[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

========================================================================