Analytical Perspectives - 19. Tax Expenditures

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

[[Page 315]]

19. TAX EXPENDITURES

The Congressional Budget Act of 1974 (Public Law 93-344) requires that
a list of ``tax expenditures'' be included in the budget. Tax
expenditures are defined in the law as ``revenue losses attributable to
provisions of the Federal tax laws which allow a special exclusion,
exemption, or deduction from gross income or which provide a special
credit, a preferential rate of tax, or a deferral of liability.'' These
exceptions may be viewed as alternatives to other policy instruments,
such as spending or regulatory programs. Identification and measurement
of tax expenditures depends importantly on the baseline tax system
against which the actual tax system is compared.
The largest reported tax expenditures tend to be associated with the
individual income tax. For example, sizeable deferrals, deductions and
exclusions are provided for employer contributions for medical
insurance, pension contributions and earnings, capital gains, and
payments of State and local individual income and property taxes.
Reported tax expenditures under the corporate income tax tend to be
related to timing differences in the rate of cost recovery for various
investments. As is discussed below, the extent to which these provisions
are classified as tax expenditures varies according to the conceptual
baseline used.
Each tax expenditure estimate in this chapter was calculated assuming
other parts of the tax code remained unchanged. The estimates would be
different if all tax expenditures or major groups of tax expenditures
were changed simultaneously because of potential interactions among
provisions. For that reason, this chapter does not present a grand total
for the estimated tax expenditures. Moreover, past tax changes entailing
broad elimination of tax expenditures were generally accompanied by
changes in tax rates or other basic provisions, so that the net effects
on Federal revenues were considerably (if not totally) offset.
Tax expenditures relating to the individual and corporate income taxes
are estimated for fiscal years 2004-2010 using three methods of
accounting: revenue effects, outlay equivalents, and present values. The
present value approach provides estimates of the revenue effects for tax
expenditures that generally involve deferrals of tax payments into the
future.
The section of the chapter on performance measures and economic
effects presents information related to assessment of the effect of tax
expenditures on the achievement of program performance goals. This
section is a complement to the Government-wide performance plan required
by the Government Performance and Results Act of 1993.
The 2004 and 2005 Budgets included a thorough review of important
ambiguities in the tax expenditure concept. In particular, this review
focused on defining tax expenditures relative to a comprehensive income
tax baseline, defining tax expenditures relative to a broad-based
consumption tax baseline, and defining negative tax expenditures, i.e.,
provisions of current law that over-tax certain items or activities. A
similar review is presented in the Appendix again this year.

TAX EXPENDITURES IN THE INCOME TAX

Tax Expenditure Estimates

All tax expenditure estimates presented here are based upon current
tax law enacted as of December 31, 2004. Expired or repealed provisions
are not listed if their revenue effects result only from taxpayer
activity occurring before fiscal year 2004. Due to the time required to
estimate the large number of tax expenditures, the estimates are based
on Mid-Session economic assumptions; exceptions are the earned income
tax credit and child credit provisions, which involve outlay components
and hence are updated to reflect the economic assumptions used elsewhere
in the budget.
The total revenue effects for tax expenditures for fiscal years 2004-
2010 are displayed according to the budget's functional categories in
Table 19-1. Descriptions of the specific tax expenditure provisions
follow the tables of estimates and the discussion of general features of
the tax expenditure concept.
As in prior years, two baseline concepts, the normal tax baseline and
the reference tax law baseline, are used to identify tax expenditures.
These baseline concepts are thoroughly discussed in Special Analysis G
of the 1985 Budget, where the former is referred to as the pre-1983
method and the latter the post-1982 method. For the most part, the two
concepts coincide. However, items treated as tax expenditures under the
normal tax baseline, but not the reference tax law baseline, are
indicated by the designation ``normal tax method'' in the tables. The
revenue effects for these items are zero using the reference tax rules.
The alternative baseline concepts are discussed in detail following the
tables.
Table 19-2 reports the respective portions of the total revenue
effects that arise under the individual and corporate income taxes
separately. The location of the estimates under the individual and
corporate headings does not imply that these categories of filers
benefit from the special tax provisions in proportion to the respective
tax expenditure amounts shown. Rather, these breakdowns show the
specific tax accounts through which

[[Page 316]]

the various provisions are cleared. The ultimate beneficiaries of
corporate tax expenditures could be shareholders, employees, customers,
or other providers of capital, depending on economic forces.
Table 19-3 ranks the major tax expenditures by the size of their 2006-
2010 revenue effect.

Interpreting Tax Expenditure Estimates

The estimates shown for individual tax expenditures in Tables 19-1,
19-2, and 19-3 do not necessarily equal the increase in Federal revenues
(or the change in the budget balance) that would result from repealing
these special provisions, for the following reasons.
Eliminating a tax expenditure may have incentive effects that alter
economic behavior. These incentives can affect the resulting magnitudes
of the activity or of other tax provisions or Government programs. For
example, if capital gains were taxed at ordinary rates, capital gain
realizations would be expected to decline, potentially resulting in a
decline in tax receipts. Such behavioral effects are not reflected in
the estimates.
Tax expenditures are interdependent even without incentive effects.
Repeal of a tax expenditure provision can increase or decrease the tax
revenues associated with other provisions. For example, even if behavior
does not change, repeal of an itemized deduction could increase the
revenue costs from other deductions because some taxpayers would be
moved into higher tax brackets. Alternatively, repeal of an itemized
deduction could lower the revenue cost from other deductions if
taxpayers are led to claim the standard deduction instead of itemizing.
Similarly, if two provisions were repealed simultaneously, the increase
in tax liability could be greater or less than the sum of the two
separate tax expenditures, because each is estimated assuming that the
other remains in force. In addition, the estimates reported in Table 19-
1 are the totals of individual and corporate income tax revenue effects
reported in Table 19-2 and do not reflect any possible interactions
between individual and corporate income tax receipts. For this reason,
the estimates in Table 19-1 should be regarded as approximations.

Present-Value Estimates

The annual value of tax expenditures for tax deferrals is reported on
a cash basis in all tables except Table 19-4. Cash-based estimates
reflect the difference between taxes deferred in the current year and
incoming revenues that are received due to deferrals of taxes from prior
years. Although such estimates are useful as a measure of cash flows
into the Government, they do not accurately reflect the true economic
cost of these provisions. For example, for a provision where activity
levels have changed, so that incoming tax receipts from past deferrals
are greater than deferred receipts from new activity, the cash-basis tax
expenditure estimate can be negative, despite the fact that in present-
value terms current deferrals do have a real cost to the Government.
Alternatively, in the case of a newly enacted deferral provision, a
cash-based estimate can overstate the real effect on receipts to the
Government because the newly deferred taxes will ultimately be received.
Present-value estimates, which are a useful complement to the cash-basis
estimates for provisions involving deferrals, are discussed below.
Discounted present-value estimates of revenue effects are presented in
Table 19-4 for certain provisions that involve tax deferrals or other
long-term revenue effects. These estimates complement the cash-based tax
expenditure estimates presented in the other tables.
The present-value estimates represent the revenue effects, net of
future tax payments, that follow from activities undertaken during
calendar year 2004 which cause the deferrals or other long-term revenue
effects. For instance, a pension contribution in 2004 would cause a
deferral of tax payments on wages in 2004 and on pension earnings on
this contribution (e.g., interest) in later years. In some future year,
however, the 2004 pension contribution and accrued earnings will be paid
out and taxes will be due; these receipts are included in the present-
value estimate. In general, this conceptual approach is similar to the
one used for reporting the budgetary effects of credit programs, where
direct loans and guarantees in a given year affect future cash flows.

Outlay Equivalents

The concept of ``outlay equivalents'' is another theoretical measure
of the budget effect of tax expenditures. It is the amount of budget
outlays that would be required to provide the taxpayer the same after-
tax income as would be received through the tax provision. The outlay-
equivalent measure allows the cost of a tax expenditure to be compared
with a direct Federal outlay on a more even footing. Outlay equivalents
are reported in Table 19-5.

[[Page 317]]

Table 19-1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES
(in millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total from corporations and individuals
--------------------------------------------------------------------------------
2004 2005 2006 2007 2008 2009 2010 2006-10
--------------------------------------------------------------------------------------------------------------------------------------------------------

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

International affairs:
2 Exclusion of income earned abroad by U.S. citizens...... 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570
3 Exclusion of certain allowances for Federal employees 850 900 950 1,000 1,050 1,100 1,160 5,260
abroad.................................................
4 Extraterritorial income exclusion....................... 5,500 5,170 4,270 1,820 220 40 20 6,370
5 Inventory property sales source rules exception......... 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980
6 Deferral of income from controlled foreign corporations 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740
(normal tax method)....................................
7 Deferred taxes for financial firms on certain income 2,130 2,190 2,260 960 ........ ........ ........ 3,220
earned overseas........................................

General science, space, and technology
8 Expensing of research and experimentation expenditures -2,330 4,110 7,920 6,990 6,260 5,360 4,800 31,330
(normal tax method)....................................
9 Credit for increasing research activities............... 4,680 5,130 2,140 910 390 180 50 3,670

Energy
10 Expensing of exploration and development costs, fuels... 260 400 370 280 240 190 140 1,220
11 Excess of percentage over cost depletion, fuels......... 1,320 1,280 1,350 1,420 1,470 1,510 1,550 7,300
12 Alternative fuel production credit...................... 1,040 1,040 1,040 1,040 420 ........ ........ 2,500
13 Exception from passive loss limitation for working 20 20 20 20 20 20 20 100
interests in oil and gas properties....................
14 Capital gains treatment of royalties on coal............ 70 70 80 80 100 70 60 390
15 Exclusion of interest on energy facility bonds.......... 100 100 110 110 120 120 130 590
16 Enhanced oil recovery credit............................ 330 340 340 350 360 370 390 1,810
17 New technology credit................................... 330 470 620 700 800 820 690 3,630
18 Alcohol fuel credits \1\................................ 30 30 30 30 40 40 40 180
19 Tax credit and deduction for clean-fuel burning vehicles 70 70 50 -20 -70 -80 -60 -180
20 Exclusion of conservation subsidies provided by public 100 100 100 100 90 90 90 470
utilities..............................................

Natural resources and environment
21 Expensing of exploration and development costs, nonfuel 230 230 250 250 250 270 270 1,290
minerals...............................................
22 Excess of percentage over cost depletion, nonfuel ........ ........ ........ ........ ........ ........ 10 10
minerals...............................................
23 Exclusion of interest on bonds for water, sewage, and 500 530 570 600 630 650 680 3,130
hazardous waste facilities.............................
24 Capital gains treatment of certain timber income........ 70 70 80 80 100 70 60 390
25 Expensing of multiperiod timber growing costs........... 340 350 370 380 400 410 430 1,990
26 Tax incentives for preservation of historic structures.. 300 320 330 340 360 380 400 1,810
27 Expensing of capital costs with respect to complying ........ 10 ........ 10 20 40 10 90
with EPA sulfur regulations............................
28 Exclusion of gain or loss on sale or exchange of certain ........ ........ ........ -10 -30 -40 -40 -120
brownfield sites.......................................

Agriculture
29 Expensing of certain capital outlays.................... 100 110 130 130 130 140 140 670
30 Expensing of certain multiperiod production costs....... 50 60 70 70 80 80 80 380
31 Treatment of loans forgiven for solvent farmers......... 10 10 10 10 10 10 10 50
32 Capital gains treatment of certain income............... 670 730 760 820 990 720 580 3,870
33 Income averaging for farmers............................ 40 40 40 40 40 40 40 200
34 Deferral of gain on sale of farm refiners............... 10 10 10 20 20 20 20 90
35 Bio-Diesel tax credit................................... ........ 30 30 10 ........ ........ ........ 40

Commerce and housing
Financial institutions and insurance:
36 Exemption of credit union income....................... 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550
37 Excess bad debt reserves of financial institutions..... -20 -20 -10 -10 -10 ........ ........ -30
38 Exclusion of interest on life insurance savings........ 20,830 22,750 24,070 26,180 28,770 30,980 33,610 143,610
39 Special alternative tax on small property and casualty 10 10 10 10 10 10 10 50
insurance companies...................................
40 Tax exemption of certain insurance companies owned by 180 190 210 220 230 250 260 1,170
tax-exempt organizations..............................
41 Small life insurance company deduction................. 80 80 80 80 80 80 80 400
Housing:
42 Exclusion of interest on owner-occupied mortgage 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470
subsidy bonds.........................................
43 Exclusion of interest on rental housing bonds.......... 360 390 410 420 460 470 480 2,240
44 Deductibility of mortgage interest on owner-occupied 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540
homes.................................................
45 Deductibility of State and local property tax on owner- 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
occupied homes........................................
46 Deferral of income from post 1987 installment sales.... 1,100 1,120 1,140 1,160 1,190 1,200 1,320 6,010
47 Capital gains exclusion on home sales.................. 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180
48 Exclusion of net imputed rental income on owner- 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206
occupied homes........................................
49 Exception from passive loss rules for $25,000 of rental 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060
loss..................................................
50 Credit for low-income housing investments.............. 3,660 3,850 4,010 4,190 4,390 4,610 4,850 22,050
51 Accelerated depreciation on rental housing (normal tax 750 -156 -993 -1,846 -2,697 -3,961 -5,901 -15,398
method)...............................................
Commerce:
52 Cancellation of indebtedness........................... 30 30 30 40 40 40 40 190
53 Exceptions from imputed interest rules................. 50 50 50 50 50 50 50 250
54 Capital gains (except agriculture, timber, iron ore, 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190
and coal).............................................
55 Capital gains exclusion of small corporation stock..... 160 210 250 300 350 390 430 1,720

[[Page 318]]

56 Step-up basis of capital gains at death................ 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420
57 Carryover basis of capital gains on gifts.............. 210 240 290 290 310 430 850 2,170
58 Ordinary income treatment of loss from small business 50 50 50 50 50 50 50 250
corporation stock sale................................
59 Accelerated depreciation of buildings other than rental -3,250 -4,180 -4,790 -6,940 -10,360 -14,740 -21,240 -58,060
housing (normal tax method)...........................
60 Accelerated depreciation of machinery and equipment 44,690 -11,000 -37,830 -30,920 -27,950 -26,190 -25,760 -148,650
(normal tax method)...................................
61 Expensing of certain small investments (normal tax 1,520 4,820 1,650 -490 -30 140 230 1,500
method)...............................................
62 Amortization of start-up costs (normal tax method)..... 80 50 ........ -40 -90 -140 -170 -440
63 Graduated corporation income tax rate (normal tax 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630
method)...............................................
64 Exclusion of interest on small issue bonds............. 450 490 510 540 580 590 610 2,830
65 Deduction for U.S. production activities............... ........ 3,270 5,420 8,750 11,230 11,670 15,860 52,930
66 Special rules for certain film and TV production....... ........ 90 110 90 70 -40 -90 140

Transportation
67 Deferral of tax on shipping companies................... 20 20 20 20 20 20 20 100
68 Exclusion of reimbursed employee parking expenses....... 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150
69 Exclusion for employer-provided transit passes.......... 410 480 550 630 710 790 880 3,560
70 Tax credit for certain expenditures for maintaining ........ 70 140 150 110 50 30 480
railroad tracks........................................

Community and regional development
71 Investment credit for rehabilitation of structures 40 40 40 40 40 40 40 200
(other than historic)..................................
72 Exclusion of interest for airport, dock, and similar 850 930 980 1,030 1,100 1,130 1,170 5,410
bonds..................................................
73 Exemption of certain mutuals' and cooperatives' income.. 60 60 60 70 70 70 70 340
74 Empowerment zones, Enterprise communities, and Renewal 1,080 1,120 1,210 1,340 1,480 1,740 1,130 6,900
communities............................................
75 New markets tax credit.................................. 290 430 610 830 870 790 670 3,770
76 Expensing of environmental remediation costs............ 80 70 20 -10 -10 -20 -10 -30
77 Deferral of capital gains with respect of dispositions ........ -490 -620 -530 -230 100 360 -920
of transmission property...............................

Education, training, employment, and social services
Education:
78 Exclusion of scholarship and fellowship income (normal 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020
tax method)...........................................
79 HOPE tax credit........................................ 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890
80 Lifetime Learning tax credit........................... 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560
81 Education Individual Retirement Accounts............... 110 140 190 240 300 370 440 1,540
82 Deductibility of student-loan interest................. 760 780 800 810 820 830 840 4,100
83 Deduction for higher education expenses................ 1,280 1,830 1,840 ........ ........ ........ ........ 1,840
84 State prepaid tuition plans............................ 210 490 650 740 830 920 1,010 4,150
85 Exclusion of interest on student-loan bonds............ 290 310 340 350 370 380 390 1,830
86 Exclusion of interest on bonds for private nonprofit 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170
educational facilities................................
87 Credit for holders of zone academy bonds............... 90 110 130 130 140 140 140 680
88 Exclusion of interest on savings bonds redeemed to 10 10 20 20 20 20 20 100
finance educational expenses..........................
89 Parental personal exemption for students age 19 or over 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370
90 Deductibility of charitable contributions (education).. 3,690 3,420 3,680 4,030 4,260 4,550 4,870 21,390
91 Exclusion of employer-provided educational assistance.. 530 560 590 620 650 690 720 3,270
92 Special deduction for teacher expenses................. 150 160 150 ........ ........ ........ ........ 150
93 Discharge of student loan indebtedness................. ........ 20 20 20 20 20 20 100
Training, employment, and social services:
94 Work opportunity tax credit............................ 280 250 280 190 60 30 10 570
95 Welfare-to-work tax credit............................. 60 60 80 60 20 10 ........ 170
96 Employer provided child care exclusion................. 600 620 810 930 970 1,010 1,060 4,780
97 Employer-provided child care credit.................... ........ 8 10 10 10 10 10 50
98 Assistance for adopted foster children................. 290 310 350 380 420 460 500 2,110
99 Adoption credit and exclusion.......................... 450 500 540 560 570 580 600 2,850
100 Exclusion of employee meals and lodging (other than 810 850 890 930 970 1,010 1,060 4,860
military).............................................
101 Child credit \2\....................................... 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030
102 Credit for child and dependent care expenses........... 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850
103 Credit for disabled access expenditures................ 30 40 40 40 40 50 50 220
104 Deductibility of charitable contributions, other than 27,370 29,670 32,550 34,500 36,790 39,410 42,210 185,460
education and health..................................
105 Exclusion of certain foster care payments.............. 440 440 440 450 450 460 470 2,270
106 Exclusion of parsonage allowances...................... 430 460 480 510 540 580 610 2,720

Health
107 Exclusion of employer contributions for medical 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240
insurance premiums and medical care....................
108 Self-employed medical insurance premiums................ 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400
109 Medical Savings Accounts/Health Savings Accounts........ 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860
110 Deductibility of medical expenses....................... 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770
111 Exclusion of interest on hospital construction bonds.... 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840
112 Deductibility of charitable contributions (health)...... 3,090 3,350 3,670 3,890 4,150 4,450 4,770 20,930
113 Tax credit for orphan drug research..................... 180 210 230 260 290 330 360 1,470
114 Special Blue Cross/Blue Shield deduction................ 400 390 360 390 340 370 430 1,890
115 Tax credit for health insurance purchased by certain 50 60 40 40 40 50 50 220
displaced and retired individuals \3\..................

[[Page 319]]

Income security
116 Exclusion of railroad retirement system benefits........ 400 400 400 400 400 400 400 2,000
117 Exclusion of workers' compensation benefits............. 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590
118 Exclusion of public assistance benefits (normal tax 410 430 450 470 490 510 480 2,400
method)................................................
119 Exclusion of special benefits for disabled coal miners.. 60 50 50 50 40 40 40 220
120 Exclusion of military disability pensions............... 100 100 110 110 110 120 120 570
Net exclusion of pension contributions and earnings:
121 Employer plans......................................... 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030
122 401(k) plans........................................... 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410
123 Individual Retirement Accounts......................... 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850
124 Low and moderate income savers credit.................. 970 1,100 1,170 700 ........ ........ ........ 1,870
125 Keogh plans............................................ 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670
Exclusion of other employee benefits:
126 Premiums on group term life insurance.................. 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750
127 Premiums on accident and disability insurance.......... 260 280 290 300 310 320 330 1,550
128 Small business retirement plan credit................... 80 100 120 140 150 150 140 700
129 Income of trusts to finance supplementary unemployment 20 20 20 20 20 20 20 100
benefits...............................................
130 Special ESOP rules...................................... 1,920 2,060 2,220 2,400 2,580 2,780 3,000 12,980
131 Additional deduction for the blind...................... 30 40 40 40 40 40 40 200
132 Additional deduction for the elderly.................... 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680
133 Tax credit for the elderly and disabled................. 20 20 20 20 10 10 10 70
134 Deductibility of casualty losses........................ 550 250 270 280 290 300 320 1,460
135 Earned income tax credit \4\............................ 4,890 4,980 5,420 5,170 5,290 5,480 5,600 26,960

Social Security
Exclusion of social security benefits
136 Social Security benefits for retired workers........... 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120
137 Social Security benefits for disabled.................. 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680
138 Social Security benefits for dependents and survivors.. 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880

Veterans benefits and services
139 Exclusion of veterans death benefits and disability 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850
compensation...........................................
140 Exclusion of veterans pensions.......................... 110 120 120 120 120 130 140 630
141 Exclusion of GI bill benefits........................... 130 150 160 170 180 190 200 900
142 Exclusion of interest on veterans housing bonds......... 50 50 50 60 60 60 60 290

General purpose fiscal assistance
143 Exclusion of interest on public purpose State and local 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840
bonds..................................................
144 Deductibility of nonbusiness state and local taxes other 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
than on owner-occupied homes...........................
145 Tax credit for corporations receiving income from doing 1,000 900 500 50 ........ ........ ........ 550
business in U.S. possessions...........................

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

Addendum: Aid to State and local governments
Deductibility of:
Property taxes on owner-occupied homes................. 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
Nonbusiness State and local taxes other than on owner- 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
occupied homes........................................
Exclusion of interest on State and local bonds for:
Public purposes........................................ 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840
Energy facilities...................................... 100 100 110 110 120 120 130 590
Water, sewage, and hazardous waste disposal facilities. 500 530 570 600 630 650 680 3,130
Small-issues........................................... 450 490 510 540 580 590 610 2,830
Owner-occupied mortgage subsidies...................... 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470
Rental housing......................................... 360 390 410 420 460 470 480 2,240
Airports, docks, and similar facilities................ 850 930 980 1,030 1,100 1,130 1,170 5,410
Student loans.......................................... 290 310 340 350 370 380 390 1,830
Private nonprofit educational facilities............... 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170
Hospital construction.................................. 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840
Veterans' housing...................................... 50 50 50 60 60 60 60 290
Credit for holders of zone academy bonds................ 90 110 130 130 140 140 140 680
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in
millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680.
\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as
follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364
\3\ In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130
million in 2008, and $140 million in 2009 and $150 million in 2010 projected.
\4\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of
dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099.
Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.
All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.

