
percent for uranium; 15 percent for oil, gas and oil shale; and 10
percent for coal. The deduction is limited to 50 percent of net income
from the property, except for oil and gas where the deduction can be 100
percent of net property income. Production from geothermal deposits is
eligible for percentage depletion at 65 percent of net income, but with
no limit on output and no limitation with respect to qualified
producers. Unlike depreciation or cost depletion, percentage depletion
deductions can exceed the cost of the investment.
12. Alternative fuel production credit.--A nontaxable credit of $3 per
oil-equivalent barrel of production (in 1979 dollars) is provided for
several forms of alternative fuels. The credit is generally available if
the price of oil stays below $29.50 (in 1979 dollars). The credit
generally expires on December 31, 2002.
13. Oil and gas exception to passive loss limitation.--Owners of
working interests in oil and gas properties are exempt from the
``passive income'' limitations. As a result, the working interest-
holder, who manages on behalf of himself and all other owners the
development of wells and incurs all the costs of their operation, may
aggregate negative taxable income from such interests with his income
from all other sources.
14. Capital gains treatment of royalties on coal.--Sales of certain
coal under royalty contracts can be treated as capital gains rather than
ordinary income.
15. Energy facility bonds.--Interest earned on State and local bonds
used to finance construction of certain energy facilities is tax-exempt.
These bonds are generally subject to the State private-activity bond
annual volume cap.
16. Enhanced oil recovery credit.--A credit is provided equal to 15
percent of the taxpayer's costs for tertiary oil recovery on U.S.
projects. Qualifying costs include tertiary injectant expenses,
intangible drilling and development costs on a qualified enhanced oil
recovery project, and amounts incurred for tangible depreciable
property.
17. New technology credits.--A credit of 10 percent is available for
investment in solar and geothermal energy facilities. In addition, a
credit of 1.5 cents 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
[[Page 306]]
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, debtors must include the
amount of loan forgiveness as income or reduce their recoverable basis
in the property to which the loan relates. If the debtor elects to
reduce basis and the amount of forgiveness exceeds the basis in the
property, the excess forgiveness is taxable. For insolvent (bankrupt)
debtors, however, the amount of loan forgiveness reduces carryover
losses, then unused credits, and then basis; any remainder of the
forgiven debt is excluded from tax. Farmers with forgiven debt are
considered insolvent for tax purposes, and thus qualify for income tax
forgiveness.
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 was $62.50 per capita ($187.5 million
minimum) per State in 2001, and $75 per capita ($225 million minimum) in
2002. The Community Renewal Tax Relief Act of 2000 accelerated the
scheduled increase in the state volume cap and indexed the cap for
inflation, beginning in 2003. States may issue mortgage credit
certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home
buyers to income tax credits for a specified percentage of interest on
qualified mortgages. The total amount of MCCs issued by a State cannot
exceed 25 percent of its annual ceiling for mortgage-revenue bonds.
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
[[Page 307]]
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.
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. Under the revised reference law
baseline used for the FY 2005 Budget, the lower rate on capital gains is
considered a tax expenditure under the reference law method, but only
for capital gains that have not been previously taxed under the
corporate income tax. As discussed above, this treatment excludes the
double tax on corporate income and is more consistent with a
comprehensive income tax base.
Prior to passage of the Jobs Growth Tax Relief Reconciliation Act
(JGTRRA), the top capital gains tax rate for most assets held for more
than 1 year was 20 percent. For assets acquired after December 31, 2000,
the top capital gains tax rate for assets held for more than 5 years was
18 percent. Since January 1, 2001, taxpayers may mark-to-market existing
assets to start the 5-year holding period. Losses from the mark-to-
market are not recognized.
For assets held for more than 1 year by taxpayers in the 15-percent
ordinary tax bracket, the top capital gains tax rate was 10 percent.
After December 31, 2000, the top capital gains tax rate for assets held
by these taxpayers for more than 5 years was 8 percent.
JGTRRA reduced the previous 20 percent and 18 percent rates on net
capital gains to 15 percent and the previous 10 percent and 8 percent
rates to 5 percent (0 percent, in 2008). The lower rates apply to assets
held for more than one year. The lower rates apply to assets sold after
May 6, 2003 through 2008.
[[Page 308]]
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 for 2010 under the Economic Growth and Tax Relief Reconciliation Act
(EGTRRA) of 2001, the basis for property acquired from a decedent will
be the lesser of fair market value or the decedent's basis. Certain
types of additions to basis will be allowed so that assets in most
estates that are not currently subject to estate tax will not be subject
to capital gains tax in the hands of the heirs.
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.
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 could 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 was completely phased out when qualifying investments
exceeded $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. Since 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.
[[Page 309]]
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. Since 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 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 expires 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 2003, the credit is phased out
ratably for taxpayers with modified AGI between $83,000 and $103,000
($41,000 and $51,000 for singles), indexed.
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 after December 31,
2002, the maximum credit per return is $2,000. The credit is phased out
ratably for taxpayers with modified AGI between $83,000 and $103,000
($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 maximum annual
deduction for qualified higher education expenses is $3,000 in 2003 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
[[Page 310]]
singles) may deduct up to $2,000 beginning in 2004. No deduction is
allowed for expenses paid after December 31, 2005.
74. Education Individual Retirement Accounts.--Contributions to an
education IRA are not tax-deductible. Investment income earned by
education IRAs is not taxed when earned, and investment income from an
education IRA is tax-exempt when withdrawn to pay for a student's
tuition and fees. The maximum contribution to an education IRA in 2003
is $200 per beneficiary. The maximum contribution is phased down ratably
for taxpayers with modified AGI between $159,000 and $220,000 ($95,000
and $110,000 for singles). EGTRRA increases the maximum contribution to
$2,000 and the phase-out range for joint filers to $190,000 through
$220,000 of modified AGI, double the range of singles.
75. Student-loan interest.--Taxpayers may claim an above-the-line
deduction of up to $2,500 on interest paid on an education loan.
Interest may only be deducted for the first five years in which interest
payments are required. In 2003, the maximum deduction is phased down
ratably for taxpayers with modified AGI between $100,000 and $130,000
($50,000 and $65,000 for singles), indexed.
76. State prepaid tuition plans.--Some States have adopted prepaid
tuition plans and prepaid room and board plans, which allow persons to
pay in advance for college expenses for designated beneficiaries. In
2001 taxes on the earnings from these plans are paid by the
beneficiaries and are deferred until tuition is actually paid. Beginning
in 2002, investment income is not taxed when earned, and is tax-exempt
when withdrawn to pay for qualified expenses. These changes were the
result of EGTRRA.
77. Student-loan bonds.--Interest earned on State and local bonds
issued to finance student loans is 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
$87,750 and $117.750 ($58,500 and $73,500 for singles) in 2003.
81. Dependent students age 19 or older.--Taxpayers may claim personal
exemptions for dependent children age 19 or over who (1) receive
parental support payments of $1,000 or more per year, (2) are full-time
students, and (3) do not claim a personal exemption on their own tax
returns.
82. Charitable contributions to educational institutions.--Taxpayers
may deduct contributions to nonprofit educational institutions.
Taxpayers who donate capital assets to educational institutions can
deduct the assets' current value without being taxed on any appreciation
in value. An individual's total charitable contribution generally may
not exceed 50 percent of adjusted gross income; a corporation's total
charitable contributions generally may not exceed 10 percent of pre-tax
income.
83. Employer-provided educational assistance.--Employer-provided
educational assistance is excluded from an employee's gross income even
though the employer's costs for this assistance are a deductible
business expense. EGTRRA permanently extended this exclusion and
extended the exclusion to also include graduate education (beginning in
2002).
84. Special deduction for teacher expenses.--Educators in both public
and private elementary and secondary schools, who work at least 900
hours during a school year as a teacher, instructor, counselor,
principal or aide, may subtract up to $250 of qualified expenses when
figuring their adjusted gross income (AGI).
85. 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.
86. 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.
87. 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.
88. Employer-provided child care credit.--Employers can deduct
expenses for supporting child care or child care resource and referral
services. EGTRRA
[[Page 311]]
provides a tax credit to employers for qualified expenses beginning in
2002. The credit is equal to 25 percent of qualified expenses for
employee child care and 10 percent of qualified expenses for child care
resource and referral services. Employer deductions for such expenses
are reduced by the amount of the credit. The maximum total credit is
limited to $150,000 per taxable year.
89. 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.
90. Adoption credit and exclusion.--Taxpayers can receive a
nonrefundable tax credit for qualified adoption expenses. The maximum
credit is $10,160 per child for 2003. The credit is phased-out ratably
for taxpayers with modified AGI between $152,390 and $192,390 in 2003.
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.
91. 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.
92. Child credit.--Taxpayers with children under age 17 can qualify
for a $1,000 refundable per child credit. The maximum credit is equal to
$700 in 2005, $800 in 2009, and $1,000 in 2010, and declines to $500 in
2011 and later years. The credit is phased out for taxpayers at the rate
of $50 per $1,000 of modified AGI above $110,000 ($75,000 for singles).
93. Child and dependent care expenses.--Married couples with child and
dependent care expenses may claim a tax credit when one spouse works
full time and the other works at least part time or goes to school. The
credit may also be claimed by single parents and by divorced or
separated parents who have custody of children. Expenditures up to a
maximum $3,000 for one dependent and $6,000 for two or more dependents
are eligible for the credit. The credit is equal to 35 percent of
qualified expenditures for taxpayers with incomes of $15,000. The credit
is reduced to a minimum of 20 percent by one percentage point for each
$2,000 of income in excess of $15,000.
94. 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.
95. 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.
96. 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.
97. 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
98. 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.
99. 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.
100. Medical and health savings accounts.--Some employees may deduct
annual contributions to a medical savings account (MSA); employer
contributions to MSAs (except those made through cafeteria plans) for
qualified employees are also excluded from income. An employee may
contribute to an MSA in a given year only if the employer does not
contribute to the MSA in that year. MSAs are only available to self-
employed individuals or employees covered under an 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. The Medicare Prescription
Drug, Improvemnet, and Modernization Act of 2003 introduced health
savings accounts (HSA) which provides a tax-favored savings for health
care expenses. The definition of a high-
[[Page 312]]
deductible health plan is less restrictive for HSAs than for MSAs.
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 certain 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.
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 $12,000 of wages
from AGI under a qualified arrangement with an employer's 401(k) plan.
This increases to $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.
Employees are allowed to make after-tax contributions to 401(k) and
401(k)-type plans. These contributions are not excluded from AGI, but
the investment income of such after-tax contributions is not taxed when
earned or withdrawn.
114. Individual Retirement Accounts.--Individual taxpayers can take
advantage of several different Individual Retirement Accounts (IRAs):
deductible IRAs, non-deductible IRAs, and Roth IRAs. The annual
contributions limit applies to the total of a taxpayer's deductible,
non-deductible, and Roth IRAs contributions. The IRA contribution limit
to $3,000 in 2003, $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 $70,000 ($50,000 for non-joint filers) in
2003 can claim a deduction for IRA contributions. The IRA deduction is
phased out for taxpayers with AGI between $60,000 and $70,000 ($40,000
and $50,000 for non-joint). The phase-out range increases annually until
it reaches $80,000 to $100,000 in 2007 ($50,000 to $60,000 in 2005 for
non-joint filers). Taxpayers whose AGI is above the phase-out range can
also claim a deduction for their IRA contributions depending on whether
they (or their spouse) are an active participant in an employer-provided
retirement plan. The tax on the investment income earned by 401(k)
plans, non-deductible IRAs, and deductible IRAs is deferred until the
money is withdrawn.
Taxpayers with incomes below $160,000 ($110,000 for nonjoint filers)
can make contributions to Roth IRAs. The maximum contribution to a Roth
IRA is phased out for taxpayers with AGI between $150,000 and $160,000
($95,000 and $110,000 for singles). Investment income of a Roth IRA is
not taxed when earned nor when withdrawn. Withdrawals from a Roth IRA
are penalty free if: (1) the Roth IRA was opened at least 5 years before
the withdrawal, and (2) the taxpayer either (a) is at least 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.