[[Page 320]]

Table 19-2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Corporations Individuals
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2004 2005 2006 2007 2008 2009 2010 2006-10 2004 2005 2006 2007 2008 2009 2010 2006-10
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

International affairs:
2 Exclusion of income earned abroad by U.S. ....... ....... ......... ......... ......... ......... ......... ......... 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570
citizens....................................
3 Exclusion of certain allowances for Federal ....... ....... ......... ......... ......... ......... ......... ......... 850 900 950 1000 1050 1100 1160 5,260
employees abroad............................
4 Extraterritorial income exclusion............ 5,500 5,170 4,270 1,820 220 40 20 6,370 ......... ......... ......... ......... ......... ......... ......... .........
5 Inventory property sales source rules 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980 ......... ......... ......... ......... ......... ......... ......... .........
exception...................................
6 Deferral of income from controlled foreign 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ......... ......... ......... ......... ......... ......... ......... .........
corporations (normal tax method)............
7 Deferred taxes for financial firms on certain 2,130 2,190 2,260 960 ......... ......... ......... 3,220 ......... ......... ......... ......... ......... ......... ......... .........
income earned overseas......................

General science, space, and technology
8 Expensing of research and experimentation -2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 -50 100 150 140 120 110 100 620
expenditures (normal tax method)............
9 Credit for increasing research activities.... 4,630 5,080 2,100 910 390 180 50 3,630 50 50 40 ......... ......... ......... ......... 40

Energy
10 Expensing of exploration and development 230 350 320 240 210 160 120 1,050 30 50 50 40 30 30 20 170
costs, fuels................................
11 Excess of percentage over cost depletion, 1,210 1,180 1,240 1,310 1,350 1,390 1,430 6,720 110 100 110 110 120 120 120 580
fuels.......................................
12 Alternative fuel production credit........... 1,000 1,000 1,000 1,000 400 ......... ......... 2,400 40 40 40 40 20 ......... ......... 100
13 Exception from passive loss limitation for ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
working interests in oil and gas properties.
14 Capital gains treatment of royalties on coal. ....... ....... ......... ......... ......... ......... ......... ......... 70 70 80 80 100 70 60 390
15 Exclusion of interest on energy facility 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490
bonds.......................................
16 Enhanced oil recovery credit................. 300 310 310 320 330 340 350 1,650 30 30 30 30 30 30 40 160
17 New technology credit........................ 330 470 620 700 800 820 690 3,630 ......... ......... ......... ......... ......... ......... ......... .........
18 Alcohol fuel credits \1\..................... 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50
19 Tax credit and deduction for clean-fuel 20 30 40 20 -10 -20 -10 20 50 40 10 -40 -60 -60 -50 -200
burning vehicles............................
20 Exclusion of conservation subsidies provided ....... ....... ......... ......... ......... ......... ......... ......... 100 100 100 100 90 90 90 470
by public utilities.........................

Natural resources and environment
21 Expensing of exploration and development 210 210 230 230 230 250 250 1,190 20 20 20 20 20 20 20 100
costs, nonfuel minerals.....................
22 Excess of percentage over cost depletion, ....... ....... ......... ......... ......... ......... 10 10 ......... ......... ......... ......... ......... ......... ......... .........
nonfuel minerals............................
23 Exclusion of interest on bonds for water, 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530
sewage, and hazardous waste facilities......
24 Capital gains treatment of certain timber ....... ....... ......... ......... ......... ......... ......... ......... 70 70 80 80 100 70 60 390
income......................................
25 Expensing of multiperiod timber growing costs 230 240 250 260 280 290 300 1,380 110 110 120 120 120 120 130 610
26 Tax incentives for preservation of historic 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440
structures..................................
27 Expensing of capital costs with respect to ....... 10 ......... 10 20 40 10 90 ......... ......... ......... ......... ......... ......... ......... .........
complying with EPA sulfur regulations.......
28 Exclusion of gain or loss on sale or exchange ....... ....... ......... -10 -20 -30 -30 -90 ......... ......... ......... ......... -10 -10 -10 -30
of certain brownfield sites.................

Agriculture
29 Expensing of certain capital outlays......... 20 20 20 20 20 20 20 100 80 90 110 110 110 120 120 570
30 Expensing of certain multiperiod production 10 10 10 10 10 10 10 50 40 50 60 60 70 70 70 330
costs.......................................
31 Treatment of loans forgiven for solvent ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 10 10 50
farmers.....................................
32 Capital gains treatment of certain income.... ....... ....... ......... ......... ......... ......... ......... ......... 670 730 760 820 990 720 580 3,870
33 Income averaging for farmers................. ....... ....... ......... ......... ......... ......... ......... ......... 40 40 40 40 40 40 40 200
34 Deferral of gain on sale of farm refiners.... 10 10 10 20 20 20 20 90 ......... ......... ......... ......... ......... ......... ......... .........
35 Bio-Diesel tax credit........................ ....... ....... ......... ......... ......... ......... ......... ......... ......... 30 30 10 ......... ......... ......... 40

Commerce and housing
Financial institutions and insurance:
36 Exemption of credit union income............ 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550 ......... ......... ......... ......... ......... ......... ......... .........
37 Excess bad debt reserves of financial -20 -20 -10 -10 -10 ......... ......... -30 ......... ......... ......... ......... ......... ......... ......... .........
institutions...............................
38 Exclusion of interest on life insurance 2,010 2,180 2,270 2,570 2,880 3,070 3,330 14,120 18,820 20,570 21,800 23,610 25,890 27,910 30,280 129,490
savings....................................
39 Special alternative tax on small property 10 10 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
and casualty insurance companies...........
40 Tax exemption of certain insurance companies 180 190 210 220 230 250 260 1,170 ......... ......... ......... ......... ......... ......... ......... .........
owned by tax-exempt organizations..........
41 Small life insurance company deduction...... 80 80 80 80 80 80 80 400 ......... ......... ......... ......... ......... ......... ......... .........
Housing:

[[Page 321]]

42 Exclusion of interest on owner-occupied 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240
mortgage subsidy bonds.....................
43 Exclusion of interest on rental housing 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810
bonds......................................
44 Deductibility of mortgage interest on owner- ....... ....... ......... ......... ......... ......... ......... ......... 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540
occupied homes.............................
45 Deductibility of State and local property ....... ....... ......... ......... ......... ......... ......... ......... 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
tax on owner-occupied homes................
46 Deferral of income from post 1987 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 1,000 4,470
installment sales..........................
47 Capital gains exclusion on home sales....... ....... ....... ......... ......... ......... ......... ......... ......... 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180
48 Exclusion of net imputed rental income on ....... ....... ......... ......... ......... ......... ......... ......... 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206
owner-occupied homes.......................
49 Exception from passive loss rules for ....... ....... ......... ......... ......... ......... ......... ......... 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060
$25,000 of rental loss.....................
50 Credit for low-income housing investments... 2,930 3,080 3,210 3,350 3,510 3,690 3,880 17,640 730 770 800 840 880 920 970 4,410
51 Accelerated depreciation on rental housing -10 -50 -100 -140 -200 -280 -390 -1,100 760 -110 -900 -1,700 -2,500 -3,690 -5,510 -14,300
(normal tax method)........................
Commerce:
52 Cancellation of indebtedness................ ....... ....... ......... ......... ......... ......... ......... ......... 30 30 30 40 40 40 40 190
53 Exceptions from imputed interest rules...... ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
54 Capital gains (except agriculture, timber, ....... ....... ......... ......... ......... ......... ......... ......... 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190
iron ore, and coal)........................
55 Capital gains exclusion of small corporation ....... ....... ......... ......... ......... ......... ......... ......... 160 210 250 300 350 390 430 1,720
stock......................................
56 Step-up basis of capital gains at death..... ....... ....... ......... ......... ......... ......... ......... ......... 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420
57 Carryover basis of capital gains on gifts... ....... ....... ......... ......... ......... ......... ......... ......... 210 240 290 290 310 430 850 2,170
58 Ordinary income treatment of loss from small ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
business corporation stock sale............
59 Accelerated depreciation of buildings other -2,980 -3,850 -4,340 -6,170 -9,220 -12,620 -17,320 -49,670 -280 -330 -450 -760 -1,140 -2,110 -3,930 -8,390
than rental housing (normal tax method)....
60 Accelerated depreciation of machinery and 37,080 -8,780 -32,880 -26,480 -23,310 -21,260 -20,290 -124,220 7,610 -2,220 -4,950 -4,440 -4,640 -4,930 -5,470 -24,430
equipment (normal tax method)..............
61 Expensing of certain small investments 680 1,780 680 -390 -140 -30 -10 110 840 3,040 970 -100 110 170 240 1,390
(normal tax method)........................
62 Amortization of start-up costs (normal tax 70 40 ......... -40 -80 -120 -150 -390 10 10 ......... ......... -10 -20 -20 -50
method)....................................
63 Graduated corporation income tax rate 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630 ......... ......... ......... ......... ......... ......... ......... .........
(normal tax method)........................
64 Exclusion of interest on small issue bonds.. 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300
65 Deduction for U.S. production activities.... ....... 2,560 4,330 7,110 9,130 9,470 12,860 42,900 ......... 710 1,090 1,640 2,100 2,200 3,000 10,030
66 Special rules for certain film and TV ....... 70 90 70 60 -30 -70 120 ......... 20 20 20 10 -10 -20 20
production.................................

Transportation
67 Deferral of tax on shipping companies........ 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
68 Exclusion of reimbursed employee parking ....... ....... ......... ......... ......... ......... ......... ......... 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150
expenses....................................
69 Exclusion for employer-provided transit ....... ....... ......... ......... ......... ......... ......... ......... 410 480 550 630 710 790 880 3,560
passes......................................
70 Tax credit for certain expenditures for ....... 70 140 150 110 50 30 480 ......... ......... ......... ......... ......... ......... ......... .........
maintaining railroad tracks.................

Community and regional development
71 Investment credit for rehabilitation of 20 20 20 20 20 20 20 100 20 20 20 20 20 20 20 100
structures (other than historic)............
72 Exclusion of interest for airport, dock, and 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380
similar bonds...............................
73 Exemption of certain mutuals' and 60 60 60 70 70 70 70 340 ......... ......... ......... ......... ......... ......... ......... .........
cooperatives' income........................
74 Empowerment zones, Enterprise communities, 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270
and Renewal communities.....................
75 New markets tax credit....................... 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820
76 Expensing of environmental remediation costs. 70 60 20 -10 -10 -20 -10 -30 10 10 ......... ......... ......... ......... ......... .........
77 Deferral of capital gains with respect of ....... -490 -620 -530 -230 100 360 -920 ......... ......... ......... ......... ......... ......... ......... .........
dispositions of transmission property.......

Education, training, employment, and social
services
Education:
78 Exclusion of scholarship and fellowship ....... ....... ......... ......... ......... ......... ......... ......... 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020
income (normal tax method).................
79 HOPE tax credit............................. ....... ....... ......... ......... ......... ......... ......... ......... 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890
80 Lifetime Learning tax credit................ ....... ....... ......... ......... ......... ......... ......... ......... 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560
81 Education Individual Retirement Accounts.... ....... ....... ......... ......... ......... ......... ......... ......... 110 140 190 240 300 370 440 1,540
82 Deductibility of student-loan interest...... ....... ....... ......... ......... ......... ......... ......... ......... 760 780 800 810 820 830 840 4,100
83 Deduction for higher education expenses..... ....... ....... ......... ......... ......... ......... ......... ......... 1,280 1,830 1,840 ......... ......... ......... ......... 1,840
84 State prepaid tuition plans................. ....... ....... ......... ......... ......... ......... ......... ......... 210 490 650 740 830 920 1,010 4,150
85 Exclusion of interest on student-loan bonds. 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480

[[Page 322]]

86 Exclusion of interest on bonds for private 210 210 220 230 230 240 250 1,170 760 840 900 950 1020 1050 1080 5,000
nonprofit educational facilities...........
87 Credit for holders of zone academy bonds.... 90 110 130 130 140 140 140 680 ......... ......... ......... ......... ......... ......... ......... .........
88 Exclusion of interest on savings bonds ....... ....... ......... ......... ......... ......... ......... ......... 10 10 20 20 20 20 20 100
redeemed to finance educational expenses...
89 Parental personal exemption for students age ....... ....... ......... ......... ......... ......... ......... ......... 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370
19 or over.................................
90 Deductibility of charitable contributions 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 4,170 18,260
(education)................................
91 Exclusion of employer-provided educational ....... ....... ......... ......... ......... ......... ......... ......... 530 560 590 620 650 690 720 3,270
assistance.................................
92 Special deduction for teacher expenses...... ....... ....... ......... ......... ......... ......... ......... ......... 150 160 150 ......... ......... ......... ......... 150
93 Discharge of student loan indebtedness...... ....... ....... ......... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 100
Training, employment, and social services:
94 Work opportunity tax credit................. 240 210 240 160 50 30 10 490 40 40 40 30 10 ......... ......... 80
95 Welfare-to-work tax credit.................. 50 50 70 50 20 10 ......... 150 10 10 10 10 ......... ......... ......... 20
96 Employer provided child care exclusion...... ....... ....... ......... ......... ......... ......... ......... ......... 600 620 810 930 970 1010 1060 4,780
97 Employer-provided child care credit......... ....... 8 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
98 Assistance for adopted foster children...... ....... ....... ......... ......... ......... ......... ......... ......... 290 310 350 380 420 460 500 2,110
99 Adoption credit and exclusion............... ....... ....... ......... ......... ......... ......... ......... ......... 450 500 540 560 570 580 600 2,850
100 Exclusion of employee meals and lodging ....... ....... ......... ......... ......... ......... ......... ......... 810 850 890 930 970 1,010 1,060 4,860
(other than military)......................
101 Child credit \2\............................ ....... ....... ......... ......... ......... ......... ......... ......... 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030
102 Credit for child and dependent care expenses ....... ....... ......... ......... ......... ......... ......... ......... 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850
103 Credit for disabled access expenditures..... 10 10 10 10 10 20 20 70 20 30 30 30 30 30 30 150
104 Deductibility of charitable contributions, 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 40,640 178,310
other than education and health............
105 Exclusion of certain foster care payments... ....... ....... ......... ......... ......... ......... ......... ......... 440 440 440 450 450 460 470 2,270
106 Exclusion of parsonage allowances........... ....... ....... ......... ......... ......... ......... ......... ......... 430 460 480 510 540 580 610 2,720

Health
107 Exclusion of employer contributions for ....... ....... ......... ......... ......... ......... ......... ......... 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240
medical insurance premiums and medical care.
108 Self-employed medical insurance premiums..... ....... ....... ......... ......... ......... ......... ......... ......... 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400
109 Medical Savings Accounts/Health Savings ....... ....... ......... ......... ......... ......... ......... ......... 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860
Accounts....................................
110 Deductibility of medical expenses............ ....... ....... ......... ......... ......... ......... ......... ......... 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770
111 Exclusion of interest on hospital 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580
construction bonds..........................
112 Deductibility of charitable contributions 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,570 20,030
(health)....................................
113 Tax credit for orphan drug research.......... 180 210 230 260 290 330 360 1,470 ......... ......... ......... ......... ......... ......... ......... .........
114 Special Blue Cross/Blue Shield deduction..... 400 390 360 390 340 370 430 1,890 ......... ......... ......... ......... ......... ......... ......... .........
115 Tax credit for health insurance purchased by ....... ....... ......... ......... ......... ......... ......... ......... 50 60 40 40 40 50 50 220
certain displaced and retired individuals
\3\.........................................

Income security
116 Exclusion of railroad retirement system ....... ....... ......... ......... ......... ......... ......... ......... 400 400 400 400 400 400 400 2,000
benefits....................................
117 Exclusion of workers' compensation benefits.. ....... ....... ......... ......... ......... ......... ......... ......... 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590
118 Exclusion of public assistance benefits ....... ....... ......... ......... ......... ......... ......... ......... 410 430 450 470 490 510 480 2,400
(normal tax method).........................
119 Exclusion of special benefits for disabled ....... ....... ......... ......... ......... ......... ......... ......... 60 50 50 50 40 40 40 220
coal miners.................................
120 Exclusion of military disability pensions.... ....... ....... ......... ......... ......... ......... ......... ......... 100 100 110 110 110 120 120 570
Net exclusion of pension contributions and
earnings:
121 Employer plans.............................. ....... ....... ......... ......... ......... ......... ......... ......... 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030
122 401(k) plans................................ ....... ....... ......... ......... ......... ......... ......... ......... 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410
123 Individual Retirement Accounts.............. ....... ....... ......... ......... ......... ......... ......... ......... 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850
124 Low and moderate income savers credit....... ....... ....... ......... ......... ......... ......... ......... ......... 970 1,100 1,170 700 ......... ......... ......... 1,870
125 Keogh plans................................. ....... ....... ......... ......... ......... ......... ......... ......... 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670
Exclusion of other employee benefits:
126 Premiums on group term life insurance....... ....... ....... ......... ......... ......... ......... ......... ......... 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750
127 Premiums on accident and disability ....... ....... ......... ......... ......... ......... ......... ......... 260 280 290 300 310 320 330 1,550
insurance..................................
128 Small business retirement plan credit........ 40 50 60 70 80 80 70 360 40 50 60 70 70 70 70 340
129 Income of trusts to finance supplementary ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
unemployment benefits.......................
130 Special ESOP rules........................... 1600 1720 1870 2030 2190 2390 2610 11,090 320 340 350 370 390 390 390 1,890
131 Additional deduction for the blind........... ....... ....... ......... ......... ......... ......... ......... ......... 30 40 40 40 40 40 40 200
132 Additional deduction for the elderly......... ....... ....... ......... ......... ......... ......... ......... ......... 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680
133 Tax credit for the elderly and disabled...... ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 10 10 10 70
134 Deductibility of casualty losses............. ....... ....... ......... ......... ......... ......... ......... ......... 550 250 270 280 290 300 320 1,460
135 Earned income tax credit \4\................. ....... ....... ......... ......... ......... ......... ......... ......... 4,893 4,983 5,423 5,168 5,287 5,480 5,597 26,955

[[Page 323]]

Social Security
Exclusion of social security benefits
136 Social Security benefits for retired workers ....... ....... ......... ......... ......... ......... ......... ......... 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120
137 Social Security benefits for disabled....... ....... ....... ......... ......... ......... ......... ......... ......... 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680
138 Social Security benefits for dependents and ....... ....... ......... ......... ......... ......... ......... ......... 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880
survivors..................................

Veterans benefits and services
139 Exclusion of veterans death benefits and ....... ....... ......... ......... ......... ......... ......... ......... 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850
disability compensation.....................
140 Exclusion of veterans pensions............... ....... ....... ......... ......... ......... ......... ......... ......... 110 120 120 120 120 130 140 630
141 Exclusion of GI bill benefits................ ....... ....... ......... ......... ......... ......... ......... ......... 130 150 160 170 180 190 200 900
142 Exclusion of interest on veterans housing 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240
bonds.......................................

General purpose fiscal assistance
143 Exclusion of interest on public purpose State 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890
and local bonds.............................
144 Deductibility of nonbusiness state and local ....... ....... ......... ......... ......... ......... ......... ......... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
taxes other than on owner-occupied homes....
145 Tax credit for corporations receiving income 1,000 900 500 50 ......... ......... ......... 550 ......... ......... ......... ......... ......... ......... ......... .........
from doing business in U.S. possessions.....

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

Addendum: Aid to State and local governments
Deductibility of:
Property taxes on owner-occupied homes...... ....... ....... ......... ......... ......... ......... ......... ......... 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
Nonbusiness State and local taxes other than ....... ....... ......... ......... ......... ......... ......... ......... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
on owner-occupied homes....................
Exclusion of interest on State and local
bonds for:
Public purposes............................. 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890
Energy facilities........................... 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490
Water, sewage, and hazardous waste disposal 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530
facilities.................................
Small-issues................................ 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300
Owner-occupied mortgage subsidies........... 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240
Rental housing.............................. 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810
Airports, docks, and similar facilities..... 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380
Student loans............................... 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480
Private nonprofit educational facilities.... 210 210 220 230 230 240 250 1,170 760 840 900 950 1,020 1,050 1,080 5,000
Hospital construction....................... 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580
Veterans' housing........................... 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240
Credit for holders of zone academy bonds..... 90 110 130 130 140 140 140 680 ......... ......... ......... ......... ......... ......... ......... .........
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590;
2008 $1,620; 2009 $1,650; and 2010 $1,680.
\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040;
2009 $11,693 and 2010 $11,364
\3\ In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million in 2010 projected.
\4\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008
$34,723; 2009 $35,517; and 2010 $36,099.
Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.
All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.

[[Page 324]]

Table 19-3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006-2010 PROJECTED REVENUE EFFECTS
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Provision 2006 2006-10
----------------------------------------------------------------------------------------------------------------
Exclusion of employer contributions for medical insurance premiums and medical 125,690 760,240
care.........................................................................
Deductibility of mortgage interest on owner-occupied homes.................... 76,030 445,540
Net exclusion of pension contributions and earnings: 401(k) plans............. 48,140 283,410
Capital gains exclusion on home sales......................................... 36,270 247,180
Net exclusion of pension contributions and earnings: Employer plans........... 51,050 241,030
Deductibility of charitable contributions, other than education and health.... 32,550 185,460
Exclusion of net imputed rental income on owner-occupied homes................ 29,720 185,206
Step-up basis of capital gains at death....................................... 28,760 164,420
Child credit.................................................................. 32,810 164,030
Deductibility of nonbusiness State and local taxes other than on owner- 34,620 163,240
occupied homes...............................................................
Capital gains (except agriculture, timber, iron ore, and coal)................ 28,370 144,190
Exclusion of interest on life insurance savings............................... 24,070 143,610
Exclusion of interest on public purpose State and local bonds................. 26,610 136,840
Social Security benefits for retired workers.................................. 19,770 106,120
Deductibility of State and local property tax on owner-occupied homes......... 14,830 68,140
Net exclusion of pension contributions and earnings: Keough plans............. 9,980 58,670
Deductibility of medical expenses............................................. 9,140 54,770
Deduction for U.S. production activities...................................... 5,420 52,930
Deferral of income from controlled foreign corporations (normal tax method)... 7,440 42,740
Net exclusion of pension contributions and earnings: Individual Retirement 7,310 32,850
Accounts.....................................................................
Exclusion of workers' compensation benefits................................... 5,940 31,590
Expensing of research and experimentation expenditures (normal tax method).... 7,920 31,330
Earned income tax credit...................................................... 5,423 26,955
Self-employed medical insurance premiums...................................... 4,330 26,400
Exception from passive loss rules for $25,000 of rental loss.................. 4,750 22,060
Credit for low-income housing investments..................................... 4,010 22,050
Social Security benefits for disabled......................................... 3,870 21,680
Deductibility of charitable contributions (education)......................... 3,680 21,390
Deductibility of charitable contributions (health)............................ 3,670 20,930
Exclusion of veterans death benefits and disability compensation.............. 3,750 20,850
Social Security benefits for dependents and survivors......................... 3,990 19,880
Graduated corporation income tax rate (normal tax method)..................... 3,730 19,630
HOPE tax credit............................................................... 3,220 16,890
Medical Savings Accounts / Health Savings Accounts............................ 1,830 15,860
Exclusion of income earned abroad by U.S. citizens............................ 2,810 15,570
Exclusion of reimbursed employee parking expenses............................. 2,730 15,150
Special ESOP rules............................................................ 2,220 12,980
Exclusion of benefits and allowances to armed forces personnel................ 2,520 12,830
Exclusion of interest on hospital construction bonds.......................... 2,160 11,840
Lifetime Learning tax credit.................................................. 2,080 11,560
Inventory property sales source rules exception............................... 1,770 10,980
Premiums on group term life insurance......................................... 2,110 10,750
Credit for child and dependent care expenses.................................. 2,810 9,850
Additional deduction for the elderly.......................................... 1,960 9,680
Parental personal exemption for students age 19 or over....................... 2,110 8,370
Exclusion of scholarship and fellowship income (normal tax method)............ 1,460 8,020
Exemption of credit union income.............................................. 1,390 7,550
Excess of percentage over cost depletion, fuels............................... 1,350 7,300
Empowerment zones, Enterprise communities, and Renewal communities............ 1,210 6,900
Exclusion of interest on owner-occupied mortgage subsidy bonds................ 1,180 6,470
Extraterritorial income exclusion............................................. 4,270 6,370
Exclusion of interest on bonds for private nonprofit educational facilities... 1,120 6,170
Deferral of income from post 1987 installment sales........................... 1,140 6,010
Exclusion of interest for airport, dock, and similar bonds.................... 980 5,410
Exclusion of certain allowances for Federal employees abroad.................. 950 5,260
Exclusion of employee meals and lodging (other than military)................. 890 4,860
Employer provided child care exclusion........................................ 810 4,780
State prepaid tuition plans................................................... 650 4,150
Deductibility of student-loan interest........................................ 800 4,100
Capital gains treatment of certain income..................................... 760 3,870
New markets tax credit........................................................ 610 3,770
Credit for increasing research activities..................................... 2,140 3,670
New technology credit......................................................... 620 3,630
Exclusion for employer-provided transit passes................................ 550 3,560
Exclusion of employer-provided educational assistance......................... 590 3,270
Deferred taxes for financial firms on certain income earned overseas.......... 2,260 3,220
Exclusion of interest on bonds for water, sewage, and hazardous waste 570 3,130
facilities...................................................................
Adoption credit and exclusion................................................. 540 2,850
Exclusion of interest on small issue bonds.................................... 510 2,830

[[Page 325]]

Exclusion of parsonage allowances............................................. 480 2,720
Alternative fuel production credit............................................ 1,040 2,500
Exclusion of public assistance benefits (normal tax method)................... 450 2,400
Exclusion of certain foster care payments..................................... 440 2,270
Exclusion of interest on rental housing bonds................................. 410 2,240
Carryover basis of capital gains on gifts..................................... 290 2,170
Assistance for adopted foster children........................................ 350 2,110
Exclusion of railroad retirement system benefits.............................. 400 2,000
Expensing of multiperiod timber growing costs................................. 370 1,990
Special Blue Cross/Blue Shield deduction...................................... 360 1,890
Low and moderate income savers credit......................................... 1,170 1,870
Deduction for higher education expenses....................................... 1,840 1,840
Exclusion of interest on student-loan bonds................................... 340 1,830
Tax incentives for preservation of historic structures........................ 330 1,810
Enhanced oil recovery credit.................................................. 340 1,810
Capital gains exclusion of small corporation stock............................ 250 1,720
Premiums on accident and disability insurance................................. 290 1,550
Education Individual Retirement Accounts...................................... 190 1,540
Expensing of certain small investments (normal tax method).................... 1,650 1,500
Tax credit for orphan drug research........................................... 230 1,470
Deductibility of casualty losses.............................................. 270 1,460
Expensing of exploration and development costs, nonfuel minerals.............. 250 1,290
Expensing of exploration and development costs, fuels......................... 370 1,220
Tax exemption of certain insurance companies owned by tax-exempt organizations 210 1,170
Exclusion of GI bill benefits................................................. 160 900
Small business retirement plan credit......................................... 120 700
Credit for holders of zone academy bonds...................................... 130 680
Expensing of certain capital outlays.......................................... 130 670
Exclusion of veterans pensions................................................ 120 630
Exclusion of interest on energy facility bonds................................ 110 590
Work opportunity tax credit................................................... 280 570
Exclusion of military disability pensions..................................... 110 570
Tax credit for corporations receiving income from doing business in U.S. 500 550
possessions..................................................................
Tax credit for certain expenditures for maintaining railroad tracks........... 140 480
Exclusion of conservation subsidies provided by public utilities.............. 100 470
Small life insurance company deduction........................................ 80 400
Capital gains treatment of royalties on coal.................................. 80 390
Capital gains treatment of certain timber income.............................. 80 390
Expensing of certain multiperiod production costs............................. 70 380
Exemption of certain mutuals' and cooperatives' income........................ 60 340
Deferral of interest on U.S. savings bonds.................................... 50 300
Exclusion of interest on veterans housing bonds............................... 50 290
Ordinary income treatment of loss from small business corporation stock sale.. 50 250
Exceptions from imputed interest rules........................................ 50 250
Tax credit for health insurance purchased by certain displaced and retired 40 220
individuals..................................................................
Exclusion of special benefits for disabled coal miners........................ 50 220
Credit for disabled access expenditures....................................... 40 220
Investment credit for rehabilitation of structures (other than historic)...... 40 200
Income averaging for farmers.................................................. 40 200
Additional deduction for the blind............................................ 40 200
Cancellation of indebtedness.................................................. 30 190
Alcohol fuel credits.......................................................... 30 180
Welfare-to-work tax credit.................................................... 80 170
Special deduction for teacher expenses........................................ 150 150
Special rules for certain film and TV production.............................. 110 140
Income of trusts to finance supplementary unemployment benefits............... 20 100
Exclusion of interest on savings bonds redeemed to finance educational 20 100
expenses.....................................................................
Exception from passive loss limitation for working interests in oil and gas 20 100
properties...................................................................
Discharge of student loan indebtedness........................................ 20 100
Deferral of tax on shipping companies......................................... 20 100
Expensing of capital costs with respect to complying with EPA sulfur ............... 90
regulations..................................................................
Deferral of gain on sale of farm refiners..................................... 10 90
Tax credit for the elderly and disabled....................................... 20 70
Treatment of loans forgiven for solvent farmers............................... 10 50
Special alternative tax on small property and casualty insurance companies.... 10 50
Employer-provided child care credit........................................... 10 50
Bio-Diesel tax credit......................................................... 30 40

[[Page 326]]

Excess of percentage over cost depletion, nonfuel minerals.................... ............... 10
Expensing of environmental remediation costs.................................. 20 -30
Excess bad debt reserves of financial institutions............................ -10 -30
Exclusion of gain or loss on sale or exchange of certain brownfield sites..... ............... -120
Tax credit and deduction for clean-fuel burning vehicles...................... 50 -180
Amortization of start-up costs (normal tax method)............................ ............... -440
Deferral of capital gains with respect of dispositions of transmission -620 -920
property.....................................................................
Accelerated depreciation of buildings other than rental housing (normal tax -4,786 -58,061
method)......................................................................
Accelerated depreciation of machinery and equipment (normal tax method)....... -37,830 -148,650
----------------------------------------------------------------------------------------------------------------

Table 19-4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2004
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
2004 Present
Provision Value of
Revenue Loss
----------------------------------------------------------------------------------------------------------------
1 Deferral of income from controlled foreign corporations (normal tax method)......... 6,360
2 Deferred taxes for financial firms on income earned overseas........................ 2,160
3 Expensing of research and experimentation expenditures (normal tax method).......... 2,220
4 Expensing of exploration and development costs--fuels............................... 160
5 Expensing of exploration and development costs--nonfuels............................ .............
6 Expensing of multiperiod timber growing costs....................................... 200
7 Expensing of certain multiperiod production costs--agriculture...................... 140
8 Expensing of certain capital outlays--agriculture................................... 180
9 Deferral of income on life insurance and annuity contracts.......................... 25,020
10 Accelerated depreciation on rental housing.......................................... 5,210
11 Accelerated depreciation of buildings other than rental............................. 543
12 Accelerated depreciation of machinery and equipment................................. 39,380
13 Expensing of certain small investments (normal tax method).......................... 670
14 Amortization of start-up costs (normal tax method).................................. 50
15 Deferral of tax on shipping companies............................................... 20
16 Credit for holders of zone academy bonds............................................ 200
17 Credit for low-income housing investments........................................... 3,870
18 Deferral for State prepaid tuition plans............................................ 1,310
19 Exclusion of pension contributions--employer plans.................................. 85,040
20 Exclusion of 401(k) contributions................................................... 82,400
21 Exclusion of IRA contributions and earnings......................................... 3,460
22 Exclusion of contributions and earnings for Keogh plans............................. 3,000
23 Exclusion of interest on public-purpose bonds....................................... 14,650
24 Exclusion of interest on non-public purpose bonds................................... 5,680
25 Deferral of interest on U.S. savings bonds.......................................... 230
26 Expensing of capital costs with respect to complying with EPA sulfur regulations.... .............
----------------------------------------------------------------------------------------------------------------

[[Page 327]]

Table 19-5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Corporations Individuals
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2004 2005 2006 2007 2008 2009 2010 2006-10 2004 2005 2006 2007 2008 2009 2010 2006-10
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
National Defense
1 Exclusion of benefits and allowances to armed ....... ....... ......... ......... ......... ......... ......... ......... 2,860 2,880 2,920 2,950 2,980 3,010 3,040 14,900
forces personnel............................

International affairs
2 Exclusion of income earned abroad by U.S. ....... ....... ......... ......... ......... ......... ......... ......... 3,530 3,640 3,700 3,880 4,100 4,320 4,560 20,560
citizens....................................
3 Exclusion of certain allowances for Federal ....... ....... ......... ......... ......... ......... ......... ......... 1,100 1,150 1,210 1,280 1,350 1,410 1,490 6,740
employees abroad............................
4 Extraterritorial income exclusion............ 8,470 7,950 6,570 2,800 330 50 30 9,780 ......... ......... ......... ......... ......... ......... ......... .........
5 Inventory property sales solurce rules 2,310 2,490 2,720 3,000 3,390 3,740 4,050 16,900 ......... ......... ......... ......... ......... ......... ......... .........
exception...................................
6 Deferral of income from controlled foreign 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ......... ......... ......... ......... ......... ......... ......... .........
corporations (normal tax method)............
7 Deferred taxes for financial firms on certain 2,130 2,190 2,260 960 ......... ......... ......... 3,220 ......... ......... ......... ......... ......... ......... ......... .........
income earned overseas......................

General science, space, and technology
8 Expensing of research and experimentation -2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 -50 100 150 140 120 110 100 620
expenditures (normal tax method)............
9 Credit for increasing research activities.... 7,120 7,820 3,230 1,400 590 270 70 5,560 80 80 60 ......... ......... ......... ......... 60

Energy
10 Expensing of exploration and development 230 350 330 250 210 180 140 1,110 40 70 60 50 40 30 30 210
costs, fuels................................
11 Excess of percentage over cost depletion, 1,570 1,570 1,690 1,760 1,820 1,880 1,910 9,060 140 140 150 150 170 170 180 820
fuels.......................................
12 Alternative fuel production credit........... 1,330 1,330 1,330 1,330 530 ......... ......... 3,190 70 70 70 70 30 ......... ......... 170
13 Exception from passive loss limitation for ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
working interests in oil and gas properties.
14 Capital gains treatment of royalties on coal. ....... ....... ......... ......... ......... ......... ......... ......... 100 100 110 110 140 100 90 550
15 Exclusion of interest on energy facility 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700
bonds.......................................
16 Enhanced oil recovery credit................. 400 410 420 430 440 450 460 2,200 10 10 10 10 10 10 10 50
17 New technology credit........................ 470 680 880 1,000 1,130 1,160 970 5,140 ......... ......... ......... ......... ......... ......... ......... .........
18 Alcohol fuel credits \1\..................... 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50
19 Tax credit and deduction for clean-fuel 30 40 50 30 -10 -30 -10 30 70 50 10 -50 -80 -80 -70 -270
burning vehicles............................
20 Exclusion of utility conservation subsidies.. ....... ....... ......... ......... ......... ......... ......... ......... 130 130 130 130 130 120 120 630

Natural resources and environment
21 Expensing of exploration and development 10 10 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
costs, nonfuel minerals.....................
22 Excess of percentage over cost depletion, 280 280 300 300 320 320 340 1,580 20 20 30 30 30 30 30 150
nonfuel minerals............................
23 Exclusion of interest on bonds for water, 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680
sewage, and hazardous waste facilities......
24 Capital gains treatment of certain timber ....... ....... ......... ......... ......... ......... ......... ......... 100 100 110 110 140 100 90 550
income......................................
25 Expensing of multiperiod timber growing costs 310 320 330 350 370 380 400 1,830 140 140 140 150 150 150 150 740
26 Tax incentives for preservation of historic 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440
structures..................................
27 Expensing of capital costs with respect to ....... 20 ......... 10 30 70 10 120 ......... ......... ......... ......... ......... ......... ......... .........
complying with EPA sulfur regulations.......
28 Exclusion of gain or loss on sale or exchange ....... ....... ......... -10 -20 -30 -50 -110 ......... ......... ......... ......... -10 -10 -20 -40
of certain brownfield sites.................

Agriculture
29 Expensing of certain capital outlays......... 20 30 30 30 30 30 30 150 100 110 130 130 130 140 140 670
30 Expensing of certain multiperiod production 10 10 20 20 20 20 20 100 50 60 70 70 80 80 80 380
costs.......................................
31 Treatment of loans forgiven for solvent ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 10 10 50
farmers.....................................
32 Capital gains treatment of certain income.... ....... ....... ......... ......... ......... ......... ......... ......... 960 1,040 1,090 1,170 1,410 1,030 830 5,530
33 Income averaging for farmers................. ....... ....... ......... ......... ......... ......... ......... ......... 40 40 40 40 50 50 50 230
34 Deferral of gain on sale of farm refiners.... 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
35 Bio-Diesel tax credit........................ ....... ....... ......... ......... ......... ......... ......... ......... ......... 40 40 10 ......... ......... ......... 50

Commerce and housing
Financial institutions and insurance:
36 Exemption of credit union income............ 1,620 1,690 1,760 1,840 1,920 2,000 2,080 9,600 ......... ......... ......... ......... ......... ......... ......... .........
37 Bad debt reserves of financial institutions. -30 -30 -10 -10 -10 ......... ......... -30 ......... ......... ......... ......... ......... ......... ......... .........
38 Exclusion of interest on life insurance 2,280 2,450 2,520 2,840 3,180 3,380 3,660 15,580 21,380 23,090 24,260 26,130 28,560 30,690 33,310 142,950
savings....................................
39 Special alternative tax on small property 10 10 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
and casualty insurance companies...........
40 Tax exemption of certain insurance companies 270 290 320 330 350 380 400 1,780 ......... ......... ......... ......... ......... ......... ......... .........
owned by tax-exempt organizations..........
41 Small life insurance company deduction...... 120 120 120 120 120 120 120 600 ......... ......... ......... ......... ......... ......... ......... .........
Housing:
42 Exclusion of interest on owner-occupied 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590
mortgage subsidy bonds.....................

[[Page 328]]

43 Exclusion of interest on rental housing 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620
bonds......................................
44 Deductibility of mortgage interest on owner- ....... ....... ......... ......... ......... ......... ......... ......... 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540
occupied homes.............................
45 Deductibility of State and local property ....... ....... ......... ......... ......... ......... ......... ......... 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
tax on owner-occupied homes................
46 Deferral of income from post 1987 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 890 4,360
installment sales..........................
47 Capital gains exclusion on home sales....... ....... ....... ......... ......... ......... ......... ......... ......... 34,980 38,630 42,670 47,120 52,050 68,320 89,950 300,110
48 Exclusion of net imputed rental income...... ....... ....... ......... ......... ......... ......... ......... ......... 32,790 38,130 39,630 44,280 49,150 54,170 59,710 246,940
49 Exception from passive loss rules for ....... ....... ......... ......... ......... ......... ......... ......... 5,030 4,900 4,750 4,580 4,410 4,240 4,240 22,220
$25,000 of rental loss.....................
50 Credit for low-income housing investments... 3,910 4,110 4,290 4,470 4,680 4,920 5,170 23,530 1,050 1,100 1,150 1,200 1,250 1,320 1,380 6,300
51 Accelerated depreciation on rental housing -8 -46 -98 -143 -197 -275 -389 -1,102 758 -110 -895 -1,703 -2,500 -3,686 -5,512 -14,296
(normal tax method)........................
Commerce:
52 Cancellation of indebtedness................ ....... ....... ......... ......... ......... ......... ......... ......... 30 30 30 40 40 40 40 190
53 Exceptions from imputed interest rules...... ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
54 Capital gains (except agriculture, timber, ....... ....... ......... ......... ......... ......... ......... ......... 35,930 38,860 40,530 43,500 52,620 38,430 30,900 205,980
iron ore, and coal)........................
55 Capital gains exclusion of small corporation ....... ....... ......... ......... ......... ......... ......... ......... 220 270 340 400 460 530 610 2,340
stock......................................
56 Step-up basis of capital gains at death..... ....... ....... ......... ......... ......... ......... ......... ......... 32,260 34,860 38,340 42,180 46,390 47,410 44,910 219,230
57 Carryover basis of capital gains on gifts... ....... ....... ......... ......... ......... ......... ......... ......... 250 280 340 350 370 530 1,060 2,650
58 Ordinary income treatment of loss from small ....... ....... ......... ......... ......... ......... ......... ......... 60 60 60 60 60 60 60 300
business corporation stock sale............
59 Accelerated depreciation of buildings other -2,980 -3,850 -4,340 -6,170 -9,220 -12,620 -17,320 -49,670 -280 -330 -450 -760 -1,140 -2,110 -3,930 -8,390
than rental housing (normal tax method)....
60 Accelerated depreciation of machinery and 37,080 -8,780 -32,880 -26,480 -23,310 -21,260 -20,290 -124,230 7,610 -2,220 -4,950 -4,440 -4,640 -4,930 -5,470 -24,430
equipment (normal tax method)..............
61 Expensing of certain small investments 680 1,780 680 -390 -140 -30 -10 120 840 3,040 970 -100 110 170 240 1,400
(normal tax method)........................
62 Amortization of start-up costs (normal tax 70 40 ......... -40 -80 -120 -150 -390 10 10 ......... ......... -10 -20 -20 -50
method)....................................
63 Graduated corporation income tax rate 3,760 4,910 5,730 5,880 6,030 6,180 6,360 30,180 ......... ......... ......... ......... ......... ......... ......... .........
(normal tax method)........................
64 Exclusion of interest on small issue bonds.. 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330
65 Deduction for U.S. production activities.... ....... 3,420 5,780 9,480 12,170 12,620 17,150 57,200 ......... 950 1,460 2,180 2,800 2,940 4,000 13,380
66 Special rules for certain film and TV ....... 70 90 70 60 -30 -70 120 ......... 20 20 20 10 -10 -20 20
production.................................

Transportation
67 Deferral of tax on shipping companies........ 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
68 Exclusion of reimbursed employee parking ....... ....... ......... ......... ......... ......... ......... ......... 3,190 3,350 3,530 3,710 3,900 4,100 4,300 19,540
expenses....................................
69 Exclusion for employer-provided transit ....... ....... ......... ......... ......... ......... ......... ......... 510 600 690 790 890 980 1,100 4,450
passes......................................
70 Tax credit for certain expenditures for ....... 100 190 200 140 70 30 630 ......... ......... ......... ......... ......... ......... ......... .........
maintaining railroad tracks.................

Community and regional development
71 Investment credit for rehabilitation of 20 20 20 20 20 20 20 100 20 20 20 20 20 20 20 100
structures (other than historic)............
72 Exclusion of interest for airport, dock, and 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340
similar bonds...............................
73 Exemption of certain mutuals' and 70 70 70 80 80 80 80 390 ......... ......... ......... ......... ......... ......... ......... .........
cooperatives' income........................
74 Empowerment zones, Enterprise communities and 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270
Renewal communities.........................
75 New markets tax credit....................... 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820
76 Expensing of environmental remediation costs. 90 80 20 -20 -20 -20 -20 -60 20 20 ......... ......... ......... ......... ......... .........
77 Deferral of capital gains with respect of ....... -490 -620 -530 -230 100 360 -920 ......... ......... ......... ......... ......... ......... ......... .........
dispositions of transmission property.......

Education, training, employment, and social
services
Education:
78 Exclusion of scholarship and fellowship ....... ....... ......... ......... ......... ......... ......... ......... 1,450 1,540 1,610 1,680 1,760 1,840 1,930 8,820
income (normal tax method).................
79 HOPE tax credit............................. ....... ....... ......... ......... ......... ......... ......... ......... 4,260 4,380 4,130 4,260 4,300 4,380 4,590 21,660
80 Lifetime Learning tax credit................ ....... ....... ......... ......... ......... ......... ......... ......... 2,800 2,730 2,660 2,960 3,000 3,050 3,150 14,820
81 Education Individual Retirement Accounts.... ....... ....... ......... ......... ......... ......... ......... ......... 130 180 240 310 390 470 570 1,980
82 Deductibility of student-loan interest...... ....... ....... ......... ......... ......... ......... ......... ......... 900 930 960 970 980 990 1,000 4,900
83 Deduction for higher education expenses..... ....... ....... ......... ......... ......... ......... ......... ......... 1,640 2,340 2,360 ......... ......... ......... ......... 2,360
84 State prepaid tuition plans................. ....... ....... ......... ......... ......... ......... ......... ......... 270 620 830 950 1,070 1,180 1,300 5,330
85 Exclusion of interest on student-loan bonds. 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140
86 Exclusion of interest on bonds for private 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240
nonprofit educational facilities...........
87 Credit for holders of zone academy bonds.... 130 160 180 190 200 200 190 960 ......... ......... ......... ......... ......... ......... ......... .........