[[Page 313]]
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 2001. Total plan
contributions are limited to 25 percent of a firm's total wages. The tax
on the investment income earned by Keogh plans is deferred until
withdrawn.
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.--EGTRRA provides
businesses with 100 or fewer employees a credit for 50 percent of the
qualified startup costs associated with a new qualified retirement plan.
The credit is limited to $500 annually and may only be claimed for
expenses incurred during the first three years from the start of the
qualified plan. Qualified startup expenses include expenses related to
the establishment and administration of the plan, and the retirement-
related education of employees. The credit applies to costs incurred
beginning in 2002.
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 $950 if
married in 2003.
123. Additional deduction for the elderly.--Taxpayers who are 65 years
or older may take an additional $1,150 standard deduction if single, or
$950 if married in 2003.
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 $7,490 of earned income in 2003. The credit is 40
percent of the first $10,510 of income for a family with two or more
qualifying children. The credit is phased out beginning when the
taxpayer's income exceeds $13,730 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 $29,666 ($33,692 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 2003, the credit is 7.65
percent of the first $4,990 of earned income. When the taxpayer's income
exceeds $6,240, the credit is phased out at the rate of 7.65 percent. It
is completely phased out at $11,230 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, The base amount for the phase-out
increases by $2,000 in 2005 through 2007, and $3,000 in 2008 (indexed
thereafter).
Earned income tax credits in excess of tax liabilities owed through
the individual income tax system are re
[[Page 314]]
fundable 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.--The non-taxation
of Social Security benefits that exceed the beneficiary's contributions
out of taxed income is a tax expenditure. These additional retirement
benefits are paid for partly by employers' contributions that were not
included in employees' taxable compensation. Portions (reaching as much
as 85 percent) of recipients' Social Security and Tier 1 Railroad
Retirement benefits are included in the income tax base, however, if the
recipient's provisional income exceeds certain base amounts. Provisional
income is equal to adjusted gross income plus foreign or U.S. possession
income and tax-exempt interest, and one half of Social Security and tier
1 railroad retirement benefits. The tax expenditure is limited to the
portion of the benefits received by taxpayers who are below the base
amounts at which 85 percent of the benefits are taxable.
128. Social Security benefits for the disabled.--Benefit payments from
the Social Security Trust Fund for disability are partially excluded
from a beneficiary's gross incomes.
129. Social Security benefits for dependents and survivors.--Benefit
payments from the Social Security Trust Fund for dependents and
survivors are partially excluded from a beneficiary's gross income.
Veterans Benefits and Services
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, which was first
prepared for the 2004 Budget. The review focuses on three issues: (1)
using comprehensive income as a baseline tax system, (2) using a
consumption tax as a baseline tax system, and (3) defining negative tax
expenditures (provisions that cause taxpayers to pay too much tax).
The first section of this appendix compares major tax expenditures in
the current budget to those implied by a comprehensive income baseline.
This comparison includes a discussion of negative tax expenditures. The
second section compares the major tax expenditures in the current budget
to those implied by a consumption tax baseline, and also discusses
negative tax expenditures. The final section addresses concerns that
have been raised over the measurement of some current tax expenditures
by describing a new estimate of the tax expenditure caused by
accelerated depreciation and alternative estimates of the tax
expenditures resulting from the tax exemption of the return earned on
owner-occupied housing and preferential treatment of capital gains. The
final section also provides an estimate of the negative tax expenditure
caused by the double tax on corporate profits.
[[Page 315]]
DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON
COMPREHENSIVE INCOME
As discussed in the main body of the tax expenditure chapter, official
tax expenditures are measured relative to normal law or reference law
baselines that deviate from a uniform tax on a comprehensive concept of
income. Consequently, tax expenditures identified in the budget can
differ from those that would be identified if a comprehensive income tax
were chosen as the baseline tax system. This appendix addresses this
issue by comparing major tax expenditures listed in the current tax
expenditure budget with those implied by a comprehensive income
baseline. Most large tax expenditures would continue to be tax
expenditures were the baseline taken to be comprehensive income,
although some would be much smaller. A comprehensive income baseline
would also result in a number of additional tax provisions being counted
as tax expenditures.
Current budgetary practice excludes from the list of official tax
expenditures those provisions that over-tax certain items of income.
This exclusion conforms to the view that tax expenditures are
substitutes for direct Government spending programs. However, this
treatment gives a one-sided picture of how current law deviates from the
baseline tax system. Relative to comprehensive income, a number of
current tax provisions would be negative tax expenditures. Some of these
also might be negative tax expenditures under the reference law or
normal law baselines, expanded to admit negative tax expenditures.
Treatment of Major Tax Expenditures from the Current Budget under a
Comprehensive Income Tax Baseline
Comprehensive income, also called Haig-Simons income, is the real,
inflation adjusted, accretion to one's economic power arising between
two points in time, e.g., the beginning and ending of the year. It
includes all accretions to wealth, whether or not realized, whether or
not related to a market transaction, and whether a return to capital or
labor. Inflation adjusted capital gains (and losses) would be included
in comprehensive income as they accrue. Business, investment, and
casualty losses, including losses caused by depreciation, would be
deducted. Implicit returns, such as those accruing to homeowners, also
would be included in comprehensive income. A comprehensive income tax
baseline would tax all sources of income once. Thus, it would not
include a separate tax on corporate income that leads to the double
taxation of corporate 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 consumer durable goods,
including housing, 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 does not necessarily represent an
ideal tax base; efficiency or equity might be improved by deviating from
comprehensive income as a tax base, e.g., by reducing the tax on capital
income in order to further spur economic growth or by subsidizing
certain types of activities in order to correct for market failures or
to improve the 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.
Classifying items under a comprehensive income baseline is difficult,
in part because of the ambiguity of the baseline. It also is difficult
because of interactions between tax provisions (or their absence). These
interactions mean that it may not always be appropriate to consider each
item in isolation. Nonetheless, Appendix Table 1 attempts such a
classification for each of the thirty largest tax expenditures from the
Budget.