[[Page 329]]

88 Exclusion of interest on savings bonds ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
redeemed to finance educational expenses...
89 Parental personal exemption for students age ....... ....... ......... ......... ......... ......... ......... ......... 3,550 2,960 2,340 2,040 1,800 1,600 1,480 9,260
19 or over.................................
90 Deductibility of charitable contributions 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 3,890 17,980
(education)................................
91 Exclusion of employer-provided educational ....... ....... ......... ......... ......... ......... ......... ......... 650 690 730 770 810 850 890 4,050
assistance.................................
92 Special deduction for teacher expenses...... ....... ....... ......... ......... ......... ......... ......... ......... 190 200 180 ......... ......... ......... ......... 180
93 Discharge of student loan indebtedness...... ....... ....... ......... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 100
Training, employment, and social services:
94 Work opportunity tax credit................. 240 210 240 160 50 30 10 490 40 40 40 30 10 ......... ......... 80
95 Welfare-to-work tax credit.................. 50 50 70 50 20 10 ......... 150 10 10 10 10 ......... ......... ......... 20
96 Exclusion of employer provided child care... ....... ....... ......... ......... ......... ......... ......... ......... 800 830 1,080 1,240 1,290 1,350 1,410 6,370
97 Employer-provided child care................ 6 11 13 15 17 18 20 83 ......... ......... ......... ......... ......... ......... ......... .........
98 Assistance for adopted foster children...... ....... ....... ......... ......... ......... ......... ......... ......... 330 350 390 430 470 520 570 2,380
99 Adoption credit and exclusion............... ....... ....... ......... ......... ......... ......... ......... ......... 570 640 690 710 730 750 760 3,640
100 Exclusion of employee meals and lodging ....... ....... ......... ......... ......... ......... ......... ......... 990 1,030 1,080 1,130 1,180 1,230 1,290 5,910
(other than military)......................
101 Child credit \2\............................ ....... ....... ......... ......... ......... ......... ......... ......... 25,950 39,010 32,280 31,960 31,450 31,450 31,450 158,590
102 Credit for child and dependent care expenses ....... ....... ......... ......... ......... ......... ......... ......... 3,990 4,190 3,750 2,530 2,400 2,280 2,170 13,130
103 Credit for disabled access expenditures..... 20 20 20 20 20 20 20 100 30 30 40 40 40 40 40 200
104 Deductibility of charitable contributions, 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 37,910 175,580
other than education and health............
105 Exclusion of certain foster care payments... ....... ....... ......... ......... ......... ......... ......... ......... 510 510 510 510 520 530 540 2,610
106 Exclusion of parsonage allowances........... ....... ....... ......... ......... ......... ......... ......... ......... 520 550 590 630 660 710 750 3,340

Health
107 Exclusion of employer contributions for ....... ....... ......... ......... ......... ......... ......... ......... 126,660 139,650 158,980 177,050 195,850 214,730 228,090 974,700
medical insurance premiums and medical care.
108 Self-employed medical insurance premiums..... ....... ....... ......... ......... ......... ......... ......... ......... 4,140 4,730 5,480 6,110 6,700 7,360 7,990 33,640
109 Medical Savings Accounts Health Savings ....... ....... ......... ......... ......... ......... ......... ......... 520 1,040 1,670 2,450 3,150 3,540 3,520 14,330
Accounts....................................
110 Deductibility of medical expenses............ ....... ....... ......... ......... ......... ......... ......... ......... 7,930 9,280 9,880 10,780 12,050 12,910 13,750 59,370
111 Exclusion of interest on hospital 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880
construction bonds..........................
112 Deductibility of charitable contributions 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,260 19,720
(health)....................................
113 Tax credit for orphan drug research.......... 280 310 350 390 430 480 540 2,190 ......... ......... ......... ......... ......... ......... ......... .........
114 Special Blue Cross/Blue Shield deduction..... 570 560 510 560 490 530 610 2,700 ......... ......... ......... ......... ......... ......... ......... .........
115 Tax credit for health insurance purchased by ....... ....... ......... ......... ......... ......... ......... ......... 50 60 40 40 50 50 50 230
certain displaced and retired individuals
\3\.........................................

Income security
116 Exclusion of railroad retirement system ....... ....... ......... ......... ......... ......... ......... ......... 400 400 400 400 400 400 400 2,000
benefits....................................
117 Exclusion of workers' compensation benefits.. ....... ....... ......... ......... ......... ......... ......... ......... 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590
118 Exclusion of public assistance benefits ....... ....... ......... ......... ......... ......... ......... ......... 410 430 450 470 490 510 480 2,400
(normal tax method).........................
119 Exclusion of special benefits for disabled ....... ....... ......... ......... ......... ......... ......... ......... 60 50 50 50 40 40 40 220
coal miners.................................
120 Exclusion of military disability pensions.... ....... ....... ......... ......... ......... ......... ......... ......... 100 100 110 110 110 120 120 570
Net exclusion of pension contributions and
earnings:
121 Employer plans.............................. ....... ....... ......... ......... ......... ......... ......... ......... 57,280 61,380 62,260 64,110 57,960 55,260 54,350 293,940
122 401(k) plans................................ ....... ....... ......... ......... ......... ......... ......... ......... 58,210 55,940 58,710 63,170 68,460 74,300 80,980 345,620
123 Individual Retirement Accounts.............. ....... ....... ......... ......... ......... ......... ......... ......... 8,470 9,300 9,140 9,120 8,730 8,340 7,790 43,120
124 Low and moderate income savers credit....... ....... ....... ......... ......... ......... ......... ......... ......... 1,150 1,310 1,380 830 ......... ......... ......... 2,210
125 Keogh plans................................. ....... ....... ......... ......... ......... ......... ......... ......... 11,170 11,800 12,500 13,290 14,490 15,780 17,200 73,260
Exclusion of other employee benefits:
126 Premiums on group term life insurance....... ....... ....... ......... ......... ......... ......... ......... ......... 2,660 2,690 2,700 2,700 2,750 2,790 2,830 13,770
127 Premiums on accident and disability ....... ....... ......... ......... ......... ......... ......... ......... 350 370 390 400 410 430 440 2,070
insurance..................................
128 Small business retirement plan credit........ 60 70 90 100 110 110 100 510 50 70 80 100 100 100 100 480
129 Income of trusts to finance supplementary ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
unemployment benefits.......................
130 Special ESOP rules........................... 2,550 2,740 2,970 3,210 3,460 3,750 4,070 17,460 510 540 550 590 620 610 610 2,980
131 Additional deduction for the blind........... ....... ....... ......... ......... ......... ......... ......... ......... 40 40 50 40 50 50 50 240
132 Additional deduction for the elderly......... ....... ....... ......... ......... ......... ......... ......... ......... 2,060 2,190 2,370 2,350 2,290 2,330 2,360 11,700
133 Tax credit for the elderly and disabled...... ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 10 10 80
134 Deductibility of casualty losses............. ....... ....... ......... ......... ......... ......... ......... ......... 610 270 290 280 290 300 320 1,480
135 Earned income tax credit \4\................. ....... ....... ......... ......... ......... ......... ......... ......... 5,437 5,536 6,026 5,742 5,874 6,089 5,868 29,599

Social Security
Exclusion of social security benefits:

[[Page 330]]

136 Social Security benefits for retired workers ....... ....... ......... ......... ......... ......... ......... ......... 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120
137 Social Security benefits for disabled....... ....... ....... ......... ......... ......... ......... ......... ......... 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680
138 Social Security benefits for dependents and ....... ....... ......... ......... ......... ......... ......... ......... 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880
survivors..................................

Veterans benefits and services
139 Exclusion of veterans death benefits and ....... ....... ......... ......... ......... ......... ......... ......... 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850
disability compensation.....................
140 Exclusion of veterans pensions............... ....... ....... ......... ......... ......... ......... ......... ......... 110 120 120 120 120 130 140 630
141 Exclusion of GI bill benefits................ ....... ....... ......... ......... ......... ......... ......... ......... 130 150 160 170 180 190 200 900
142 Exclusion of interest on veterans housing 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340
bonds.......................................

General purpose fiscal assistance
143 Exclusion of interest on public purpose State 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570
and local bonds.............................
144 Deductibility of nonbusiness state and local ....... ....... ......... ......... ......... ......... ......... ......... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
taxes other than on owner-occupied homes....
145 Tax credit for corporations receiving income 1,430 1,290 720 70 ......... ......... ......... 790 ......... ......... ......... ......... ......... ......... ......... .........
from doing business in U.S. possessions.....

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

Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes...... ....... ....... ......... ......... ......... ......... ......... ......... 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140
Nonbusiness State and local taxes other than ....... ....... ......... ......... ......... ......... ......... ......... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240
on owner-occupied homes....................
Exclusion of interest on State and local
bonds for:
Public purposes............................. 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570
Energy facilities........................... 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700
Water, sewage, and hazardous waste disposal 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680
facilities.................................
Small-issues................................ 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330
Owner-occupied mortgage subsidies........... 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590
Rental housing.............................. 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620
Airports, docks, and similar facilities..... 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340
Student loans............................... 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140
Private nonprofit educational facilities.... 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240
Hospital construction....................... 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880
Veterans' housing........................... 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340
Credit for holders of zone academy bonds..... 130 160 180 190 200 200 190 960 ......... ......... ......... ......... ......... ......... ......... .........
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In addition, the partial exemption from the excise tax and excise credits for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590;
2008 $1,620; 2009 $1,650; and 2010 $1,680.
\2\ The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040;
2009 $11,693 and 2010 $11,364
\3\ In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million projected.
\4\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008
$34,723; 2009 $35,517; and 2010 $36,099.

Tax Expenditure Baselines

A tax expenditure is an exception to baseline provisions of the tax
structure. The 1974 Congressional Budget Act, which mandated the tax
expenditure budget, did not specify the baseline provisions of the tax
law. As noted previously, deciding whether provisions are exceptions,
therefore, is a matter of judgment. As in prior years, most of this
year's tax expenditure estimates are presented using two baselines: the
normal tax baseline and the reference tax law baseline. An exception is
provided for the lower tax rate on dividends and capital gains on
corporate shares as discussed below.
The normal tax baseline is patterned on a comprehensive income tax,
which defines income as the sum of consumption and the change in net
wealth in a given period of time. The normal tax baseline allows
personal exemptions, a standard deduction, and deductions of the
expenses incurred in earning income. It is not limited to a particular
structure of tax rates, or by a specific definition of the taxpaying
unit.
In the case of income taxes, the reference tax law baseline is also
patterned on a comprehensive income tax, but it is closer to existing
law. Tax expenditures under the reference law baseline are generally tax
expenditures under the normal tax baseline, but the reverse is not
always true.
Both the normal and reference tax baselines allow several major
departures from a pure comprehensive income tax. For example, under the
normal and reference tax baselines:

[[Page 331]]

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.
Tax rates are allowed to vary with marital status.
Values of assets and debt are not generally adjusted for
inflation. A comprehensive income tax would adjust the cost
basis of capital assets and debt for changes in the price
level during the time the assets or debt are held. Thus, under
a comprehensive income tax baseline, the failure to take
account of inflation in measuring depreciation, capital gains,
and interest income would be regarded as a negative tax
expenditure (i.e., a tax penalty), and failure to take account
of inflation in measuring interest costs would be regarded as
a positive tax expenditure (i.e., a tax subsidy).

Although the reference law and normal tax baselines are generally
similar, areas of difference include:

Tax rates. The separate schedules applying to the various
taxpaying units are included in the reference law baseline.
Thus, corporate tax rates below the maximum statutory rate do
not give rise to a tax expenditure. The normal tax baseline is
similar, except that, by convention, it specifies the current
maximum rate as the baseline for the corporate income tax. The
lower tax rates applied to the first $10 million of corporate
income are thus regarded as a tax expenditure. Again by
convention, the alternative minimum tax is treated as part of
the baseline rate structure under both the reference and
normal tax methods.

Income subject to the tax. Income subject to tax is defined
as gross income less the costs of earning that income. The
Federal income tax defines gross income to include: (1)
consideration received in the exchange of goods and services,
including labor services or property; and (2) the taxpayer's
share of gross or net income earned and/or reported by another
entity (such as a partnership). Under the reference tax rules,
therefore, gross income does not include gifts defined as
receipts of money or property that are not consideration in an
exchange or most transfer payments, which can be thought of as
gifts from the Government. \1\ The normal tax baseline also
excludes gifts between individuals from gross income. Under
the normal tax baseline, however, all cash transfer payments
from the Government to private individuals are counted in
gross income, and exemptions of such transfers from tax are
identified as tax expenditures. The costs of earning income
are generally deductible in determining taxable income under
both the reference and normal tax baselines. \2\
---------------------------------------------------------------------------
\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.

Double Taxation of Corporate Profits

In a gradual transition to a more economically neutral tax system
where corporate income is subject to a single layer of tax, the lower
tax rates on dividends and capital gains on corporate equity have not
been considered tax preferences since the 2005 Budget. Thus, the
difference between ordinary tax rates and the lower tax rates on
dividends, introduced by the Jobs and Growth Tax Relief Reconciliation
Act of 2003 (JGTRRA), does not give rise to a tax expenditure.
Similarly, the lower capital gains tax rates applied to gains realized
from the disposition of corporate equity do not give rise to a tax
expenditure as well. As a

[[Page 332]]

consequence, tax expenditure estimates for the lower tax rates on
capital, step-up in basis, and the inside build-up on pension assets,
401k plans, IRAs, among others, are limited to capital gains from
sources other than corporate equity. The Appendix provides a greater
discussion of alternative baselines.

Performance Measures and the Economic Effects of Tax Expenditures

The Government Performance and Results Act of 1993 (GPRA) directs
Federal agencies to develop annual and strategic plans for their
programs and activities. These plans set out performance objectives to
be achieved over a specific time period. Most of these objectives will
be achieved through direct expenditure programs. Tax expenditures,
however, may also contribute to achieving these goals. The report of the
Senate Governmental Affairs Committee on GPRA \3\ calls on the Executive
branch to undertake a series of analyses to assess the effect of
specific tax expenditures on the achievement of agencies' performance
objectives.
---------------------------------------------------------------------------
\3\ Committee on Government Affairs, United States Senate,
``Government Performance and Results Act of 1993'' (Report 103-58,
1993).
---------------------------------------------------------------------------
The Executive Branch is continuing to focus on the availability of
data needed to assess the effects of the tax expenditures designed to
increase savings. Treasury's Office of Tax Analysis and Statistics of
Income Division (IRS) have developed a new sample of individual income
tax filers as one part of this effort. This new ``panel'' sample will
follow the same taxpayers over a period of at least ten years. The first
year of this panel sample was drawn from tax returns filed in 2000 for
tax year 1999. The sample will capture the changing demographic and
economic circumstances of individuals and the effects of changes in tax
law over an extended period of time. Data from the sample will therefore
permit more extensive, and better, analyses of many tax provisions than
can be performed using only annual (``cross-section'') data. In
particular, data from this panel sample will enhance our ability to
analyze the effect of tax expenditures designed to increase savings.
Other efforts by OMB, Treasury, and other agencies to improve data
available for the analysis of savings tax expenditures will continue
over the next several years.
Comparison of tax expenditure, spending, and regulatory policies. Tax
expenditures by definition work through the tax system and,
particularly, the income tax. Thus, they may be relatively advantageous
policy approaches when the benefit or incentive is related to income and
is intended to be widely available. \4\ Because there is an existing
public administrative and private compliance structure for the tax
system, the incremental administrative and compliance costs for a tax
expenditure may be low in many cases. In addition, some tax expenditures
actually simplify the operation of the tax system, (for example, the
exclusion for up to $500,000 of capital gains on home sales). Tax
expenditures also implicitly subsidize certain activities. Spending,
regulatory or tax-disincentive policies can also modify behavior, but
may have different economic effects. Finally, a variety of tax
expenditure tools can be used e.g., deductions; credits; exemptions;
deferrals; floors; ceilings; phase-ins; phase-outs; dependent on income,
expenses, or demographic characteristics (age, number of family members,
etc.). This wide range means that tax expenditures can be flexible and
can have very different economic effects.
---------------------------------------------------------------------------
\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 decision-making. The income tax system may
have little or no contact with persons who have no or very low incomes,
and does not require information on certain characteristics of
individuals used in some spending programs, such as wealth. These
features may reduce the effectiveness of tax expenditures for addressing
certain income-transfer objectives. Tax expenditures also generally do
not enable the same degree of agency discretion as an outlay program.
For example, grant or direct Federal service delivery programs can
prioritize activities to be addressed with specific resources in a way
that is difficult to emulate with tax expenditures. Finally, tax
expenditures may not receive the same level of scrutiny afforded to
other programs.
Outlay programs have advantages where direct Government service
provision is particularly warranted such as equipping and providing the
armed forces or administering the system of justice. Outlay programs may
also be specifically designed to meet the needs of low-income families
who would not otherwise be subject to income taxes or need to file a tax
return. Outlay programs may also receive more year-to-year oversight and
fine tuning, through the legislative and executive budget process. In
addition, many different types of spending programs including direct
Government provision; credit programs; and payments to State and local
governments, the private sector, or individuals in the form of grants or
contracts provide flexibility for policy design. On the other hand,
certain outlay programs such as direct Government service provision may
rely less directly on economic incentives and private-market provision
than tax incentives, which may reduce the relative efficiency of
spending programs for some goals. Spending programs also require
resources to be raised via taxes, user charges, or Government borrowing,
which can impose further costs by diverting resources from their most
efficient uses. Finally, spending programs, particularly on the
discretionary side, may respond less readily to changing activity levels
and economic conditions than tax expenditures.
Regulations have more direct and immediate effects than outlay and
tax-expenditure programs because regulations apply directly and
immediately to the regulated party (i.e., the intended actor) generally
in the private sector. Regulations can also be fine-tuned more

[[Page 333]]

quickly than tax expenditures, because they can often be changed as
needed by the executive branch without legislation. Like tax
expenditures, regulations often rely largely upon voluntary compliance,
rather than detailed inspections and policing. As such, the public
administrative costs tend to be modest relative to the private resource
costs associated with modifying activities. Historically, regulations
have tended to rely on proscriptive measures, as opposed to economic
incentives. This reliance can diminish their economic efficiency,
although this feature can also promote full compliance where (as in
certain safety-related cases) policymakers believe that trade-offs with
economic considerations are not of paramount importance. Also,
regulations generally do not directly affect Federal outlays or
receipts. Thus, like tax expenditures, they may escape the degree of
scrutiny that outlay programs receive. However, major regulations are
subjected to a formal regulatory analysis that goes well beyond the
analysis required for outlays and tax-expenditures. To some extent, the
GPRA requirement for performance evaluation will address this lack of
formal analysis.
Some policy objectives are achieved using multiple approaches. For
example, minimum wage legislation, the earned income tax credit, and the
food stamp program are regulatory, tax expenditure, and direct outlay
programs, respectively, all having the objective of improving the
economic welfare of low-wage workers.
Tax expenditures, like spending and regulatory programs, have a
variety of objectives and effects. When measured against a comprehensive
income tax, for example, these include: encouraging certain types of
activities (e.g., saving for retirement or investing in certain
sectors); increasing certain types of after-tax income (e.g., favorable
tax treatment of Social Security income); reducing private compliance
costs and Government administrative costs (e.g., the exclusion for up to
$500,000 of capital gains on home sales); and promoting tax neutrality
(e.g., accelerated depreciation in the presence of inflation). Some of
these objectives are well suited to quantitative measurement, while
others are less well suited. Also, many tax expenditures, including
those cited above, may have more than one objective. For example,
accelerated depreciation may encourage investment. In addition, the
economic effects of particular provisions can extend beyond their
intended objectives (e.g., a provision intended to promote an activity
or raise certain incomes may have positive or negative effects on tax
neutrality).
Performance measurement is generally concerned with inputs, outputs,
and outcomes. In the case of tax expenditures, the principal input is
usually the revenue effect. Outputs are quantitative or qualitative
measures of goods and services, or changes in income and investment,
directly produced by these inputs. Outcomes, in turn, represent the
changes in the economy, society, or environment that are the ultimate
goals of programs.
Thus, for a provision that reduces taxes on certain investment
activity, an increase in the amount of investment would likely be a key
output. The resulting production from that investment, and, in turn, the
associated improvements in national income, welfare, or security, could
be the outcomes of interest. For other provisions, such as those
designed to address a potential inequity or unintended consequence in
the tax code, an important performance measure might be how they change
effective tax rates (the discounted present-value of taxes owed on new
investments or incremental earnings) or excess burden (an economic
measure of the distortions caused by taxes). Effects on the incomes of
members of particular groups may be an important measure for certain
provisions.
An overview of evaluation issues by budget function. The discussion
below considers the types of measures that might be useful for some
major programmatic groups of tax expenditures. The discussion is
intended to be illustrative and not all encompassing. However, it is
premised on the assumption that the data needed to perform the analysis
are available or can be developed. In practice, data availability is
likely to be a major challenge, and data constraints may limit the
assessment of the effectiveness of many provisions. In addition, such
assessments can raise significant challenges in economic modeling.
National defense. Some tax expenditures are intended to assist
governmental activities. For example, tax preferences for military
benefits reflect, among other things, the view that benefits such as
housing, subsistence, and moving expenses are intrinsic aspects of
military service, and are provided, in part, for the benefit of the
employer, the U.S. Government. Tax benefits for combat service are
intended to reduce tax burdens on military personnel undertaking
hazardous service for the Nation. A portion of the tax expenditure
associated with foreign earnings is targeted to benefit U.S. Government
civilian personnel working abroad by offsetting the living costs that
can be higher than those in the United States. These tax expenditures
should be considered together with direct agency budget costs in making
programmatic decisions.
International affairs. Tax expenditures are also aimed at goals such
as tax neutrality. These include the exclusion for income earned abroad
by nongovernmental employees and exclusions for income of U.S.-
controlled foreign corporations. Measuring the effectiveness of these
provisions raises challenging issues.
General science, space and technology; energy; natural resources and
the environment; agriculture; and commerce and housing. A series of tax
expenditures reduces the cost of investment, both in specific activities
such as research and experimentation, extractive industries, and certain
financial activities and more generally, through accelerated
depreciation for plant and equipment. These provisions can be evaluated
along a number of dimensions. For example, it could be useful to
consider the strength of the incentives by measuring their effects on
the cost of capital (the interest rate which investments must yield to
cover their costs) and effective tax rates. The impact of these
provisions on the amounts of corresponding forms of investment (e.g.,