We classify fourteen of the thirty items as tax expenditures under a
comprehensive tax base (those in panel A). Most of these give
preferential tax treatment to the return on certain types of savings or
investment. They are a result of the explicitly hybrid nature of the
existing tax system, and arise out of policy decisions that reflect
discomfort with the high tax rate on capital income that would otherwise
arise under the current structure of the income tax. Even these
relatively clear cut items, however, can raise ambiguities particularly
in light of the absence of integration of the corporate and individual
tax systems. Consider, for example, the tax expenditures related to
retirement savings. Considered alone, these items clearly would be tax
expenditures under a comprehensive income tax baseline. However, much of
the income earned in these accounts is subject to the corporate income
tax, and would not be taxed again under a comprehensive income tax. If
account is taken simultaneously of the corporate income tax and the
individual income tax, then much of what is measured in these tax
expenditures might not be considered preferential tax treatment under a
comprehensive income tax baseline. But, if the corporate level income
tax is separately itemized as a surcharge, or a negative tax
expenditure, then the preferential treatments of retirement saving would
remain tax expenditures.
[[Page 316]]
The exclusion of worker's compensation benefits also would be a tax
expenditure under comprehensive income principles. Under comprehensive
income tax principles, if the worker were to buy the insurance himself,
he would be able to deduct the premium (since it represents a reduction
in net worth) but should include in income the benefit when paid (since
it represents an increase in net worth).\7\ If the employer pays the
premium, the proper treatment would allow the employer a deduction and
allow the employee to disregard the premium, but he would take the
proceeds, if any, into income. Current law allows the employer to deduct
the premium and excludes both the premium and the benefits from the
employee's tax base.
---------------------------------------------------------------------------
\7\ Suppose a taxpayer buys a one year term unemployment insurance
policy at the beginning of the year. At that time he exchanges one
asset, cash, for another, the insurance policy, so there is no change in
net worth. But, at the end of the year, the policy expires and so is
worthless, hence the taxpayer has a reduction in net worth equal to the
premium. If the policy pays off during the year (i.e., the taxpayer has
a work related injury), then the taxpayer would include the proceeds in
income because they represent an increase in his net worth.
---------------------------------------------------------------------------
Panel B deals with items that probably are tax expenditures, but that
raise some issues. The step-up of basis at death lowers the income tax
on capital gains for those who inherit assets below what it would be
otherwise. From that perspective it would be a tax expenditure under a
comprehensive income baseline. Nonetheless, there are ambiguities. Under
a comprehensive income baseline, all real inflation adjusted gains would
be taxed as accrued, so there would be no deferred unrealized gains on
assets held at death.
The lack of full taxation of Social Security benefits also is listed
in panel B. Consider first Social Security retirement benefits. To the
extent that Social Security 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).\8\ Benefits paid out of prior contributions and
the inside 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.
---------------------------------------------------------------------------
\8\ 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.
---------------------------------------------------------------------------
A similar analysis applies to Social Security benefits paid to
dependents and survivors. If these benefits represent transfers from the
Government, then they should be included in the tax base. If the
taxpaying unit consists of the worker plus dependents and survivors,
then to the extent that Social Security benefits represent payments from
a pension, the annual pension earnings should be taxed in the same way
that earnings accruing to retirees are taxed. However, benefits paid to
dependents and survivors might be viewed as a gift or transfer from the
decedent, in which case the dependents and survivors should pay tax on
the full amount of the benefit received. (In this case the decedent or
his estate should pay tax on the pension income as well, to the extent
that the gift represents consumption rather than a reduction in net
worth).
In addition, dependent and survivors benefits might be viewed in part
as providing life insurance. In that case, the annual premiums paid each
year, or the portion of Social Security taxes attributable to the
premiums, should be deducted from income, since they represent a decline
in net worth, while benefits should be included in income.
Alternatively, taxing premiums and excluding benefits also would
represent appropriate income tax policy.
In contrast to any of these treatments, current law excludes one-half
of contributions (employer-paid payroll taxes) from the base of the
income tax, makes no attempt to tax accretions, and subjects some, but
not all, benefits to taxation. The difference between current law's
treatment of Social Security benefits and their treatment under a
comprehensive income tax would qualify as a tax expenditure, but such a
tax expenditure differs in concept from that included in the official
budget.
The tax expenditures in the official budget\9\ reflect exemptions for
lower income beneficiaries from the tax on 85 percent of Social Security
benefits.\10\ Historically, payroll taxes paid by the employee
represented no more than 15 percent of the expected value of the
retirement benefits received by a lower-earnings Social Security
beneficiary. The 85 percent inclusion rate is therefore intended to tax
the remaining amount of the retirement 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 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,\11\ on the assumption that Social Security is comparable to such
pensions. Hence, the official tax expenditure understates the tax
advantage accorded Social Security retirement benefits relative to a
comprehensive income baseline.
---------------------------------------------------------------------------
\9\ This includes the tax expenditure for benefits paid to workers,
that for benefits paid to survivors and dependents, and that for
benefits paid to dependents.
\10\ 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.
\11\ 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 benefits paid to dependents and survivors
should be taxed as private pensions, the same conclusion applies: the
official tax expenditure understates the tax advantage.
To the extent that the personal and dependent care exemptions and the
standard deduction properly remove from taxable income all expenditures
that do not
[[Page 317]]
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. Even accepting this competing
perspective, however, one might question why these programs come in the
form of credits rather than deductions.
The next category (panel C) includes items whose treatment is less
certain. The proper treatment of some of these items under a
comprehensive income tax is ambiguous, while others perhaps serve as
proxies for what would be a tax expenditure under a comprehensive income
base.\12\ 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.\13\
---------------------------------------------------------------------------
\12\ 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.
\13\ 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.\14\
---------------------------------------------------------------------------
\14\ If recipients tend to be in lower tax brackets, then the tax
expenditure is smaller than when measured at the donor's tax rates.
---------------------------------------------------------------------------
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 aren't
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 exemption of full taxation of Social Security benefits paid to the
disabled also raises some issues. Social Security benefits for the
disabled most closely resemble either Government transfers or insurance.
A comprehensive income tax would require the worker to include the
benefit fully in his income and would allow him to deduct associated
Social Security taxes. If viewed as insurance, he also could include the
premium (i.e., tax) and exclude the benefit. The deviation between such
treatment and current law's treatment (described above) would be a tax
expenditure under a comprehensive income baseline.