[[Page 334]]

research spending, exploration activity, equipment) might also be
estimated. In some cases, such as research, there is evidence that the
investment can provide significant positive externalities that is,
economic benefits that are not reflected in the market transactions
between private parties. It could be useful to quantify these
externalities and compare them with the size of tax expenditures.
Measures could also indicate the effects on production from these
investments such as numbers or values of patents, energy production and
reserves, and industrial production. Issues to be considered include the
extent to which the preferences increase production (as opposed to
benefitting existing output) and their cost-effectiveness relative to
other policies. Analysis could also consider objectives that are more
difficult to measure but still are ultimate goals, such as promoting the
Nation's technological base, energy security, environmental quality, or
economic growth. Such an assessment is likely to involve tax analysis as
well as consideration of non-tax matters such as market structure,
scientific, and other information (such as the effects of increased
domestic fuel production on imports from various regions, or the effects
of various energy sources on the environment).
Housing investment also benefits from tax expenditures. The imputed
net rental income from owner-occupied housing is excluded from the tax
base. The mortgage interest deduction and property tax deduction on
personal residences also are reported as tax expenditures because the
value of owner-occupied housing services is not included in a taxpayer's
taxable income. Taxpayers also may exclude up to $500,000 of the capital
gains from the sale of personal residences. Measures of the
effectiveness of these provisions could include their effects on
increasing the extent of home ownership and the quality of housing.
Similarly, analysis of the extent of accumulated inflationary gains is
likely to be relevant to evaluation of the capital gains for home sales.
Deductibility of State and local property taxes assists with making
housing more affordable as well as easing the cost of providing
community services through these taxes. Provisions intended to promote
investment in rental housing could be evaluated for their effects on
making such housing more available and affordable. These provisions
should then be compared with alternative programs that address housing
supply and demand.
Transportation. Employer-provided parking is a fringe benefit that,
for the most part, is excluded from taxation. The tax expenditure
estimates reflect the cost of parking that is leased by employers for
employees; an estimate is not currently available for the value of
parking owned by employers and provided to their employees. The
exclusion for employer-provided transit passes is intended to promote
use of this mode of transportation, which has environmental and
congestion benefits. The tax treatments of these different benefits
could be compared with alternative transportation policies.
Community and regional development. A series of tax expenditures is
intended to promote community and regional development by reducing the
costs of financing specialized infrastructure, such as airports, docks,
and stadiums. Empowerment zone and enterprise community provisions are
designed to promote activity in disadvantaged areas. These provisions
can be compared with grants and other policies designed to spur economic
development.
Education, training, employment, and social services. Major provisions
in this function are intended to promote post-secondary education, to
offset costs of raising children, and to promote a variety of charitable
activities. The education incentives can be compared with loans, grants,
and other programs designed to promote higher education and training.
The child credits are intended to adjust the tax system for the costs of
raising children; as such, they could be compared to other Federal tax
and spending policies, including related features of the tax system,
such as personal exemptions (which are not defined as a tax
expenditure). Evaluation of charitable activities requires consideration
of the beneficiaries of these activities, who are generally not the
parties receiving the tax reduction.
Health. Individuals also benefit from favorable treatment of employer-
provided health insurance. Measures of these benefits could include
increased coverage and pooling of risks. The effects of insurance
coverage on final outcome measures of actual health (e.g., infant
mortality, days of work lost due to illness, or life expectancy) or
intermediate outcomes (e.g., use of preventive health care or health
care costs) could also be investigated.
Income security, Social Security, and veterans benefits and services.
Major tax expenditures in the income security function benefit
retirement savings, through employer-provided pensions, individual
retirement accounts, and Keogh plans. These provisions might be
evaluated in terms of their effects on boosting retirement incomes,
private savings, and national savings (which would include the effect on
private savings as well as public savings or deficits). Interactions
with other programs, including Social Security, also may merit analysis.
As in the case of employer-provided health insurance, analysis of
employer-provided pension programs requires imputing the value of
benefits funded at the firm level to individuals.
Other provisions principally affect the incomes of members of certain
groups, rather than affecting incentives. For example, tax-favored
treatment of Social Security benefits, certain veterans' benefits, and
deductions for the blind and elderly provide increased incomes to
eligible parties. The earned-income tax credit, in contrast, should be
evaluated for its effects on labor force participation as well as the
income it provides lower-income workers.
General purpose fiscal assistance and interest. The tax-exemption for
public purpose State and local bonds reduces the costs of borrowing for
a variety of purposes (borrowing for non-public purposes is reflected
under

[[Page 335]]

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

Descriptions of Income Tax Provisions

Descriptions of the individual and corporate income tax expenditures
reported upon in this chapter follow. These descriptions relate to
current law as of December 31, 2004, and do not reflect proposals made
elsewhere in the Budget. Nine additional provisions are considered when
compared to the 2005 Budget. These are: (1) Expensing of capital costs
with respect to complying with EPA sulfur regulations, (2) Exclusion of
gain or loss on sale or exchange of certain brownfield sites, (3) Bio-
Diesel tax credit, (4) Imputed net rental income on owner occupied
housing, (5) Deduction for US production activities, (6) Special rules
for certain film and TV production, (7) Tax credit for certain
expenditures for maintaining railroad tracks, (8) Deferral of capital
gains with respect of dispositions of transmission property, and (9)
Discharge of student loan indebtedness.

National Defense

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

International Affairs

2. Income earned abroad.--U.S. citizens who lived abroad, worked in
the private sector, and satisfied a foreign residency requirement may
exclude up to $80,000 in foreign earned income from U.S. taxes. In
addition, if these taxpayers receive a specific allowance for foreign
housing from their employers, they may also exclude the value of that
allowance. If they do not receive a specific allowance for housing
expenses, they may deduct against their U.S. taxes that portion of such
expenses that exceeds one-sixth the salary of a civil servant at grade
GS-14, step 1 ($74,335 in 2004).
3. Exclusion of certain allowances for Federal employees abroad.--U.S.
Federal civilian employees and Peace Corps members who work outside the
continental United States are allowed to exclude from U.S. taxable
income certain special allowances they receive to compensate them for
the relatively high costs associated with living overseas. The
allowances supplement wage income and cover expenses like rent,
education, and the cost of travel to and from the United States.
4. Extraterritorial income exclusion. \5\--For purposes of calculating
U.S. tax liability, a taxpayer may exclude from gross income the
qualifying foreign trade income attributable to foreign trading gross
receipts. The exclusion generally applies to income from the sale or
lease of qualifying foreign trade property and certain types of services
income. The FSC Repeal and Extraterritorial Income Exclusion Act of 2000
created the extraterritorial income exclusion to replace the foreign
sales corporation provisions, which the Act repealed. The exclusion is
generally available for transactions entered into after September 30,
2000.
---------------------------------------------------------------------------
\5\ 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.

[[Page 336]]

General Science, Space, and Technology

8. Expensing R&E expenditures.--Research and experimentation (R&E)
projects can be viewed as investments because, if successful, their
benefits accrue for several years. It is often difficult, however, to
identify whether a specific R&E project is successful and, if
successful, what its expected life will be. Under the normal tax method,
the expensing of R&E expenditures is viewed as a tax expenditure. The
baseline assumed for the normal tax method is that all R&E expenditures
are successful and have an expected life of five years.
9. R&E credit.--The research and experimentation (R&E) credit is 20
percent of qualified research expenditures in excess of a base amount.
The base amount is generally determined by multiplying a ``fixed-base
percentage'' by the average amount of the company's gross receipts for
the prior four years. The taxpayer's fixed base percentage generally is
the ratio of its research expenses to gross receipts for 1984 through
1988. Taxpayers may also elect an alternative credit regime. Under the
alternative credit regime the taxpayer is assigned a three-tiered fixed-
base percentage that is lower than the fixed-base percentage that would
otherwise apply, and the credit rate is reduced (the rates range from
2.65 percent to 3.75 percent). A 20-percent credit with a separate
threshold is provided for a taxpayer's payments to universities for
basic research. The credit applies to research conducted before January
1, 2006 and extends to research conducted in Puerto Rico and the U.S.
possessions.

Energy

10. Exploration and development costs.--For successful investments in
domestic oil and gas wells, intangible drilling costs (e.g., wages, the
costs of using machinery for grading and drilling, the cost of
unsalvageable materials used in constructing wells) may be expensed
rather than amortized over the productive life of the property.
Integrated oil companies may deduct only 70 percent of such costs and
must amortize the remaining 30 percent over five years. The same rule
applies to the exploration and development costs of surface stripping
and the construction of shafts and tunnels for other fuel minerals.
11. Percentage depletion.--Independent fuel mineral producers and
royalty owners are generally allowed to take percentage depletion
deductions rather than cost depletion on limited quantities of output.
Under cost depletion, outlays are deducted over the productive life of
the property based on the fraction of the resource extracted. Under
percentage depletion, taxpayers deduct a percentage of gross income from
mineral production at rates of 22 percent for uranium; 15 percent for
oil, gas and oil shale; and 10 percent for coal. The deduction is
limited to 50 percent of net income from the property, except for oil
and gas where the deduction can be 100 percent of net property income.
Production from geothermal deposits is eligible for percentage depletion
at 65 percent of net income, but with no limit on output and no
limitation with respect to qualified producers. Unlike depreciation or
cost depletion, percentage depletion deductions can exceed the cost of
the investment.
12. Alternative fuel production credit.--A nontaxable credit of $3 per
oil-equivalent barrel of production (in 1979 dollars) is provided for
several forms of alternative fuels. The credit is generally available if
the price of oil stays below $29.50 (in 1979 dollars). The credit
generally expires on December 31, 2002.
13. Oil and gas exception to passive loss limitation.--Owners of
working interests in oil and gas properties are exempt from the
``passive income'' limitations. As a result, the working interest-
holder, who manages on behalf of himself and all other owners the
development of wells and incurs all the costs of their operation, may
aggregate negative taxable income from such interests with his income
from all other sources.
14. Capital gains treatment of royalties on coal.--Sales of certain
coal under royalty contracts can be treated as capital gains rather than
ordinary income.
15. Energy facility bonds.--Interest earned on State and local bonds
used to finance construction of certain energy facilities is tax-exempt.
These bonds are generally subject to the State private-activity bond
annual volume cap.
16. Enhanced oil recovery credit.--A credit is provided equal to 15
percent of the taxpayer's costs for tertiary oil recovery on U.S.
projects. Qualifying costs include tertiary injectant expenses,
intangible drilling and development costs on a qualified enhanced oil
recovery project, and amounts incurred for tangible depreciable
property.
17. New technology credits.--A credit of 10 percent is available for
investment in solar and geothermal energy facilities. In addition, a
credit of 1.5 cents (indexed for inflation) is provided per kilowatt
hour of electricity produced from certain renewable resources.
Generally, qualifying sources include wind, closed-loop biomass, open-
loop biomass including agricultural livestock waste nutrients,
geothermal energy, solar energy, small irrigation, landfill gas, and
trash combustion used to produce electricity at a facility placed in
service before January 1, 2006. For facilities using open-loop biomass,
small irrigation, landfill gas, or trash combustion, the credit rate is
reduced by half. In addition, refined coal produced at a facility placed
in service before January 1, 2009 cn claim a credit at a rate of $4.375
per ton (indexed for inflation).
18. Alcohol fuel credits.--An income tax credit is provided for
ethanol that is derived from renewable sources and used as fuel. The
credit equals 53 cents per gallon in 2001 and 2002; 52 cents per gallon
in 2003 and 2004; and 51 cents per gallon through 2010. To the extent
that ethanol is mixed with taxable motor fuel to create gasohol,
taxpayers may claim an exemption of the Federal excise tax rather than
the income tax credit. In addition, small ethanol producers are eligible
for a separate 10 cents per gallon credit.
19. Credit and deduction for clean-fuel vehicles and property.--A tax
credit of 10 percent (not to ex

[[Page 337]]

ceed $4,000) is provided for purchasers of electric vehicles. Purchasers
of other clean-fuel burning vehicles and owners of clean-fuel refueling
property may deduct part of their expenditures. The deduction and credit
are reduced by 75 percent for vehicles placed in service in 2006 and are
not available for vehicles placed in service after December 31, 2006.
20. Exclusion of utility conservation subsidies.--Non-business
customers can exclude from gross income subsidies received from public
utilities for expenditures on energy conservation measures.

Natural Resources and Environment

21. Exploration and development costs.--Certain capital outlays
associated with exploration and development of nonfuel minerals may be
expensed rather than depreciated over the life of the asset.
22. Percentage depletion.--Most nonfuel mineral extractors may use
percentage depletion rather than cost depletion, with percentage
depletion rates ranging from 22 percent for sulfur to 5 percent for sand
and gravel.
23. Sewage, water, solid and hazardous waste facility bonds.--Interest
earned on State and local bonds used to finance the construction of
sewage, water, or hazardous waste facilities is tax-exempt. These bonds
are generally subject to the State private-activity bond annual volume
cap.
24. Capital gains treatment of certain timber.--Certain timber sales
can be treated as a capital gain rather than ordinary income.
25. Expensing multiperiod timber growing costs.--Most of the
production costs of growing timber may be expensed rather than
capitalized and deducted when the timber is sold. In most other
industries, these costs are capitalized under the uniform capitalization
rules.
26. Historic preservation.--Expenditures to preserve and restore
historic structures qualify for a 20-percent investment credit, but the
depreciable basis must be reduced by the full amount of the credit
taken.
27. Expensing of capital costs with respect to complying with EPA
sulfur regulations.--Small refiners are allowed to deduct 75 percent of
qualified capital costs incurred by the taxpayer during the taxable
year. This provision was introduced by the American Jobs Creation Act
(AJCA) enacted in 2004.
28. Exclusion of gain or loss on sale or exchange of certain
brownfield sites.--This provision was introduced by the AJCA enacted in
2004. This exclusion applies to taxpayers who have incurred remediation
expenditures in an amount which exceeds the greater of $550,000 or 12
percent of the fair market value of the property at the time such
property was acquired by the eligible taxpayer, determined as if there
were not a presence of a hazardous substance, pollutant, or contaminant
on the property which is complicating the expansion, redevelopment, or
reuse of the property.

Agriculture

29. Expensing certain capital outlays.--Farmers, except for certain
agricultural corporations and partnerships, are allowed to expense
certain expenditures for feed and fertilizer, as well as for soil and
water conservation measures. Expensing is allowed, even though these
expenditures are for inventories held beyond the end of the year, or for
capital improvements that would otherwise be capitalized.
30. Expensing multiperiod livestock and crop production costs.--The
production of livestock and crops with a production period of less than
two years is exempt from the uniform cost capitalization rules. Farmers
establishing orchards, constructing farm facilities for their own use,
or producing any goods for sale with a production period of two years or
more may elect not to capitalize costs. If they do, they must apply
straight-line depreciation to all depreciable property they use in
farming.
31. Loans forgiven solvent farmers.--Farmers are forgiven the tax
liability on certain forgiven debt. Normally, debtors must include the
amount of loan forgiveness as income or reduce their recoverable basis
in the property to which the loan relates. If the debtor elects to
reduce basis and the amount of forgiveness exceeds the basis in the
property, the excess forgiveness is taxable. For insolvent (bankrupt)
debtors, however, the amount of loan forgiveness reduces carryover
losses, then unused credits, and then basis; any remainder of the
forgiven debt is excluded from tax. Farmers with forgiven debt are
considered insolvent for tax purposes, and thus qualify for income tax
forgiveness.
32. Capital gains treatment of certain income.--Certain agricultural
income, such as unharvested crops, can be treated as capital gains
rather than ordinary income.
33. Income averaging for farmers.--Taxpayers can lower their tax
liability by averaging, over the prior three-year period, their taxable
income from farming and fishing.
34. Deferral of gain on sales of farm refiners.--A taxpayer who sells
stock in a farm refiner to a farmers' cooperative can defer recognition
of gain if the taxpayer reinvests the proceeds in qualified replacement
property.
35. Bio-Diesel tax credit.--An income tax credit of $0.50, similar to
Ethanol benefits, is available for each gallon of biodiesel used or
sold. Biodiesel derived from virgin sources (agri-biodiesel) receives an
increased credit of $1.00 per gallon. The provision was introduced by
the AJCA in 2004, and is set to expire on after December 31, 2006.

Commerce and Housing

This category includes a number of tax expenditure provisions that
also affect economic activity in other functional categories. For
example, provisions related to investment, such as accelerated
depreciation, could be classified under the energy, natural resources
and environment, agriculture, or transportation categories.

[[Page 338]]

36. Credit union income.--The earnings of credit unions not
distributed to members as interest or dividends are exempt from income
tax.
37. Bad debt reserves.--Small (less than $500 million in assets)
commercial banks, mutual savings banks, and savings and loan
associations may deduct additions to bad debt reserves in excess of
actually experienced losses.
38. Deferral of income on life insurance and annuity contracts.--
Favorable tax treatment is provided for investment income within
qualified life insurance and annuity contracts. Investment income earned
on qualified life insurance contracts held until death is permanently
exempt from income tax. Investment income distributed prior to the death
of the insured is tax-deferred, if not tax-exempt. Investment income
earned on annuities is treated less favorably than income earned on life
insurance contracts, but it benefits from tax deferral without annual
contribution or income limits generally applicable to other tax-favored
retirement income plans.
39. Small property and casualty insurance companies.--For taxable
years beginning before January 1, 2004, insurance companies that were
not life insurance companies and which had annual net premiums of less
than $350,000 were exempt from tax; those with $350,000 to $1.2 million
of annual net premiums could elect to pay tax only on the income earned
by their taxable investment portfolio. For taxable years beginning after
December 31, 2003, stock non-life insurance companies are generally
exempt from tax if their gross receipts for the taxable year do not
exceed $600,00 and more than 50 percent of such gross receipts consists
of premiums. Mutual non-life insurance companies are generally tax-
exempt if their annual gross receipts do not exceed $150,000 and more
than 35 percent of gross receipts consist of premiums. Also, for taxable
years beginning after December 31, 2003, non-life insurance companies
with no more than $1.2 million of annual net premiums may elect to pay
tax only on their taxable investment income.
40. Insurance companies owned by exempt organizations.--Generally, the
income generated by life and property and casualty insurance companies
is subject to tax, albeit by special rules. Insurance operations
conducted by such exempt organizations as fraternal societies and
voluntary employee benefit associations, however, are exempt from tax.
41. Small life insurance company deduction.--Small life insurance
companies (gross assets of less than $500 million) can deduct 60 percent
of the first $3 million of otherwise taxable income. The deduction
phases out for otherwise taxable income between $3 million and $15
million.
42. Mortgage housing bonds.--Interest earned on State and local bonds
used to finance homes purchased by first-time, low-to-moderate-income
buyers is tax-exempt. The amount of State and local tax-exempt bonds
that can be issued to finance these and other private activity is
limited. The combined volume cap for private activity bonds, including
mortgage housing bonds, rental housing bonds, student loan bonds, and
industrial development bonds was $62.50 per capita ($187.5 million
minimum) per State in 2001, and $75 per capita ($225 million minimum) in
2002. The Community Renewal Tax Relief Act of 2000 accelerated the
scheduled increase in the state volume cap and indexed the cap for
inflation, beginning in 2003. States may issue mortgage credit
certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home
buyers to income tax credits for a specified percentage of interest on
qualified mortgages. The total amount of MCCs issued by a State cannot
exceed 25 percent of its annual ceiling for mortgage-revenue bonds.
43. Rental housing bonds.--Interest earned on State and local
government bonds used to finance multifamily rental housing projects is
tax-exempt. At least 20 percent (15 percent in targeted areas) of the
units must be reserved for families whose income does not exceed 50
percent of the area's median income; or 40 percent for families with
incomes of no more than 60 percent of the area median income. Other tax-
exempt bonds for multifamily rental projects are generally issued with
the requirement that all tenants must be low or moderate income
families. Rental housing bonds are subject to the volume cap discussed
in the mortgage housing bond section above.
44. Interest on owner-occupied homes.--Owner-occupants of homes may
deduct mortgage interest on their primary and secondary residences as
itemized nonbusiness deductions. The mortgage interest deduction is
limited to interest on debt no greater than the owner's basis in the
residence and, for debt incurred after October 13, 1987; it is limited
to no more than $1 million. Interest on up to $100,000 of other debt
secured by a lien on a principal or second residence is also deductible,
irrespective of the purpose of borrowing, provided the debt does not
exceed the fair market value of the residence. Mortgage interest
deductions on personal residences are tax expenditures because the value
of owner-occupied housing services is not included in a taxpayer's
taxable income.
45. Taxes on owner-occupied homes.--Owner-occupants of homes may
deduct property taxes on their primary and secondary residences even
though they are not required to report the value of owner-occupied
housing services as gross income.
46. Installment sales.--Dealers in real and personal property (i.e.,
sellers who regularly hold property for sale or resale) cannot defer
taxable income from installment sales until the receipt of the loan
repayment. Nondealers (i.e., sellers of real property used in their
business) are required to pay interest on deferred taxes attributable to
their total installment obligations in excess of $5 million. Only
properties with sales prices exceeding $150,000 are includable in the
total. The payment of a market rate of interest eliminates the benefit
of the tax deferral. The tax exemption for nondealers with total
installment obligations of less than $5 million is, therefore, a tax
expenditure.

[[Page 339]]

47. Capital gains exclusion on home sales.--A homeowner can exclude
from tax up to $500,000 ($250,000 for singles) of the capital gains from
the sale of a principal residence. The exclusion may not be used more
than once every two years.
48. Imputed net rental income on owner occupied housing.--The implicit
rental value of home ownership, net of expenses such as mortgage
interest and depreciation, is excluded from income. The appendix
provides a greater explanation of this new addition to the tax
expenditure budget.
49. Passive loss real estate exemption.--In general, passive losses
may not offset income from other sources. Losses up to $25,000
attributable to certain rental real estate activity, however, are exempt
from this rule.
50. Low-income housing credit.--Taxpayers who invest in certain low-
income housing are eligible for a tax credit. The credit rate is set so
that the present value of the credit is equal to 70 percent for new
construction and 30 percent for (1) housing receiving other Federal
benefits (such as tax-exempt bond financing), or (2) substantially
rehabilitated existing housing. The credit is allowed in equal amounts
over 10 years. State agencies determine who receives the credit; States
are limited in the amount of credit they may authorize annually. The
Community Renewal Tax Relief Act of 2000 increased the per-resident
limit to $1.50 in 2001 and to $1.75 in 2002 and indexed the limit for
inflation, beginning in 2003. The Act also created a $2 million minimum
annual cap for small States beginning in 2002; the cap is indexed for
inflation, beginning in 2003.
51. Accelerated depreciation of rental property.--The tax depreciation
allowance provisions are part of the reference law rules, and thus do
not give rise to tax expenditures under the reference method. Under the
normal tax method, however, economic depreciation is assumed. This
calculation is described in more detail in the Appendix.
52. Cancellation of indebtedness.--Individuals are not required to
report the cancellation of certain indebtedness as current income. If
the canceled debt is not reported as current income, however, the basis
of the underlying property must be reduced by the amount canceled.
53. Imputed interest rules.--Holders (issuers) of debt instruments are
generally required to report interest earned (paid) in the period it
accrues, not when paid. In addition, the amount of interest accrued is
determined by the actual price paid, not by the stated principal and
interest stipulated in the instrument. In general, any debt associated
with the sale of property worth less than $250,000 is excepted from the
general interest accounting rules. This general $250,000 exception is
not a tax expenditure under reference law but is under normal law.
Exceptions above $250,000 are a tax expenditure under reference law;
these exceptions include the following: (1) sales of personal residences
worth more than $250,000, and (2) sales of farms and small businesses
worth between $250,000 and $1 million.
54. Capital gains (other than agriculture, timber, iron ore, and
coal).--Capital gains on assets held for more than 1 year are taxed at a
lower rate than ordinary income. Under the revised reference law
baseline used for the 2005 Budget, the lower rate on capital gains is
considered a tax expenditure under the reference law method, but only
for capital gains that have not been previously taxed under the
corporate income tax. As discussed above, this treatment partially
adjusts for the double tax on corporate income and is more consistent
with a comprehensive income tax base.
Prior to passage of the Jobs Growth Tax Relief Reconciliation Act
(JGTRRA), the top capital gains tax rate for most assets held for more
than 1 year was 20 percent. For assets acquired after December 31, 2000,
the top capital gains tax rate for assets held for more than 5 years was
18 percent. Since January 1, 2001, taxpayers may mark-to-market existing
assets to start the 5-year holding period. Losses from the mark-to-
market are not recognized.
For assets held for more than 1 year by taxpayers in the 15-percent
ordinary tax bracket, the top capital gains tax rate was 10 percent.
After December 31, 2000, the top capital gains tax rate for assets held
by these taxpayers for more than 5 years was 8 percent.
JGTRRA reduced the previous 20 percent and 18 percent rates on net
capital gains to 15 percent and the previous 10 percent and 8 percent
rates to 5 percent (0 percent, in 2008). The lower rates apply to assets
held for more than one year. The lower rates apply to assets sold after
May 6, 2003 through 2008.
55. Capital gains exclusion for small business stock.--An exclusion of
50 percent is provided for capital gains from qualified small business
stock held by individuals for more than 5 years. A qualified small
business is a corporation whose gross assets do not exceed $50 million
as of the date of issuance of the stock.
56. Step-up in basis of capital gains at death.--Capital gains on
assets held at the owner's death are not subject to capital gains taxes.
The cost basis of the appreciated assets is adjusted upward to the
market value at the owner's date of death. After repeal of the estate
tax for 2010 under the Economic Growth and Tax Relief Reconciliation Act
(EGTRRA) of 2001, the basis for property acquired from a decedent will
be the lesser of fair market value or the decedent's basis. Certain
types of additions to basis will be allowed so that assets in most
estates that are not currently subject to estate tax will not be subject
to capital gains tax in the hands of the heirs.
57. Carryover basis of capital gains on gifts.--When a gift is made,
the donor's basis in the transferred property (the cost that was
incurred when the transferred property was first acquired) carries-over
to the donee. The carryover of the donor's basis allows a continued
deferral of unrealized capital gains. Even though the estate tax is
repealed for 2010 under

[[Page 340]]

EGTRRA, the gift tax is retained with a lifetime exemption of $1
million.
58. Ordinary income treatment of losses from sale of small business
corporate stock shares.--Up to $100,000 in losses from the sale of small
business corporate stock (capitalization less than $1 million) may be
treated as ordinary losses. Such losses would, thus, not be subject to
the $3,000 annual capital loss write-off limit.
59. Accelerated depreciation of non-rental-housing buildings.--The tax
depreciation allowance provisions are part of the reference law rules,
and thus do not give rise to tax expenditures under reference law. Under
normal law, however, economic depreciation is assumed. This calculation
is described in more detail in the Appendix.
60. Accelerated depreciation of machinery and equipment.--The tax
depreciation allowance provisions are part of the reference law rules,
and thus do not give rise to tax expenditures under reference law. Under
the normal tax baseline, this tax depreciation allowance is measured
relative to economic depreciation. This calculation is described in more
detail in the Appendix.
61. Expensing of certain small investments.--As of 2003, under prior
law, qualifying investments in tangible property up to $25,000 could
have been expensed rather than depreciated over time. The amount
eligible for expensing was decreased to the extend the taxpayer's
qualifying investment during the year exceeded $200,000. For 2003,
however, the expensing limit was temporarily increased to $100,000, the
phase-out limit was temporarily increased to $400,000, and computer
software became temporarily eligible for expensing treatment. For 2004,
through 2007, these higher limits are indexed for inflation, and
computer software continues to be an eligible investment. In all years,
the amount expensed cannot exceed the taxpayer's taxable income for the
year. The prior rules will apply for taxable years beginning after 2007.
62. Business start-up costs.--Business start-up costs are costs
incurred prior to the creation of an active trade or business that would
be deductible if incurred in connection with the operation of an
existing trade or business. If the start-up costs were incurred on or
before October 22, 2004, a taxpayer could elect to amortize them over 60
months. For costs incurred after that date, a taxpayer may elect to
deduct up to $5,000 of start-up costs, but this deductible amount is
reduced (but now below zero) by the amount by which the taxpayer's total
start-up costs for the year exceed $50,000. Non-deducted start-up costs
incurred after October 22, 2004 are amortized over a 15-year period. The
normal-tax method treats the 60-month amortized amounts and the deducted
amounts as tax expenditures; the reference tax method does not.
63. Graduated corporation income tax rate schedule.--The corporate
income tax schedule is graduated, with rates of 15 percent on the first
$50,000 of taxable income, 25 percent on the next $25,000, and 34
percent on the next $9.925 million. Compared with a flat 34-percent
rate, the lower rates provide an $11,750 reduction in tax liability for
corporations with taxable income of $75,000. This benefit is recaptured
for corporations with taxable incomes exceeding $100,000 by a 5-percent
additional tax on corporate incomes in excess of $100,000 but less than
$335,000.
The corporate tax rate is 35 percent on income over $10 million.
Compared with a flat 35-percent tax rate, the 34-percent rate provides a
$100,000 reduction in tax liability for corporations with taxable
incomes of $10 million. This benefit is recaptured for corporations with
taxable incomes exceeding $15 million by a 3-percent additional tax on
income over $15 million but less than $18.33 million. Because the
corporate rate schedule is part of reference tax law, it is not
considered a tax expenditure under the reference method. A flat
corporation income tax rate is taken as the baseline under the normal
tax method; therefore the lower rates is considered a tax expenditure
under this concept.
64. Small issue industrial development bonds.--Interest earned on
small issue industrial development bonds (IDBs) issued by State and
local governments to finance manufacturing facilities is tax-exempt.
Depreciable property financed with small issue IDBs must be depreciated,
however, using the straight-line method. The annual volume of small
issue IDBs is subject to the unified volume cap discussed in the
mortgage housing bond section above.
65. Deduction for U.S. production activities.--This provision was
introduced by the AJCA in 2004 and allows for a deduction equal to a
portion of taxable income attributable to domestic production. For
taxable years beginning in 2004, 2005, 2006, 2007, and 2008, the amount
of the deduction is 5, 5, 5, 6, and 7 percent, respectively. For taxable
years beginning after 2008, the amount of the deduction is 9 percent.
66. Special rules for certain film and TV production.--Taxpayers may
deduct up to $15 million ($15 million in certain distressed areas) per
production expenditures in the year incurred. Excess expenditures may be
deducted over three years using the straight line method. This provision
was introduced by the AJCA enacted in 2004. Under prior law, production
expenses were depreciated.

Transportation

67. Deferral of tax on U.S. shipping companies.--Certain companies
that operate U.S. flag vessels can defer income taxes on that portion of
their income used for shipping purposes, primarily construction,
modernization and major repairs to ships, and repayment of loans to
finance these investments. Once indefinite, the deferral has been
limited to 25 years since January 1, 1987.
68. Exclusion of employee parking expenses.--Employee parking expenses
that are paid for by the employer or that are received in lieu of wages
are excludable from the income of the employee. In 2004,

[[Page 341]]

the maximum amount of the parking exclusion is $195 (indexed) per month.
The tax expenditure estimate does not include parking at facilities
owned by the employer.
69. Exclusion of employee transit pass expenses.--Transit passes,
tokens, fare cards, and vanpool expenses paid for by an employer or
provided in lieu of wages to defray an employee's commuting costs are
excludable from the employee's income. In 2005, the maximum amount of
the exclusion is $105 (indexed) per month.
70. Tax credit for certain expenditures for maintaining railroad
tracks.--Eligible taxpayers may claim a credit equal to the lesser of 50
percent of maintenance expenditures and the product of $3,500 and the
number of miles of track owned or leased. This provision was introduced
by the AJCA in 2004.

Community and Regional Development

71. Rehabilitation of structures.--A 10-percent investment tax credit
is available for the rehabilitation of buildings that are used for
business or productive activities and that were erected before 1936 for
other than residential purposes. The taxpayer's recoverable basis must
be reduced by the amount of the credit.
72. Airport, dock, and similar facility bonds.--Interest earned on
State and local bonds issued to finance high-speed rail facilities and
government-owned airports, docks, wharves, and sport and convention
facilities is tax-exempt. These bonds are not subject to a volume cap.
73. Exemption of income of mutuals and cooperatives.--The incomes of
mutual and cooperative telephone and electric companies are exempt from
tax if at least 85 percent of their revenues are derived from patron
service charges.
74. Empowerment zones, enterprise communities, and renewal
communities.--Qualifying businesses in designated economically depressed
areas can receive tax benefits such as an employer wage credit,
increased expensing of investment in equipment, special tax-exempt
financing, accelerated depreciation, and certain capital gains
incentives. The Job Creation and Worker Assistance Act of 2002 expanded
the existing provisions by adding the ``New York City Liberty Zone.'' In
addition, the Working Families Tax Relief Act of 2004 extended the
District of Columbia Enterprise Zone and the District of Columbia first
time homebuyer credit by two years through 2005.
75. New markets tax credit.--Taxpayers who invest in a community
development entity (CDE) after December 31, 2000 are eligible for a tax
credit. The total equity investment available for the credit across all
CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and 2003, $2.0
billion in 2004 and 2005, and $3.5 billion in 2006 and 2007. The amount
of the credit equals (1) 5 percent in the year of purchase and the
following 2 years, and (2) 6 percent in the following 4 years. A CDE is
any domestic firm whose primary mission is to serve or provide
investment capital for low-income communities/individuals; a CDE must be
accountable to residents of low-income communities. The Community
Renewal Tax Relief Act of 2000 created the new markets tax credit.
76. Expensing of environmental remediation costs.--Taxpayers who clean
up certain hazardous substances at a qualified site may expense the
clean-up costs, rather than capitalize the costs, even though the
expenses will generally increase the value of the property significantly
or appreciably prolong the life of the property. The Working Families
Tax Relief Act of 2004 extended this provision for two years, allowing
remediation expenditures incurred before December 31, 2005 to be
eligible for expensing.
77. Deferral of capital gains with respect of dispositions of
transmission property.--This provision, introduced by the AJCA, provides
for the deferral of gains from sales or dispositions to implement
Federal Energy Regulatory Commission or State electric restructuring
policy.

Education, Training, Employment, and Social Services

78. Scholarship and fellowship income.--Scholarships and fellowships
are excluded from taxable income to the extent they pay for tuition and
course-related expenses of the grantee. Similarly, tuition reductions
for employees of educational institutions and their families are not
included in taxable income. From an economic point of view, scholarships
and fellowships are either gifts not conditioned on the performance of
services, or they are rebates of educational costs. Thus, under the
reference law method, this exclusion is not a tax expenditure because
this method does not include either gifts or price reductions in a
taxpayer's gross income. The exclusion, however, is considered a tax
expenditure under the normal tax method, which includes gift-like
transfers of Government funds in gross income (many scholarships are
derived directly or indirectly from Government funding).
79. HOPE tax credit.--The non-refundable HOPE tax credit allows a
credit for 100 percent of an eligible student's first $1,000 of tuition
and fees and 50 percent of the next $1,000 of tuition and fees. The
credit only covers tuition and fees paid during the first two years of a
student's post-secondary education. In 2004, the credit is phased out
ratably for taxpayers with modified AGI between $85,000 and $105,000
($42,000 and $52,000 for singles), indexed.
80. Lifetime Learning tax credit.--The non-refundable Lifetime
Learning tax credit allows a credit for 20 percent of an eligible
student's tuition and fees. For tuition and fees paid after December 31,
2002, the maximum credit per return is $2,000. The credit is phased out
ratably for taxpayers with modified AGI between $85,000 and $105,000
($42,000 and $52,000 for singles) (indexed beginning in 2002). The
credit applies to both undergraduate and graduate students.
81. Deduction for Higher Education Expenses.--The maximum annual
deduction for qualified higher education expenses is $4,000 in 2004 for
taxpayers with

[[Page 342]]

adjusted gross income up to $130,000 on a joint return ($65,000 for
singles). Taxpayers with adjusted gross income up to $160,000 on a joint
return ($80,000 for singles) may deduct up to $2,000 beginning in 2004.
No deduction is allowed for expenses paid after December 31, 2005.
82. Education Individual Retirement Accounts.--Contributions to an
education IRA are not tax-deductible. Investment income earned by
education IRAs is not taxed when earned, and investment income from an
education IRA is tax-exempt when withdrawn to pay for a student's
tuition and fees. The maximum contribution to an education IRA in 2004
is $2000 per beneficiary. The maximum contribution is phased down
ratably for taxpayers with modified AGI between $190,000 and $220,000
($95,000 and $110,000 for singles).
83. Student-loan interest.--Taxpayers may claim an above-the-line
deduction of up to $2,500 on interest paid on an education loan.
Interest may only be deducted for the first five years in which interest
payments are required. In 2004, the maximum deduction is phased down
ratably for taxpayers with modified AGI between $100,000 and $130,000
($50,000 and $65,000 for singles), indexed.
84. State prepaid tuition plans.--Some States have adopted prepaid
tuition plans and prepaid room and board plans, which allow persons to
pay in advance for college expenses for designated beneficiaries. In
2001 taxes on the earnings from these plans are paid by the
beneficiaries and are deferred until tuition is actually paid. Beginning
in 2002, investment income is not taxed when earned, and is tax-exempt
when withdrawn to pay for qualified expenses.
85. Student-loan bonds.--Interest earned on State and local bonds
issued to finance student loans is tax-exempt. The volume of all such
private activity bonds that each State may issue annually is limited.
86. Bonds for private nonprofit educational institutions.--Interest
earned on State and local Government bonds issued to finance the
construction of facilities used by private nonprofit educational
institutions is not taxed.
87. Credit for holders of zone academy bonds.--Financial institutions
that own zone academy bonds receive a non-refundable tax credit (at a
rate set by the Treasury Department) rather than interest. The credit is
included in gross income. Proceeds from zone academy bonds may only be
used to renovate, but not construct, qualifying schools and for certain
other school purposes. The total amount of zone academy bonds that may
be issued is limited to $1.6 billion--$400 million in each year from
1998 to 2005.
88. U.S. savings bonds for education.--Interest earned on U.S. savings
bonds issued after December 31, 1989 is tax-exempt if the bonds are
transferred to an educational institution to pay for educational
expenses. The tax exemption is phased out for taxpayers with AGI between
$89,750 and $119.750 ($59,850 and $74,850 for singles) in 2004.
89. Dependent students age 19 or older.--Taxpayers may claim personal
exemptions for dependent children age 19 or over who (1) receive
parental support payments of $1,000 or more per year, (2) are full-time
students, and (3) do not claim a personal exemption on their own tax
returns.
90. Charitable contributions to educational institutions.--Taxpayers
may deduct contributions to nonprofit educational institutions.
Taxpayers who donate capital assets to educational institutions can
deduct the asset's current value without being taxed on any appreciation
in value. An individual's total charitable contribution generally may
not exceed 50 percent of adjusted gross income; a corporation's total
charitable contributions generally may not exceed 10 percent of pre-tax
income.
91. Employer-provided educational assistance.--Employer-provided
educational assistance is excluded from an employee's gross income even
though the employer's costs for this assistance are a deductible
business expense. EGTRRA permanently extended this exclusion and
extended the exclusion to also include graduate education (beginning in
2002).
92. Special deduction for teacher expenses.--Educators in both public
and private elementary and secondary schools, who work at least 900
hours during a school year as a teacher, instructor, counselor,
principal or aide, may subtract up to $250 of qualified expenses when
figuring their adjusted gross income (AGI).
93. Discharge of student loan indebtedness.--Certain professionals who
perform in underserved areas, and as a consequence get their student
loans discharged, may not recognize such discharge as income. This
provision was expanded by the AJCA to include health professionals.
94. Work opportunity tax credit.--Employers can claim a tax credit for
qualified wages paid to individuals who begin work on or before December
31, 2005 and who are certified as members of various targeted groups.
The amount of the credit that can be claimed is 25 percent for
employment of less than 400 hours and 40 percent for employment of 400
hours or more. The maximum credit per employee is $2,400 and can only be
claimed on the first year of wages an individual earns from an employer.
Employers must reduce their deduction for wages paid by the amount of
the credit claimed.
95. Welfare-to-work tax credit.--An employer is eligible for a tax
credit on the first $20,000 of eligible wages paid to qualified long-
term family assistance recipients during the first two years of
employment. The credit is 35 percent of the first $10,000 of wages in
the first year of employment and 50 percent of the first $10,000 of
wages in the second year of employment. The maximum credit is $8,500 per
employee. The credit applies to wages paid to employees who are hired on
or before December 31, 2005.
96. Employer-provided child care exclusion.--Up to $5,000 of employer-
provided child care is excluded from an employee's gross income even
though the em

[[Page 343]]

ployer's costs for the child care are a deductible business expense.
97. Employer-provided child care credit.--Employers can deduct
expenses for supporting child care or child care resource and referral
services. EGTRRA provides a tax credit to employers for qualified
expenses beginning in 2002. The credit is equal to 25 percent of
qualified expenses for employee child care and 10 percent of qualified
expenses for child care resource and referral services. Employer
deductions for such expenses are reduced by the amount of the credit.
The maximum total credit is limited to $150,000 per taxable year.
98. Assistance for adopted foster children.--Taxpayers who adopt
eligible children from the public foster care system can receive monthly
payments for the children's significant and varied needs and a
reimbursement of up to $2,000 for nonrecurring adoption expenses. These
payments are excluded from gross income.
99. Adoption credit and exclusion.--Taxpayers can receive a
nonrefundable tax credit for qualified adoption expenses. The maximum
credit is $10,390 per child for 2004, and is phased-out ratably for
taxpayers with modified AGI between $155,860 and $195,860. The credit
amounts and the phase-out thresholds are indexed for inflation beginning
in 2003. Unused credits may be carried forward and used during the five
subsequent years. Taxpayers may also exclude qualified adoption expenses
from income, subject to the same maximum amounts and phase-out as the
credit. The same expenses cannot qualify for tax benefits under both
programs; however, a taxpayer may use the benefits of the exclusion and
the tax credit for different expenses. Stepchild adoptions are not
eligible for either benefit.
100. Employer-provided meals and lodging.--Employer-provided meals and
lodging are excluded from an employee's gross income even though the
employer's costs for these items are a deductible business expense.
101. Child credit.--Taxpayers with children under age 17 can qualify
for a $1,000 refundable per child credit. The maximum credit declines to
$500 in 2011 and later years. The credit is phased out for taxpayers at
the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 for
singles).
102. Child and dependent care expenses.--Married couples with child
and dependent care expenses may claim a tax credit when one spouse works
full time and the other works at least part time or goes to school. The
credit may also be claimed by single parents and by divorced or
separated parents who have custody of children. Expenditures up to a
maximum $3,000 for one dependent and $6,000 for two or more dependents
are eligible for the credit. The credit is equal to 35 percent of
qualified expenditures for taxpayers with incomes of $15,000. The credit
is reduced to a minimum of 20 percent by one percentage point for each
$2,000 of income in excess of $15,000.
103. Disabled access expenditure credit.--Small businesses (less than
$1 million in gross receipts or fewer than 31 full-time employees) can
claim a 50-percent credit for expenditures in excess of $250 to remove
access barriers for disabled persons. The credit is limited to $5,000.
104. Charitable contributions, other than education and health.--
Taxpayers may deduct contributions to charitable, religious, and certain
other nonprofit organizations. Taxpayers who donate capital assets to
charitable organizations can deduct the assets' current value without
being taxed on any appreciation in value. An individual's total
charitable contribution generally may not exceed 50 percent of adjusted
gross income; a corporation's total charitable contributions generally
may not exceed 10 percent of pre-tax income.
105. Foster care payments.--Foster parents provide a home and care for
children who are wards of the State, under contract with the State.
Compensation received for this service is excluded from the gross
incomes of foster parents; the expenses they incur are nondeductible.
106. Parsonage allowances.--The value of a minister's housing
allowance and the rental value of parsonages are not included in a
minister's taxable income.

Health

107. Employer-paid medical insurance and expenses.--Employer-paid
health insurance premiums and other medical expenses (including long-
term care) are deducted as a business expense by employers, but they are
not included in employee gross income. The self-employed also may deduct
part of their family health insurance premiums.
108. Self-employed medical insurance premiums.--Self-employed
taxpayers may deduct a percentage of their family health insurance
premiums. Taxpayers without self-employment income are not eligible for
the special percentage deduction. The deductible percentage is 60
percent in 2001, 70 percent in 2002, and 100 percent in 2003 and
thereafter.
109. Medical and health savings accounts.--Some employees may deduct
annual contributions to a medical savings account (MSA); employer
contributions to MSAs (except those made through cafeteria plans) for
qualified employees are also excluded from income. An employee may
contribute to an MSA in a given year only if the employer does not
contribute to the MSA in that year. MSAs are only available to self-
employed individuals or employees covered under an 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, Improvement,

[[Page 344]]

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-deductible health plan is less restrictive for HSAs
than for MSAs.
110. Medical care expenses.--Personal expenditures for medical care
(including the costs of prescription drugs) exceeding 7.5 percent of the
taxpayer's adjusted gross income are deductible.
111. Hospital construction bonds.--Interest earned on State and local
government debt issued to finance hospital construction is excluded from
income subject to tax.
112. Charitable contributions to health institutions.--Individuals and
corporations may deduct contributions to nonprofit health institutions.
Tax expenditures resulting from the deductibility of contributions to
other charitable institutions are listed under the education, training,
employment, and social services function.
113. Orphan drugs.--Drug firms can claim a tax credit of 50 percent of
the costs for clinical testing required by the Food and Drug
Administration for drugs that treat rare physical conditions or rare
diseases.
114. Blue Cross and Blue Shield.--Blue Cross and Blue Shield health
insurance providers in existence on August 16, 1986 and certain other
nonprofit health insurers are provided exceptions from otherwise
applicable insurance company income tax accounting rules that
substantially reduce (or even eliminate) their tax liabilities.
115. Tax credit for health insurance purchased by certain displaced
and retired individuals.--The Trade Act of 2002 provided a refundable
tax credit of 65 percent for the purchase of health insurance coverage
by individuals eligible for Trade Adjustment Assistance and certain PBGC
pension recipients.