In contrast, as described above, the official tax expenditure measures
the benefit of exemption for low income beneficiaries from the tax on 85
percent of Social Security benefits. This measurement does not
correspond closely to that required under a comprehensive income base.
If the payment of the benefit is viewed as a transfer and divorced from
the treatment of Social Security taxes, then the current tax expenditure
understates the tax expenditure measured relative to a comprehensive
income baseline. If the payment of the benefit is viewed as a transfer
but the inability to deduct the employee's share of the Social Security
tax is simultaneously considered, then it is less likely that the
current tax expenditure overstates the tax expenditure relative to a
comprehensive income baseline, and in some cases it may generate a
negative tax expenditure. Negative tax expenditures arise when the
actual tax treatment imposes a higher tax burden than would the baseline
tax system, and are discussed in more detail below. If the benefit is
viewed as insurance and the tax as a premium, then the current tax
expenditure overstates the tax expenditure relative to a comprehensive
income baseline. Indeed, in the insurance model, the ability to exclude
from tax only \1/2\ of the premium might suggest that \1/2\ of the
payout should be taxed, so that the current tax rules impose a greater
tax burden than that implied by a comprehensive income tax, i.e., a
negative tax expenditure.
The deduction of nonbusiness state and local taxes other than on
owner-occupied homes also is included here. 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.''\15\
The idea is that these taxes represent consumption expenditures, and so
are elements of income.
---------------------------------------------------------------------------
\15\ 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 official 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 value of State and local government benefits received, but
would allow a deduction for State and local taxes paid.\16\ Thus, in
this sense the deductibility of State and local taxes is consistent with
comprehensive income tax principles; it should not be a tax expenditure.
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.\17\ So, if the value of services
[[Page 318]]
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.\18\
---------------------------------------------------------------------------
\16\ U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.:
U.S. Government Printing Office, 1977) p. 92.
\17\ 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.
\18\ 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.
---------------------------------------------------------------------------
Mortgage interest would be deductible from the base of a comprehensive
income tax, since 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. One could argue, however, that because current law does
not impute rental income nor does it impute the value of Government
services, the home mortgage interest deduction and the deduction for
property taxes move away from rather than towards the outcome observed
under a comprehensive income tax base, and so might be considered tax
expenditures. Alternatively, they might be viewed as proxies for the
correct tax expenditures. They are, however, extremely crude proxies for
the implicit rental income earned on owner-occupied housing. The
interest deduction proxy, for example, understates the extent of the tax
expenditure associated with ignoring implicit rental income to the
extent a house is unencumbered by a mortgage that approximates the
house's market value, and does not include the effects on net income of
such costs as depreciation, maintenance, and repairs.
The final category (panel D) includes items that would not be tax
expenditures under a comprehensive income tax base. Most versions of a
comprehensive income tax would assign tax liability to individuals.
There would be no separate corporation income tax. Hence, the issue of
graduated corporate tax rates would not arise.\19\ 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.\20\
---------------------------------------------------------------------------
\19\ As discussed below, the double tax on corporate profits would be
a major negative tax expenditure.
\20\ 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 (and
losses) as they accrue and capital gains as they are realized, private
gifts and inheritances received, in-kind benefits from such Government
programs as food-stamps, Medicaid, and public housing, the value of
payouts from insurance policies,\21\ and benefits received from private
charities. Under some ideas of comprehensive income, the value of
leisure and of household production of goods and services also would be
included as tax expenditures. The personal exemption and standard
deduction also might be considered tax expenditures, although they can
be viewed differently, e.g., as elements of the basic tax rate schedule.
The foreign tax credit also might be a tax expenditure, since a
deduction for foreign taxes, rather than a credit, would seem to measure
the income of U.S. residents properly.
---------------------------------------------------------------------------
\21\ 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 intended to be similar to Government spending
programs.
If attention is expanded from a focus on spending-like programs to
include any deviation from the baseline tax system, negative tax
expenditures would be of interest. Relative to a comprehensive income
baseline, there are a number of important negative tax expenditures,
some of which also might be viewed as negative tax expenditures under an
expanded interpretation of the normal or reference law baseline. Among
the more important negative tax expenditures is the corporation income
tax, or more generally the double tax on corporate profits, which would
be eliminated under a comprehensive income tax. The Jobs and Growth Tax
Relief and Reconciliation Act of 2003 (JGTRRA) reduced the tax rate on
dividends and capital gains to 15 percent, thus reducing the double tax
compared to prior law. Nonetheless, as discussed later in the Appendix,
current law still imposes a substantial double tax on corporate profits.
The passive loss rules, restrictions on the deductibility of capital
losses, and NOL carry-forward requirements each would generate a
negative tax expenditure, since a comprehensive income tax would allow
full deductibility of losses. If human capital were considered an asset,
then its cost (e.g., certain education and training expenses, including
perhaps the cost of college and professional school) should be
amortizable, but it is not under current law.\22\ 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
[[Page 319]]
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.\23\ As discussed above, the current treatment of
Social Security payments to the disabled also might represent a negative
tax expenditure, if viewed as payments on an insurance policy.
---------------------------------------------------------------------------
\22\ 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.
\23\ See Bradford, Untangling the Income Tax, p. 41.
---------------------------------------------------------------------------
Current tax law also fails to index for inflation interest receipts,
capital gains, depreciation, and inventories. This failure leads to
negative tax expenditures because comprehensive income would be indexed
for inflation. Current law, however, also fails to index for inflation
the deduction for interest payments; this represents a (positive) tax
expenditure.
The issue of indexing also highlights that even if one wished to focus
only on tax policies that are similar to spending programs, accounting
for some negative tax expenditures may be required. For example, the net
subsidy created by accelerated depreciation is properly measured by the
difference between depreciation allowances specified under existing tax
law and economic depreciation, which is indexed for inflation.\24\
---------------------------------------------------------------------------
\24\ 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.