Income Security

116. Railroad retirement benefits.--Railroad retirement benefits are
not generally subject to the income tax unless the recipient's gross
income reaches a certain threshold. The threshold is discussed more
fully under the Social Security function.
117. Workers' compensation benefits.--Workers compensation provides
payments to disabled workers. These benefits, although income to the
recipients, are not subject to the income tax.
118. Public assistance benefits.--Public assistance benefits are
excluded from tax. The normal tax method considers cash transfers from
the Government as taxable and, thus, treats the exclusion for public
assistance benefits as a tax expenditure.
119. Special benefits for disabled coal miners.--Disability payments
to former coal miners out of the Black Lung Trust Fund, although income
to the recipient, are not subject to the income tax.
120. Military disability pensions.--Most of the military pension
income received by current disabled retired veterans is excluded from
their income subject to tax.
121. Employer-provided pension contributions and earnings.--Certain
employer contributions to pension plans are excluded from an employee's
gross income even though the employer can deduct the contributions. In
addition, the tax on the investment income earned by the pension plans
is deferred until the money is withdrawn.
122. 401(k) plans.--Individual taxpayers can make tax-preferred
contributions to certain types of employer-provided 401(k) plans (and
401(k)-type plans like 403(b) plans and the Federal government's Thrift
Savings Plan). In 2004, an employee could exclude up to $14,000 of wages
from AGI under a qualified arrangement with an employer's 401(k) plan.
This increases to $14,000 in 2005 and $15,000 in 2006 (indexed
thereafter). The tax on the investment income earned by 401(k)-type
plans is deferred until withdrawn.
Employees are allowed to make after-tax contributions to 401(k) and
401(k)-type plans. These contributions are not excluded from AGI, but
the investment income of such after-tax contributions is not taxed when
earned or withdrawn.
123. Individual Retirement Accounts.--Individual taxpayers can take
advantage of several different Individual Retirement Accounts (IRAs):
deductible IRAs, non-deductible IRAs, and Roth IRAs. The annual
contributions limit applies to the total of a taxpayer's deductible,
non-deductible, and Roth IRAs contributions. The IRA contribution limit
is $3,000 in 2004, $4,000 in 2005, and $5,000 in 2008 (indexed
thereafter) and allows taxpayers over age 50 to make additional ``catch-
up'' contributions of $1,000 (by 2006).
Taxpayers whose AGI is below $75,000 ($55,000 for non-joint filers) in
2004 can claim a deduction for IRA contributions. The IRA deduction is
phased out for taxpayers with AGI between $65,000 and $75,000 ($45,000
and $55,000 for non-joint). The phase-out range increases annually until
it reaches $80,000 to $100,000 in 2007 ($50,000 to $60,000 in 2005 for
non-joint filers). Taxpayers whose AGI is above the phase-out range can
also claim a deduction for their IRA contributions depending on whether
they (or their spouse) are an active participant in an employer-provided
retirement plan. The tax on the investment income earned by 401(k)
plans, non-deductible IRAs, and deductible IRAs is deferred until the
money is withdrawn.
Taxpayers with incomes below $160,000 ($110,000 for nonjoint filers)
can make contributions to Roth IRAs. The maximum contribution to a Roth
IRA is phased out for taxpayers with AGI between $150,000 and $160,000
($95,000 and $110,000 for singles). Investment income of a Roth IRA is
not taxed when earned nor when withdrawn. Withdrawals from a Roth IRA
are penalty free if: (1) the Roth IRA was opened at least 5 years before
the withdrawal, and (2) the taxpayer either (a) is at least 591/2, (b)
dies, (c) is disabled, or (d) purchases a first-time house.

[[Page 345]]

Taxpayers can contribute to a non-deductible IRA regardless of their
income and whether they are an active participant in an employer-
provided retirement plan. The tax on investment income earned by non-
deductible IRAs is deferred until the money is withdrawn.
124. Low and moderate income savers' credit.--The Tax Code provides an
additional incentive for lower-income taxpayers to save through a
nonrefundable credit of up to 50 percent on IRA and other retirement
contributions of up to $2,000. This credit is in addition to any
deduction or exclusion. The credit is completely phased out by $50,000
for joint filers and $25,000 for single filers. This temporary credit is
in effect from 2002 through 2006.
125. Keogh plans.--Self-employed individuals can make deductible
contributions to their own retirement (Keogh) plans equal to 25 percent
of their income, up to a maximum of $40,000 in 2001. Total plan
contributions are limited to 25 percent of a firm's total wages. The tax
on the investment income earned by Keogh plans is deferred until
withdrawn.
126. Employer-provided life insurance benefits.--Employer-provided
life insurance benefits are excluded from an employee's gross income
even though the employer's costs for the insurance are a deductible
business expense, but only to the extent that the employer's share of
the total costs does not exceed the cost of $50,000 of such insurance.
127. Small business retirement plan credit.--EGTRRA provides
businesses with 100 or fewer employees a credit for 50 percent of the
qualified startup costs associated with a new qualified retirement plan.
The credit is limited to $500 annually and may only be claimed for
expenses incurred during the first three years from the start of the
qualified plan. Qualified startup expenses include expenses related to
the establishment and administration of the plan, and the retirement-
related education of employees. The credit applies to costs incurred
beginning in 2002.
128. Employer-provided accident and disability benefits.--Employer-
provided accident and disability benefits are excluded from an
employee's gross income even though the employer's costs for the
benefits are a deductible business expense.
129. Employer-provided supplementary unemployment benefits.--Employers
may establish trusts to pay supplemental unemployment benefits to
employees separated from employment. Interest payments to such trusts
are exempt from taxation.
130. Employer Stock Ownership Plan (ESOP) provisions.--ESOPs are a
special type of tax-exempt employee benefit plan. Employer-paid
contributions (the value of stock issued to the ESOP) are deductible by
the employer as part of employee compensation costs. They are not
included in the employees' gross income for tax purposes, however, until
they are paid out as benefits. The following special income tax
provisions for ESOPs are intended to increase ownership of corporations
by their employees: (1) annual employer contributions are subject to
less restrictive limitations; (2) ESOPs may borrow to purchase employer
stock, guaranteed by their agreement with the employer that the debt
will be serviced by his payment (deductible by him) of a portion of
wages (excludable by the employees) to service the loan; (3) employees
who sell appreciated company stock to the ESOP may defer any taxes due
until they withdraw benefits; and (4) dividends paid to ESOP-held stock
are deductible by the employer.
131. Additional deduction for the blind.--Taxpayers who are blind may
take an additional $1,200 standard deduction if single, or $950 if
married in 2004.
132. Additional deduction for the elderly.--Taxpayers who are 65 years
or older may take an additional $1,200 standard deduction if single, or
$950 if married in 2004.
133. Tax credit for the elderly and disabled.--Individuals who are 65
years of age or older, or who are permanently disabled, can take a tax
credit equal to 15 percent of the sum of their earned and retirement
income. Income is limited to no more than $5,000 for single individuals
or married couples filing a joint return where only one spouse is 65
years of age or older, and up to $7,500 for joint returns where both
spouses are 65 years of age or older. These limits are reduced by one-
half of the taxpayer's adjusted gross income over $7,500 for single
individuals and $10,000 for married couples filing a joint return.
134. Casualty losses.--Neither the purchase of property nor insurance
premiums to protect its value are deductible as costs of earning income;
therefore, reimbursement for insured loss of such property is not
reportable as a part of gross income. Taxpayers, however, may deduct
uninsured casualty and theft losses of more than $100 each, but only to
the extent that total losses during the year exceed 10 percent of AGI.
135. Earned income tax credit (EITC).--The EITC may be claimed by low
income workers. For a family with one qualifying child, the credit is 34
percent of the first $7,660 of earned income in 2004. The credit is 40
percent of the first $10,750 of income for a family with two or more
qualifying children. The credit is phased out beginning when the
taxpayer's income exceeds $14,040 at the rate of 15.98 percent (21.06
percent if two or more qualifying children are present). It is
completely phased out when the taxpayer's modified adjusted gross income
reaches $30,338 ($34,458 if two or more qualifying children are
present), $31,338 (or $35,458) for those married.
The credit may also be claimed by workers who do not have children
living with them. Qualifying workers must be at least age 25 and may not
be claimed as a dependent on another taxpayer's return. The credit is
not available to workers age 65 or older. In 2004, the credit is 7.65
percent of the first $5,100 of earned income. When the taxpayer's income
exceeds $6,390 (7,390 if married), the credit is phased out at the rate
of 7.65 percent. It is completely phased out at $11,490 ($12,490 for
married) of modified adjusted gross income.

[[Page 346]]

For workers with or without children, the income levels at which the
credit begins to phase-out and the maximum amounts of income on which
the credit can be taken are adjusted for inflation. For married
taxpayers filing a joint return, the base amount for the phase-out
increases by $2,000 in 2005 through 2007, and $3,000 in 2008 (indexed
thereafter).
Earned income tax credits in excess of tax liabilities owed through
the individual income tax system are refundable to individuals. This
portion of the credit is shown as an outlay, while the amount that
offsets tax liabilities is shown as a tax expenditure.

Social Security

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

Veterans Benefits and Services

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

General Government

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

Interest

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

Appendix:

TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION

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

[[Page 347]]

DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON
COMPREHENSIVE INCOME

As discussed in the main body of the tax expenditure chapter, official
tax expenditures are measured relative to normal law or reference law
baselines that deviate from a uniform tax on a comprehensive concept of
income. Consequently, tax expenditures identified in the budget can
differ from those that would be identified if a comprehensive income tax
were chosen as the baseline tax system. This appendix addresses this
issue by comparing major tax expenditures listed in the current tax
expenditure budget with those implied by a comprehensive income
baseline. Many large tax expenditures would continue to be tax
expenditures were the baseline taken to be comprehensive income,
although some would be smaller. A comprehensive income baseline would
also result in a number of additional tax provisions being counted as
tax expenditures.
Current budgetary practice excludes from the list of official tax
expenditures those provisions that over-tax certain items of income.
This exclusion conforms to the view that tax expenditures are
substitutes for direct Government spending programs. However, this
treatment gives a one-sided picture of how current law deviates from the
baseline tax system. Relative to comprehensive income, a number of
current tax provisions would be negative tax expenditures. Some of these
also might be negative tax expenditures under the reference law or
normal law baselines, expanded to admit negative tax expenditures.

Treatment of Major Tax Expenditures from the Current Budget under a
Comprehensive Income Tax Baseline

Comprehensive income, also called Haig-Simons income, is the real,
inflation adjusted, accretion to one's economic power arising between
two points in time, e.g., the beginning and ending of the year. It
includes all accretions to wealth, whether or not realized, whether or
not related to a market transaction, and whether a return to capital or
labor. Inflation adjusted capital gains (and losses) would be included
in comprehensive income as they accrue. Business, investment, and
casualty losses, including losses caused by depreciation, would be
deducted. Implicit returns, such as those accruing to homeowners, also
would be included in comprehensive income. A comprehensive income tax
baseline would tax all sources of income once. Thus, it would not
include a separate tax on corporate income that leads to the double
taxation of corporate profits.
While comprehensive income can be defined on the sources side of the
consumer's balance sheet, it sometimes is instructive to use the
identity between the sources of wealth and the uses of wealth to
redefine it as the sum of consumption during the period plus the change
in net worth between the beginning and the end of the period.
Comprehensive income is widely held to be the idealized base for an
income tax even though it is not a perfectly defined concept. \6\ It
suffers from conceptual ambiguities, some of which are discussed below,
as well as practical problems in measurement and tax administration,
e.g., how to implement a practicable deduction for economic depreciation
or include in income the return earned on consumer durable goods,
including housing, automobiles, and major appliances.
---------------------------------------------------------------------------
\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 individual tax provisions relative to a comprehensive
income baseline is difficult, in part because of the ambiguity of the
baseline. It also is difficult because of interactions between tax
provisions (or their absence). These interactions mean that it may not
always be appropriate to consider each provision in isolation.
Nonetheless, Appendix Table 1 attempts such a classification for each of
the thirty largest tax expenditures from the Budget.
We classify fifteen of the thirty items as tax expenditures under a
comprehensive tax base (those in panel A). Most of these give
preferential tax treatment to the return on certain types of savings or
investment. They are a result of the explicitly hybrid nature of the
existing tax system, and arise out of policy decisions that reflect
discomfort with the high tax rate on capital income that would otherwise
arise under the current structure of the income tax. Even these
relatively clear cut items, however, can raise ambiguities particularly
in light of the absence of integration of the corporate and individual
tax systems. Given current law's corporate income tax, the reduction or
elimination of individual level tax on income from investment in
corporate equities might not be a tax expenditure relative to a
comprehensive income baseline. Rather, an individual income tax
preference might undo the corporate tax penalty (i.e., the double tax).
This perspective is reflected in adjustments that have been made to the
calculation of the tax expenditures for pensions and several other items
in the 2006 budget (as discussed above). However, these adjustments have
not been made in all tax expenditure calculations, e.g., no adjustment
was made in the exclusion of interest on life insurance saving. A
similar line of reasoning could be used to argue that in the case of
corporations, expens

[[Page 348]]

ing \7\ of R&E is not a tax expenditure because it serves to offset the
corporate tax penalty.
---------------------------------------------------------------------------
\7\ Expensing means immediate deduction. Proper income tax treatment
requires capitalization followed by annual depreciation allowances
reflecting the decay in value of the associated R&E spending.
---------------------------------------------------------------------------
In contrast to treatment in previous budgets, the 2006 budget includes
as a tax expenditure the failure to tax net rental income from owner-
occupied housing. Because net rental income (gross rents minus
depreciation, interest, taxes, and other expenses) would be in the
homeowner's tax base under a comprehensive income tax baseline, this
item would be a tax expenditure relative to a comprehensive income
baseline.
The exclusion of worker's compensation benefits also would be a tax
expenditure under comprehensive income principles. Under comprehensive
income tax principles, if the worker were to buy the insurance himself,
he would be able to deduct the premium (since it represents a reduction
in net worth) but should include in income the benefit when paid (since
it represents an increase in net worth). \8\ If the employer pays the
premium, the proper treatment would allow the employer a deduction and
allow the employee to disregard the premium, but he would take the
proceeds, if any, into income. Current law allows the employer to deduct
the premium and excludes both the premium and the benefits from the
employee's tax base.
---------------------------------------------------------------------------
\8\ 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.
---------------------------------------------------------------------------
Veteran's death and disability benefits seem likely to represent a tax
expenditure. This is clearly the case to the extent they are seen as
deferred wages or as transfers. It also is the case to the extent that
they are seen as insurance benefits, since the premiums, which come in
the form of foregone wages, were not included in taxable income. \9\
---------------------------------------------------------------------------
\9\ The treatment of insurance premiums and benefits is discussed more
completely below.
---------------------------------------------------------------------------
Panel B deals with items that probably are tax expenditures, but that
raise issues. Current law allows deductions for home mortgage interest
and for property taxes on owner-occupied housing. The tax expenditure
budget includes both of these deductions. From one perspective, these
two deductions would not be considered tax expenditures relative to a
comprehensive tax base; a comprehensive base would allow both
deductions. However, this perspective ignores current law's failure to
impute gross rental income. Conditional on this failure, the deductions
for interest and property taxes might be viewed as inappropriate,
because they move the tax system away from rather than towards a
comprehensive income tax base. \10\ Indeed, the sum of the tax
expenditure for these two deductions, plus the tax expenditure for the
failure to include net rental income, sums to the tax expenditure for
owner-occupied housing relative to a comprehensive income tax base.
Consequently, there is a strong argument for classifying them as tax
expenditures relative to a comprehensive income baseline.
---------------------------------------------------------------------------
\10\ If there were no deduction for interest and property taxes, the
tax expenditure base (i.e., the proper tax base minus the actual tax
base) for owner-occupied housing would equal the homeowner's net rental
income: gross rents--(depreciation+interest+property taxes+other
expenses). With the deduction for interest and property taxes, the tax
expenditure base rises to gross rents minus (depreciation+other
expenses).
---------------------------------------------------------------------------
The deduction of nonbusiness State and local taxes other than on
owner-occupied homes also is included in this section. These taxes
include income, sales, and property taxes. The stated justification for
this tax expenditure is that ``Taxpayers may deduct State and local
income taxes and property taxes even though these taxes primarily pay
for services that, if purchased directly by taxpayers, would not be
deductible. \11\ The idea is that these taxes represent (or serve as
proxies for) consumption expenditures for which current law makes no
imputations to income. \12\
---------------------------------------------------------------------------
\11\ Fiscal Year 2003 Budget of the United States Government,
Analytical Perspectives (Washington, D.C.: U.S. Government Printing
Office, 2002) p. 127.
\12\ Property taxes on owner-occupied housing also might serve as a
proxy for the value of untaxed local services provided to homeowners. As
such, they would be listed in the tax expenditure budget (as configured,
i.e., building on the estimate for the failure to tax net rents) twice,
once because current law does not tax rental income and again as a proxy
for government services received. Property taxes on other consumer
durables such as automobiles also might be included twice, owing to
current law's exclusion from income of the associated service flow.
---------------------------------------------------------------------------
In contrast to the view in the official Budget, however, the deduction
for State and local taxes might not be a tax expenditure if the baseline
were comprehensive income. Properly measured comprehensive income would
include the value of State and local government benefits received, but
would allow a deduction for State and local taxes paid. \13\ Thus, in
this sense the deductibility of State and local taxes is consistent with
comprehensive income tax principles; it should not be a tax expenditure.
Nonetheless, imputing the value of State and local services is difficult
and is not done under current law. Consequently, a deduction for taxes
might sensibly be viewed as a tax expenditure relative to a
comprehensive income baseline. \14\
---------------------------------------------------------------------------
\13\ U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.:
U.S. Government Printing Office, 1977) p. 92.
\14\ Under the normal tax method employed by the Joint Committee on
Taxation, the value of some public assistance benefits provided by State
Governments is included as a tax expenditure, thereby raising a
potential double counting issue.
---------------------------------------------------------------------------
To the extent that the personal and dependent care exemptions and the
standard deduction properly remove from taxable income all expenditures
that do not yield suitably discretionary consumption value, or otherwise
appropriately adjust for differing taxpaying capacity, then the child
care credit and the earned income tax credit would be tax expenditures.
In contrast, a competing perspective views these credits as appropriate
modifications that account for differing taxpaying capacity. Even
accepting this competing perspective, however, one might question why
these programs come in the form of credits rather than deductions.
The step-up of basis at death lowers the income tax on capital gains
for those who inherit assets below what it would be otherwise. From that
perspective it would be a tax expenditure under a comprehensive income
baseline. Nonetheless, there are ambiguities. Under a comprehensive
income baseline, all real inflation adjusted gains would be taxed as
accrued, so there would be no deferred unrealized gains on assets held
at death.
The lack of full taxation of Social Security benefits also is listed
in panel B. Consider first Social Security retirement benefits. To the
extent that Social Security

[[Page 349]]

is viewed as a pension, a comprehensive income tax would include in
income all contributions to Social Security retirement funds (payroll
taxes) and tax accretions to value as they arise (inside build-up). \15\
Benefits paid out of prior contributions and the inside 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.
---------------------------------------------------------------------------
\15\ As a practical matter, this may be impossible to do. Valuing
claims subject to future contingencies is very difficult, as discussed
in Bradford, Untangling the Income Tax, pp. 23-24.
---------------------------------------------------------------------------
A similar analysis applies to Social Security benefits paid to
dependents and survivors. If these benefits represent transfers from the
Government, then they should be included in the tax base. If the
taxpaying unit consists of the worker plus dependents and survivors,
then to the extent that Social Security benefits represent payments from
a pension, the annual pension earnings should be taxed in the same way
that earnings accruing to retirees are taxed. However, benefits paid to
dependents and survivors might be viewed as a gift or transfer from the
decedent, in which case the dependents and survivors should pay tax on
the full amount of the benefit received. (In this case the decedent or
his estate should pay tax on the pension income as well, to the extent
that the gift represents consumption rather than a reduction in net
worth).
In addition, dependent and survivors benefits might be viewed in part
as providing life insurance. In that case, the annual premiums paid each
year, or the portion of Social Security taxes attributable to the
premiums, should be deducted from income, since they represent a decline
in net worth, while benefits should be included in income.
Alternatively, taxing premiums and excluding benefits also would
represent appropriate income tax policy.
In contrast to any of these treatments, current law excludes one-half
of Social Security contributions (employer-paid payroll taxes) from the
base of the income tax, makes no attempt to tax accretions, and subjects
some, but not all, benefits to taxation. The difference between current
law's treatment of Social Security benefits and their treatment under a
comprehensive income tax would qualify as a tax expenditure, but such a
tax expenditure differs in concept from that included in the official
budget.
The tax expenditures in the official budget \16\ reflect exemptions
for lower income beneficiaries from the tax on 85 percent of Social
Security benefits. \17\ Historically, payroll taxes paid by the employee
represented no more than 15 percent of the expected value of the
retirement benefits received by a lower-earnings Social Security
beneficiary. The 85 percent inclusion rate is intended to tax upon
distribution the remaining amount of the retirement benefit payment--the
portion arising from the payroll tax contributions made by employers and
the implicit return on the employee and employer contributions. Thus,
the tax expenditure conceived and measured in the current budget is not
intended to capture the deviation from a comprehensive income baseline,
which would additionally account for the deferral of tax on the
employer's contributions and on the rate of return (less an inflation
adjustment attributable to the employee's payroll tax contributions).
Rather, it is intended to approximate the taxation of private pensions
with employee contributions made from after-tax income, \18\ on the
assumption that Social Security is comparable to such pensions. Hence,
the official tax expenditure understates the tax advantage accorded
Social Security retirement benefits relative to a comprehensive income
baseline.
---------------------------------------------------------------------------
\16\ 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.
\17\ 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.
\18\ 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.
The deduction for U.S. production activities also raises some
problems. To the extent it is viewed as a tax break for certain
qualifying businesses (``manufacturers''), it would be a tax
expenditure. In contrast, the deduction may prove to be so broad that it
is available to most U.S. businesses, in which case it might not be seen
as a tax expenditure. Rather, it would represent a feature of the
baseline tax rate system, because the deduction is equivalent to a lower
tax rate. In addition, to the extent that it is viewed as providing
relief from the double tax on corporate profits, it might not be a tax
expenditure.
The next category (panel C) includes items whose treatment is less
certain. The proper treatment of some of these items under a
comprehensive income tax is ambiguous, while others perhaps serve as
proxies for what would be a tax expenditure under a comprehensive income
base. \19\ Consider, for example, the items relating to charitable
contributions. Under existing law, charitable contributions are
deductible, and this deduction is considered on its face a tax
expenditure in the current budget. \20\
---------------------------------------------------------------------------
\19\ See, for example, Goode, The Economic Definition of Income, pp.
16-17, and Bradford, Untangling the Income Tax, pp. 19-21, and pp.30-31.
\20\ The item also includes gifts of appreciated property, at least
part of which represents a tax expenditure relative to an ideal income
tax, even if one assumes that charitable donations are not consumption.
---------------------------------------------------------------------------
The treatment of charitable donations, however, is ambiguous under a
comprehensive income tax. If charitable contributions are a consumption
item for the giver, then they are properly included in his taxable
income; a deduction for contributions would then be a tax expenditure
relative to a comprehensive income tax baseline. In contrast, charitable
contributions could represent a transfer of purchasing power from the
giver