---------------------------------------------------------------------------
DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES
RELATIVE TO A CONSUMPTION BASE
This section compares tax expenditures listed in the official tax
expenditure budget with those implied by a comprehensive consumption tax
baseline. It first discusses some of the difficulties encountered in
trying to compare current tax provisions to those that would be observed
under a comprehensive consumption tax. Next, it discusses which of the
thirty largest official tax expenditures would be tax expenditures under
the consumption tax baseline, concluding that about one-half of the top
thirty official tax expenditures would remain tax expenditures under a
consumption tax baseline. Most of those that fall off the list are tax
incentives for saving and investment.
The section next discusses some major differences between current law
and a comprehensive consumption tax baseline that are excluded from the
current list of tax expenditures. These differences include the
consumption value of owner-occupied housing and other consumer durables,
benefits from in-kind Government transfers, and gifts. It concludes with
a discussion of negative tax expenditures relative to a consumption tax
baseline
Ambiguities in Determining Tax Expenditures Relative to a Consumption
Baseline
A broad-based consumption tax is a combination of an income tax plus a
deduction for net saving. This follows from the definition of
comprehensive income as consumption plus the change in net worth. It
therefore seems straightforward to say that current law's deviations
from a consumption base are the sum of (a) tax expenditures on an income
base associated with exemptions and deductions for certain types of
income, plus (b) overpayments of tax, or negative tax expenditures, to
the extent net saving is not deductible from the tax base. In reality,
however, the situation is more complicated. A number of issues arise,
some of which also are problems in defining a comprehensive income tax,
but seem more severe, or at least only more obvious, for the consumption
tax baseline.
It is not always clear how to treat certain items under a consumption
tax. One problem is determining whether a particular expenditure is an
item of consumption. Spending on medical care and charitable donations
are two examples. Another problem relates 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 suggests that medical spending and
charitable contributions might be included 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 issues.
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 could well be a tax expenditure, but takes note of alternative
views.
Some exclusions of income are equivalent in many respects to
consumption tax treatment that immediately deducts the cost of an
investment while taxing the future cash-flow. For example, exempting
invest
[[Page 320]]
ment income is equivalent to consumption tax treatment as far as the
normal rate of return on new investment is concerned. This is because
expensing generates a tax reduction that offsets in present value terms
the tax paid on the investment's future normal returns. Expensing gives
the income from a marginal investment a zero effective tax rate.
However, a yield exemption approach differs from a consumption tax as
far as the distribution of income and Government revenue is concerned.
Pure profits in excess of the normal rate of return would be taxed under
a consumption tax, because they are an element of cash-flow, but would
not be taxed under a yield exemption tax system. Should exemption of
certain kinds of investment income, and certain investment tax credits,
be regarded as the equivalent of consumption tax treatment? The
classification that follows takes a fairly broad view of this
equivalence and considers many tax provisions that reduce or eliminate
the tax on capital income to be roughly consistent with a broad-based
consumption tax.
Looking at provisions one at a time can be misleading. The hybrid
character of the existing tax system leads to many provisions that might
make good sense in the context of a consumption tax, but that generate
inefficiencies because of the problem of the ``uneven playing field''
when evaluated within the context of the existing tax rules. It is not
clear how these should be classified. For example, many saving
incentives are targeted to specific tax favored sources of capital
income, and so potentially distort economic choices in ways that would
not occur under a broad-based consumption tax. As another example, under
a consumption VAT based on the destination principle, there would be a
rebate of the VAT on exports and a tax on imports. Does this mean that
the extraterritorial income exclusion (the successor of the Foreign
Sales Corporation provision) is not a tax expenditure? Resolution comes
down to judgments about how broad is broad enough to be considered
general, or whether it even matters at all that a provision is targeted
in some way. The classification that follows views many savings
incentives, even if targeted, as roughly consistent with a broad based
consumption tax.
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.
Such considerations suggest that trying to compute the current tax's
deviations from ``the'' base of a consumption tax is impossible because
deviations cannot be uniquely determined, making it very difficult to do
a consistent accounting of the differences between the current tax base
and a consumption tax base. Nonetheless, Appendix Table 2 attempts a
classification based on the 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 that is unrelated to
moderately broad-based saving or investment incentives would remain tax
expenditures under a consumption baseline. In addition, several official
tax expenditures relating to items of income and expense are difficult
to properly classify, while others may serve as proxies for properly
measured tax expenditures.
Appendix Table 2 shows the thirty largest official tax expenditures
from the Budget classified according to whether they would be considered
a tax expenditure under a consumption tax. One of the thirty items
clearly would be a tax expenditure (shown in panel A) under a
consumption tax, while an additional four (those in panel B) probably
would be tax expenditures.
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 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 com
[[Page 321]]
prehensive income tax and a consumption tax. The properly measured tax
expenditure relative to a consumption tax baseline would include only
those Social Security benefits that are accorded treatment more
favorable than that implied by a consumption tax, which would correspond
to including 50 percent of Social Security benefits in the recipient's
tax base.
A similar analysis would apply to exclusion of Social Security
benefits of dependents and retirees.
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.
The treatment of the items in panels C is less uncertain. Several of
these items relate to the costs of medical care or to charitable
contributions. As discussed in the previous section of the appendix,
there is disagreement within the tax policy community over the extent to
which medical care and charitable giving represent consumption items.
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 medical insurance premiums.
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. From some perspectives, these premiums should be in the tax base
because they appear to represent consumption. Yet an alternative
perspective would support excluding the premium from tax as long as the
consumption tax base included the value of any medical services paid for
by the insurance policy, because the premium equals the expected value
of insurance benefits received. But even from this alternative
perspective, the official tax expenditure might continue to be a tax
expenditure under a consumption tax baseline because current law
excludes the value of medical services paid with insurance benefits from
the employee's taxable income.
If medical spending is not consumption, one approach to measuring the
consumption base would ignore insurance, but allow the consumer to
deduct the value of all medical services obtained. An alternative
approach would allow a deduction for the premium but include the value
of any insurance benefits received, while continuing to allow a
deduction for a value of all medical services obtained. In either case,
the official tax expenditure for the exclusion of employer provided
medical insurance and expenses would not be a tax expenditure relative
to a consumption tax baseline.
Consider next 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
under a consumption tax, 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 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 taxation of Social Security benefits for the disabled also is
difficult to classify. As discussed in this appendix above, these
benefits generally ought to be taxed because they represent purchasing
power. However, the associated Social Security taxes ought to be fully
deductible, but they are not. Hence the proper treatment is unclear.
Moreover, if the insurance model is applied, the taxation of Social
Security benefits might be a negative tax expenditure.
The credit for low income housing acts to lower the tax burden on
qualified investment, and so from one perspective would not be a tax
expenditure under a consumption tax baseline. However, in some cases the
credit is too generous; it can give a negative tax on income from
qualified investment rather than the zero tax called for under
consumption tax principles. In addition, the credit is very narrowly
targeted. Consequently, it could be considered a tax expenditure
relative to a consumption tax baseline.
The final panel (D) shows items that are not likely to be tax
expenditures under a consumption base. Most of these relate to tax
provisions that eliminate or reduce the tax on various types of capital
income because a zero tax on capital income is consistent with
consumption tax principles. But in those cases where a tax remains, a
negative tax expenditure under the consumption tax is created.
The graduated corporate income tax rates would not be a tax
expenditure under a comprehensive consumption baseline. A consumption
tax would have no tax
[[Page 322]]
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.
A consumption tax implemented as a tax on cash flows would tax all
proceeds from sales of capital assets when consumed, rather than just
capital gains; because of expensing, taxpayers effectively would have a
zero basis. The proceeds from borrowing would be in the base of a
consumption tax that also allowed a deduction for repayment of principal
and interest, but are excluded from the current tax base. The deduction
of business interest expense might be a tax expenditure, since under
some forms of consumption taxation interest is neither deducted from the
borrower's tax base nor included in the lender's tax base. The personal
exemption and standard deduction also might be considered tax
expenditures, although they can be viewed differently, e.g., as elements
of the basic tax rate schedule.
Negative Tax Expenditures
Importantly, current law also deviates from a consumption tax norm in
ways that increase, rather than decrease, tax liability. These could be
called negative tax expenditures. The official budget excludes negative
tax expenditures on the theory that tax expenditures are intended to
substitute for Government spending programs. Yet excluding negative tax
expenditures 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, including the income earned on
inside-build up in Social Security accounts. The revenue from the
corporation income tax, or more generally a measure of the double tax on
corporate profits, also would be a negative tax expenditure.
Depreciation allowances, even 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. Under some views, the current tax
treatment of Social Security benefits paid to the disabled would be a
negative tax expenditure.
REVISED ESTIMATES OF SELECTED TAX EXPENDITURES
Accelerated Depreciation
Under the reference tax law baseline no tax expenditures arise from
accelerated depreciation. In the past, official tax expenditure
estimates of accelerated depreciation under the normal tax law baseline
compared tax allowances based on the historic cost of an asset with
allowances calculated using the straight-line method over relatively
long recovery periods. Normal law allowances also were determined by the
historical cost of the asset and so did not adjust for inflation,
although such an adjustment is required when measuring economic
depreciation, the age related fall in the real value of the asset.
Beginning with the 2004 Budget, the tax expenditures for accelerated
depreciation under the normal law concept have been recalculated using
as a baseline depreciation rates and replacement cost indexes from the
National Income and Product Accounts.\25\ The revised estimates are
intended to approximate the degree of acceleration provided by current
law over a baseline determined by real, inflation adjusted, and economic
depreciation. Current law depreciation allowances for machinery and
equipment include the benefits of a temporary expensing provision.\26\
The estimates are shown in tables in the body of the main text, e.g.,
Table 18.1.
---------------------------------------------------------------------------
\25\ 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.
\26\ 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.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the
deduction to 50 percent depreciation (up from 30 percent) of the cost
new equipment purchased after May 5, 2003 and placed into service before
January 1, 2005. Qualifying investments generally are limited to
tangible property with depreciation recovery periods of 20 years or
less, certain software, and leasehold improvements, but this set of
assets corresponds closely to machinery and equipment.
---------------------------------------------------------------------------
[[Page 323]]
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.\27\ 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
2005-2009 because the temporary expensing provision expires at the end
of 2004. Calculations that compare the present value of tax depreciation
(without the temporary expensing) with the present value of inflation
indexed economic depreciation over each investment's economic life show
that for many types of assets tax depreciation is accelerated, but only
slightly, assuming a moderate rate of inflation.\28\
---------------------------------------------------------------------------
\27\ Estimates under the old methodology are no longer shown in the
tables.
\28\ 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.
Appendix 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.\29\
---------------------------------------------------------------------------
\29\ National Income and Production Accounts, Table 2.4.
---------------------------------------------------------------------------
The tax expenditure estimate is substantial, growing from $24 billion
in 2005 to $35 billion in 2009. 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.
Accrued Capital Gains
Under a comprehensive income baseline, all real gains would be taxed
as accrued. These gains would be taxed as ordinary income rather than at
preferential rates. There would be no deferred unrealized gains on
assets held at death, nor gains carried over on gifts, or other
preferential treatments. Indeed, all of the provisions related to
capitals gains listed in the tax expenditure budget would be dropped.
Instead, in their place the difference between the ordinary tax on real
gains accrued and the actual tax paid would be calculated. For 1999, for
instance, the tax on real accrued gains on corporate equity is estimated
at $594 billion. This compares to an estimated tax on realized gains of
$62 billion, for forgone revenues of $562 billion. However, this tax
expenditure may easily turn into a penalty given the limits on capital
losses. For 2000, for instance, real accrued losses in corporate equity
amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion
in capital gains taxes. This roughly translates into an overpayment of
taxes to the tune of $464 billion.
Double Tax on Corporate Profits
A comprehensive income tax would tax all sources of income once. Taxes
would not vary by type or source of income.
In contrast to this benchmark, current law taxes income that
shareholders earn on investment in corporate stocks at least twice, and
at combined rates that generally are higher than those imposed on other
sources of income. Corporate profits are taxed once at the company level
under the corporation income tax. They are taxed again at the
shareholder level when received as a dividend or recognized as a capital
gain. Corporate profits can be taxed more then twice when they pass
through multiple corporations before being distributed to noncorporate
shareholders. Corporate level taxes cas
[[Page 324]]
cade because corporations are taxed on capital gains they realize on the
sale of stock shares and on some dividend income received. Compared to a
comprehensive income tax current law's double (or more) tax on corporate
profits is an example of a negative tax expenditure because it subjects
income to a larger tax burden than implied by a comprehensive income
baseline.
Appendix Table 3 provides an estimate of the negative tax expenditure
caused by the multiple levels of tax on corporate profits. This negative
tax expenditure is measured as the shareholder level tax on dividends
paid and capital gains realized out of earnings that have been fully
taxed at the corporate level. It also includes the corporate tax paid on
inter-corporate dividends and on corporate capital gains attributable to
the sale of stock shares. The estimate includes the reduction in the
dividends and capital gains tax rates enacted in JGTRRA.
The negative tax expenditure is large in magnitude; it exceeds $33
billion in the years 2005 through in 2009. It is comparable in size (but
opposite in sign) to all but the largest official tax expenditures.
JGTRRA reduced but did not eliminate the double tax on corporate
profits.
Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX \1\
(In millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
2005 Revenue
Description Effect
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Comprehensive Income Tax
Net exclusion of pension contributions and earnings: Employer plans.................................................................... 61,740
Net exclusion of pension contributions and earnings: 401(k) plans...................................................................... 58,910
Capital gains (except agriculture, timber, iron ore, and coal)......................................................................... 30,190
Exclusion of interest on public purpose State and local bonds.......................................................................... 26,370
Exclusion of interest on life insurance savings........................................................................................ 22,130
Capital gains exclusion on home sales.................................................................................................. 21,490
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................... 20,090
Net exclusion of pension contributions and earnings: Keogh plans....................................................................... 9,260
Deferral of income from controlled foreign corporations (normal tax method)............................................................ 8,400
Credit for low-income housing investments.............................................................................................. 6,860
Exclusion of workers' compensation benefits............................................................................................ 6,850
Extraterritorial income exclusion...................................................................................................... 5,890
Expensing of certain small investments (normal tax method)............................................................................. 4,850
Expensing of research and experimentation expenditures (normal tax method)............................................................. 4,500
B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications
Child credit........................................................................................................................... 29,860
Exclusion of Social Security benefits for retired workers.............................................................................. 19,040
Step-up basis of capital gains at death................................................................................................ 18,240
Earned income tax credit............................................................................................................... 5,006
Exclusion of Social security benefits of dependents and survivors...................................................................... 4,310
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care.................................................... 112,990
Deductibility of mortgage interest on owner-occupied homes............................................................................. 69,740
Deductibility of nonbusiness State and local taxes other than on owner-occupied homes.................................................. 46,180
Deductibility of charitable contributions, other than education and health............................................................. 29,670
Deductibility of State and local property tax on owner-occupied homes.................................................................. 19,410
Deductibility of medical expenses...................................................................................................... 7,900
Deductibility of self-employed medical insurance premiums.............................................................................. 3,780
Social Security benefits for disabled.................................................................................................. 3,720
Deductibility of charitable contributions (education).................................................................................. 3,660
D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax
Exception from passive loss rules for $25,000 of rental loss........................................................................... 4,390
Graduated corporation income tax rate (normal tax method).............................................................................. 3,910
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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 18-2, Tax Expenditure Budget.
[[Page 325]]
Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX \1\
(In millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
2005 Revenue
Description Effect
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Consumption Base
Exclusion of workers' compensation benefits............................................................................................ 6,850
B. Probably a Tax Expenditure Under a Consumption Base,
Child credit........................................................................................................................... 29,860
Exclusion of Social Security benefits for retired workers.............................................................................. 19,040
Earned income tax credit............................................................................................................... 5,006
Exclusion of Social security benefits of dependents and survivors...................................................................... 4,310
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care.................................................... 112,990
Deductibility of mortgage interest on owner-occupied homes............................................................................. 69,740
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes.................................................. 46,180
Deductibility of charitable contributions, other than education and health............................................................. 29,670
Deductibility of State and local property tax on owner-occupied homes.................................................................. 19,410
Deductibility of medical expenses...................................................................................................... 7,900
Credit for low-income housing investments.............................................................................................. 6,860
Extraterritorial income exclusion...................................................................................................... 5,890
Deductibility of self-employed medical insurance premiums.............................................................................. 3,780
Deductibility of charitable contributions (education).................................................................................. 3,660
Social Security benefits for disabled.................................................................................................. 3,720
D. Not a Tax Expenditure under a Consumption Base
Net exclusion of pension contributions and earnings: Employer plans.................................................................... 61,740
Net exclusion of pension contributions and earnings: 401(k) plans...................................................................... 58,910
Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method)..................................................... 30,190
Exclusion of interest on public purpose State and local bonds.......................................................................... 26,370
Exclusion of interest on life insurance savings........................................................................................ 22,130
Capital gains exclusion on home sales.................................................................................................. 21,490
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................... 20,090
Step-up basis of capital gains at death................................................................................................ 18,240
Net exclusion of pension contributions and earnings: Keogh plans....................................................................... 9,260
Deferral of income from controlled foreign corporations (normal tax method)............................................................ 8,400
Expensing of certain small investments (normal tax method)............................................................................. 4,850
Expensing of research and experimentation expenditures (normal tax method)............................................................. 4,500
Exception from passive loss rules for $25,000 of rental loss........................................................................... 4,390
Graduated corporation income tax rate (normal tax method).............................................................................. 3,910
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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. REVISED TAX EXPENDITURE ESTIMATES \1\
(In millions of dollars)
----------------------------------------------------------------------------------------------------------------
Revenue Loss
Provision ---------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009
----------------------------------------------------------------------------------------------------------------
Imputed Rent On Owner-Occupied Housing.... 18,340 20,540 24,100 25,160 28,250 31,400 34,710
Double Tax on corporate profit \2\........ -24,020 -26,740 -34,940 -33,340 -33,260 -33,660 -34,280
----------------------------------------------------------------------------------------------------------------
\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.
[[Page 327]]
======================================================================
DIMENSIONS OF THE BUDGET
========================================================================