[[Page 350]]

to the receiver. As such, they would represent a reduction in the
giver's net worth, not an item of consumption, and so properly would be
deductible, implying that current law's treatment is not a tax
expenditure. At the same time, however, the value of the charitable
benefits received is income to the recipient. Under current law, such
income generally is not taxed, and so represents a tax expenditure whose
size might be approximated by the size of the donor's contribution. \21\
---------------------------------------------------------------------------
\21\ If recipients tend to be in lower tax brackets, then the tax
expenditure is smaller than when measured at the donor's tax rates.
---------------------------------------------------------------------------
Medical expenditures may or may not be an element of income (or
consumption). Some argue that medical expenditures don't represent
discretionary spending, and so aren't really consumption. Instead, they
are a reduction of net worth and should be excluded from the tax base.
In contrast, others argue that there is no way to logically distinguish
medical care from other consumption items. Those who view medical
spending as consumption point out that there is choice in many health
care decisions, e.g., whether to go to the best doctor, whether to have
voluntary surgical procedures, and whether to exercise and eat
nutritiously so as to improve and maintain one's health and minimize
medical expenditures. This element of choice makes it more difficult to
argue, at least in many cases, that medical spending is more
``necessary'' than, or otherwise different from, other consumption
spending.
The exemption of full taxation of Social Security benefits paid to the
disabled also raises some issues. Social Security benefits for the
disabled most closely resemble either Government transfers or insurance.
A comprehensive income tax would require the worker to include the
benefit fully in his income and would allow him to deduct associated
Social Security taxes. If viewed as insurance, he also could include the
premium (i.e., tax) and exclude the benefit. The deviation between such
treatment and current law's treatment (described above) would be a tax
expenditure under a comprehensive income baseline.
In contrast, as described above, the official tax expenditure measures
the benefit of exemption for low income beneficiaries from the tax on 85
percent of Social Security benefits. This measurement does not
correspond closely to that required under a comprehensive income base.
If the payment of the benefit is viewed as a transfer and divorced from
the treatment of Social Security taxes, then the current tax expenditure
understates the tax expenditure measured relative to a comprehensive
income baseline. If the payment of the benefit is viewed as a transfer
but the inability to deduct the employee's share of the Social Security
tax is simultaneously considered, then it is less likely that the
current tax expenditure overstates the tax expenditure relative to a
comprehensive income baseline, and in some cases it may generate a
negative tax expenditure. If the benefit is viewed as insurance and the
tax as a premium, then the current tax expenditure overstates the tax
expenditure relative to a comprehensive income baseline. Indeed, in the
insurance model, the ability to exclude from tax only \1/2\ of the
premium might suggest that \1/2\ of the payout should be taxed, so that
the current tax rules impose a greater tax burden than that implied by a
comprehensive income tax, i.e., a negative tax expenditure. \22\
---------------------------------------------------------------------------
\22\ In contrast, the passive loss rules themselves, which restrict
the deduction of losses, would be a negative tax expenditure when
compared to a comprehensive tax base.
---------------------------------------------------------------------------
The final category (panel D) includes items that would not be tax
expenditures under a comprehensive income tax base. A tax based on
comprehensive income would allow all losses to be deducted. Hence, the
exception from the passive loss rules would not be a tax expenditure.

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

While most of the major tax expenditures in the current budget also
would be tax expenditures under a comprehensive income base, there also
are tax expenditures relative to a comprehensive income base that are
not found on the existing tax expenditure list. These additional tax
expenditures include the imputed return from certain consumer durables
(e.g., automobiles), the imputed return to consumption of financial
services (e.g., checking account services received in kind and paid for
by accepting a below market interest rate on deposits), the difference
between capital gains (and losses) as they accrue and capital gains as
they are realized, private gifts and inheritances received, in-kind
benefits from such Government programs as food-stamps, Medicaid, and
public housing, the value of payouts from insurance policies, \23\ and
benefits received from private charities. Under some ideas of
comprehensive income, the value of leisure and of household production
of goods and services also would be included as tax expenditures. The
personal exemption and standard deduction also might be considered tax
expenditures, although they can be viewed differently, e.g., as elements
of the basic tax rate schedule. The foreign tax credit also might be a
tax expenditure, since a deduction for foreign taxes, rather than a
credit, would seem to measure the income of U.S. residents properly.
---------------------------------------------------------------------------
\23\ 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

[[Page 351]]

tax on corporate profits, which would be eliminated under a
comprehensive income tax. The Jobs and Growth Tax Relief and
Reconciliation Act of 2003 (JGTRRA) reduced the tax rate on dividends
and capital gains to 15 percent, thus reducing the double tax compared
to prior law. Nonetheless, as discussed later in the Appendix, current
law still imposes a substantial double tax on corporate profits. The
passive loss rules, restrictions on the deductibility of capital losses,
and NOL carry-forward requirements each would generate a negative tax
expenditure, since a comprehensive income tax would allow full
deductibility of losses. If human capital were considered an asset, then
its cost (e.g., certain education and training expenses, including
perhaps the cost of college and professional school) should be
amortizable, but it is not under current law. \24\ Some restricted
deductions under the individual AMT might be negative tax expenditures
as might the phase-out of personal exemptions and of itemized
deductions. The inability to deduct consumer interest also might be a
negative tax expenditure, as an interest deduction may be required to
properly measure income, as seen by the equivalence between borrowing
and reduced lending. \25\ As discussed above, the current treatment of
Social Security payments to the disabled also might represent a negative
tax expenditure, if viewed as payments on an insurance policy.
---------------------------------------------------------------------------
\24\ Current law offers favorable treatment to some education costs,
thereby creating (positive) tax expenditures. Current law allows
expensing of that part of the cost of education and career training that
is related to foregone earnings and this would be a tax expenditure
under a comprehensive income baseline.
\25\ 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. \26\
---------------------------------------------------------------------------
\26\ Accelerated depreciation can be described as the equivalent of an
interest free loan from the Government to the taxpayer. Under federal
budget accounting principles, such a loan would be treated as an outlay
equal to the present value of the foregone interest.
---------------------------------------------------------------------------

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. The classification below suggests that medical
spending and charitable contributions might be included in the
definition of consumption, but also considers an alternative view.
There may be more than one way to treat various items under a
consumption tax. For example, a consumption tax might ignore borrowing
and lending by excluding from the borrower's tax base the proceeds from
loans, denying the borrower a deduction for payments of interest and
principal, and excluding interest and principal payments received from
the lender's tax base. On the other hand, a consumption tax might
include borrowing and lending in the tax base by requiring the borrower
to add the proceeds from loans in his tax base, allowing the lender to
deduct loans from his tax base, allowing the borrower to deduct payments
of principal and interest, and requiring the lender to include receipt
of principal and interest payments. In

[[Page 352]]

present value terms, the two approaches are equivalent for both the
borrower and the lender; in particular both allow the tax base to
measure consumption and both impose a zero effective tax rate on
interest income. But which approach is taken obviously has different
implications (at least on an annual flow basis) for the treatment of
many important items of income and expense, such as the home mortgage
interest deduction. The classification below suggests that the deduction
for home mortgage interest could well be a tax expenditure, but takes
note of alternative views.
Some exclusions of income are equivalent in many respects to
consumption tax treatment that immediately deducts the cost of an
investment while taxing the future cash-flow. For example, exempting
investment income is equivalent to consumption tax treatment as far as
the normal rate of return on new investment is concerned. This is
because expensing generates a tax reduction that offsets in present
value terms the tax paid on the investment's future normal returns.
Expensing gives the income from a marginal investment a zero effective
tax rate. However, a yield exemption approach differs from a consumption
tax as far as the distribution of income and Government revenue is
concerned. Pure profits in excess of the normal rate of return would be
taxed under a consumption tax, because they are an element of cash-flow,
but would not be taxed under a yield exemption tax system. Should
exemption of certain kinds of investment income, and certain investment
tax credits, be regarded as the equivalent of consumption tax treatment?
The classification that follows takes a fairly broad view of this
equivalence and considers many tax provisions that reduce or eliminate
the tax on capital income to be roughly consistent with a broad-based
consumption tax.
Looking at provisions one at a time can be misleading. The hybrid
character of the existing tax system leads to many provisions that might
make good sense in the context of a consumption tax, but that generate
inefficiencies because of the problem of the ``uneven playing field''
when evaluated within the context of the existing tax rules. It is not
clear how these should be classified. For example, many saving
incentives are targeted to specific tax favored sources of capital
income. The inability to save on a similar tax-favored basis
irrespective of the ultimate purpose to which the saving is applied
potentially distorts economic choices in ways that would not occur under
a broad-based consumption tax. As another example, under a consumption
VAT based on the destination principle, there would be a rebate of the
VAT on exports and a tax on imports. Does this mean that the
extraterritorial income exclusion (the successor of the Foreign Sales
Corporation provision) is not a tax expenditure? Resolution comes down
to judgments about how broad is broad enough to be considered general,
or whether it even matters at all that a provision is targeted in some
way. The classification that follows views many savings incentives, even
if targeted, as roughly consistent with a broad based consumption tax.
In addition, provisions can interact even once an appropriate
treatment is determined. For example, suppose that it is determined that
financial flows are out of the tax base. Then the deduction for home
mortgage interest would seem to be a tax expenditure. However, this
conclusion is cast into doubt because current law generally taxes
interest income. When combined with the homeowners' deduction, this
results in a zero tax rate on the interest flow, consistent with
consumption tax treatment.
Capital gains would not be a part of a comprehensive consumption tax
base. Proceeds from asset sales and sometimes borrowing would be part of
the cash-flow tax base, but, for transactions between domestic investors
at a flat tax rate, would cancel out in the economy as a whole. How
should existing tax expenditures related to capital gains be classified?
The classification below generally views available capital gains tax
breaks as consistent with a broad-based consumption tax because they
lower the tax rate on capital income toward the zero rate that is
consistent with a 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 judgments outlined above.

Treatment of Major Tax Expenditures under a Comprehensive Consumption
Baseline

As noted above, the major difference between a comprehensive
consumption tax and a comprehensive income tax is in the treatment of
saving, or in the taxation of capital income. Consequently, many current
tax expenditures related to preferential taxation of capital income
would not be tax expenditures under a consumption tax. However,
preferential treatment of items of income that is unrelated to
moderately broad-based saving or investment incentives would remain tax
expenditures under a consumption baseline. In addition, several official
tax expenditures relating to items of income and expense are difficult
to classify properly, while others may serve as proxies for properly
measured tax expenditures.
Appendix Table 2 shows thirty large official tax expenditures from the
Budget classified according to whether they would be considered a tax
expenditure under a consumption tax. Two of the thirty items clearly
would be a tax expenditure (shown in panel A) under a consumption tax,
while an additional seven (those in panel B) probably would be tax
expenditures.
A consumption tax would include in the homeowners' tax base the value
of the implicit (gross) rental income from owner-occupied housing. Net
rental income is a

[[Page 353]]

component of this, and so would be included as a tax expenditure,
relative to a consumption tax baseline. \27\
---------------------------------------------------------------------------
\27\ Suppose that the rental value of a house is $100 per year, and
that depreciation is $20, interest is $15, property taxes are $10, and
other expenses are $5. Net rental income is $50 (gross rents less all
items of expense). Hence, net rental income is a component of the gross
rent, which is the consumption value of the housing services. Under a
real based cash flow tax, in which financial flows are outside the tax
base, the homeowner's net tax base would be $85: gross rents--(property
taxes + other expenses), assuming that property taxes are viewed as a
reduction in net worth and that he makes no new investment (which would
be deductible).
---------------------------------------------------------------------------
Exclusion of workers' compensation benefits allows an exclusion from
income that is unrelated to investment, and so should be included in the
base of a comprehensive consumption tax.
Consider next the deductibility of home mortgage interest and of
property taxes on owner-occupied housing. Both items would seem to be
strong candidates for inclusion as a tax expenditure, given current
law's failure to impute the consumption value of housing. That is,
focusing on the homeowner's tax base, these deductions move the tax
system away from rather than towards the proper treatment of housing
services. \28\
---------------------------------------------------------------------------
\28\ Using the figures from the example in the previous footnote, the
homeowner would pay tax on gross rents minus property taxes minus other
expenses, or on $85. If property taxes and mortgage interest were not
deducted, then this would be the size of the tax expenditure. However,
current law allows these deductions, which raises the tax expenditure
base to $110.
---------------------------------------------------------------------------
However, with respect to the home mortgage interest deduction, some
ambiguity is introduced by the taxation of interest income to lenders.
In a sense, the homeowner's deduction offsets the lenders inclusion,
leaving (for equal tax rates) no net tax due on the interest flow, as
would be appropriate under a consumption tax. Hence, from the
perspective of the entire tax system, it is less clear that the home
mortgage interest deduction represents a tax expenditure. \29\
---------------------------------------------------------------------------
\29\ One must guard against double counting here, however, to the
extent that current law's general taxation of capital income is
calculated elsewhere in the tax expenditure budget as a negative tax
expenditure.
---------------------------------------------------------------------------
Some ambiguity also is introduced by the variable treatment of
financial flows possible under a consumption tax. That is, the proper
treatment of interest under a consumption tax depends on whether
financial flows are in or out of the consumption tax base. If the loans
are taken into income (as they would be under some types of consumption
taxes), then the associated interest and principal payments should be
deductible, otherwise not.
With respect to property taxes on housing as well as other State and
local taxes, some ambiguity arises because the tax might not represent
consumption--it might be considered a reduction in net worth. Considered
alone, this argument perhaps has some merit. However, there are two
problems with this argument when viewed from the context of the entire
tax system. First, the deduction for property taxes would seem to be
inappropriate when there is no imputation for the associated consumption
value, as discussed above. Second, the current tax system does not
impute the consumption value of State and local services, and tax
payments might serve as a proxy for that value, making their deduction
unnecessary for the proper measurement of consumption.
The official tax expenditures for Social Security benefits reflects
exceptions for low income taxpayers from the general rule that 85
percent of Social Security benefits are included in the recipient's tax
base. The 85 percent inclusion is intended as a simplified mechanism for
taxing Social Security benefits as if the Social Security program were a
private pension with employee contributions made from after-tax income.
Under these tax rules, income earned on contributions made by both
employers and employees benefits from tax deferral, but employer
contributions also benefit because the employee may exclude them from
his taxable income, while the employee's own contributions are included
in his taxable income. These tax rules give the equivalent of
consumption tax treatment, a zero effective tax rate on the return, to
the extent that the original pension contributions are made by the
employer, but give less generous treatment to the extent that the
original contributions are made by the employee. Income earned on
employee contributions is taxed at a low, but positive, effective tax
rate. Based on historical calculations, the 85 percent inclusion
reflects roughly the outcome of applying these tax rules to a lower-
income earner when one-half of the contributions are from the employer
and one-half from the employee.
The current tax expenditure measures a tax benefit relative to a
baseline that is somewhere between a comprehensive income tax and a
consumption tax. The properly measured tax expenditure relative to a
consumption tax baseline would include only those Social Security
benefits that are accorded treatment more favorable than that implied by
a consumption tax, which would correspond to including 50 percent of
Social Security benefits in the recipient's tax base.
A similar analysis would apply to exclusion of Social Security
benefits of dependents and retirees.
There is a strong case for viewing the child credit and the earned
income tax credit as social welfare programs (transfers). As such, they
would be tax expenditures relative to a consumption baseline.
Nonetheless, these credits could alternatively be viewed as relieving
tax on ``nondiscretionary'' consumption, and so not properly considered
a tax expenditure.
The treatment of the items in panels C is less uncertain. Several of
these items relate to the costs of medical care or to charitable
contributions. As discussed in the previous section of the appendix,
there is disagreement within the tax policy community over the extent to
which medical care and charitable giving represent consumption items.
Medical care is widely held to be consumption, except perhaps the
medical care that actually raises, rather than simply sustains the
individual's ability to work. Charitable giving, on the other hand, may
be considered to be a reduction in net worth that should be excluded
from the tax base because it does not yield direct satisfaction to
taxpayer who makes the expenditure. In this case, the tax expenditure
lies not with the individual making the charitable deduction, but with
the exclusion from taxation of the amounts received by the recipient.
There also is the issue of how to tax medical insurance premiums.
Under current law, employees do not

[[Page 354]]

have to include insurance premiums paid for by employers in their
income. The self-employed also may exclude (via a deduction) medical
insurance premiums from their taxable income. From some perspectives,
these premiums should be in the tax base because they appear to
represent consumption. Yet an alternative perspective would support
excluding the premium from tax as long as the consumption tax base
included the value of any medical services paid for by the insurance
policy, because the premium equals the expected value of insurance
benefits received. But even from this alternative perspective, the
official tax expenditure might continue to be a tax expenditure under a
consumption tax baseline because current law excludes the value of
medical services paid with insurance benefits from the employee's
taxable income.
If medical spending is not consumption, one approach to measuring the
consumption base would ignore insurance, but allow the consumer to
deduct the value of all medical services obtained. An alternative
approach would allow a deduction for the premium but include the value
of any insurance benefits received, while continuing to allow a
deduction for a value of all medical services obtained. In either case,
the official tax expenditure for the exclusion of employer provided
medical insurance and expenses would not be a tax expenditure relative
to a consumption tax baseline.
The extraterritorial income exclusion replaces the previous Foreign
Sales Corporation program. It provides an exclusion from income for
certain exports. To the extent that the program is viewed as a component
of a destination based VAT it might not be a tax expenditure. In
addition, to the extent that the exclusion reduces the income tax bias
against investment it might be consistent with consumption tax
principles (i.e., a low tax rate on capital income).
The taxation of Social Security benefits for the disabled also is
difficult to classify. As discussed in this appendix above, these
benefits generally ought to be taxed because they represent purchasing
power. However, the associated Social Security taxes ought to be fully
deductible, but they are not. Hence the proper treatment is unclear.
Moreover, if the insurance model is applied, the taxation of Social
Security benefits might be a negative tax expenditure.
The credit for low income housing acts to lower the tax burden on
qualified investment, and so from one perspective would not be a tax
expenditure under a consumption tax baseline. However, in some cases the
credit is too generous; it can give a negative tax on income from
qualified investment rather than the zero tax called for under
consumption tax principles. In addition, the credit is very narrowly
targeted. Consequently, it could be considered a tax expenditure
relative to a consumption tax baseline.
The final panel (D) shows items that are not likely to be tax
expenditures under a consumption base. Most of these relate to tax
provisions that eliminate or reduce the tax on various types of capital
income because a zero tax on capital income is consistent with
consumption tax principles.
The deduction for U.S. production activities is not classified as a
tax expenditure. This reflects the view that it represents a widespread
reduction in taxes on capital income or an offset to the corporate
income tax. In contrast to this classification, however, it would be a
tax expenditure to the extent that it is viewed as a targeted tax
incentive.
The exception from the passive loss rules probably would not be a tax
expenditure because proper measurement of income, and hence of
consumption, requires full deduction of losses.

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

Several differences between current law and a consumption tax are left
off the official tax expenditure list. Additional tax expenditures
include the imputed consumption value from consumer durables and
financial services received in kind, private gifts and inheritances
received, possibly benefits paid by insurance policies, in-kind benefits
from such Government programs as food-stamps, Medicaid, and public
housing, and benefits received from charities. Under some ideas of a
comprehensive consumption tax, the value of leisure and of household
production of goods and services would be included as a tax expenditure.
A consumption tax implemented as a tax on cash flows would tax all
proceeds from sales of capital assets when consumed, rather than just
capital gains; because of expensing, taxpayers effectively would have a
zero basis. The proceeds from borrowing would be in the base of a
consumption tax that also allowed a deduction for repayment of principal
and interest, but are excluded from the current tax base. The deduction
of business interest expense might be a tax expenditure, since under
some forms of consumption taxation interest is neither deducted from the
borrower's tax base nor included in the lender's tax base. The personal
exemption and standard deduction also might be considered tax
expenditures, although they can be viewed differently, e.g., as elements
of the basic tax rate schedule.

Negative Tax Expenditures

Importantly, current law also deviates from a consumption tax norm in
ways that increase, rather than decrease, tax liability. These could be
called negative tax expenditures. The official budget excludes negative
tax expenditures on the theory that tax expenditures are intended to
substitute for Government spending programs. Yet excluding negative tax
expenditures gives a very one-sided look at the differences between the
existing tax system and a consumption tax.
A large item on this list would be the inclusion of capital income in
the current individual income tax base, including the income earned on
inside-build up in Social Security accounts. The revenue from the
corporation income tax, or more generally a measure of the double tax on
corporate profits, also would be a negative tax expenditure.
Depreciation allowances, even

[[Page 355]]

if accelerated, would be a negative tax expenditure since consumption
tax treatment generally would require expensing. Depending on the
treatment of loans, the borrower's inability to deduct payments of
principal and the lender's inability to deduct loans might be a negative
tax expenditure. The passive loss rules and NOL carry-forward provisions
also might generate negative tax expenditures, because the change in net
worth requires a deduction for losses (consumption = income--the change
in net worth). If human capital were considered an asset, then its cost
(e.g., certain education and training expenses, including perhaps costs
of college and professional school) should be expensed, but it is not
under current law. Certain restrictions under the individual AMT as well
as the phase-out of personal exemptions and of itemized deductions also
might be considered negative tax expenditures. Under some views, the
current tax treatment of Social Security benefits paid to the disabled
would be a negative tax expenditure.

REVISED ESTIMATES OF SELECTED TAX EXPENDITURES

Accelerated Depreciation

Under the reference tax law baseline no tax expenditures arise from
accelerated depreciation. In the past, official tax expenditure
estimates of accelerated depreciation under the normal tax law baseline
compared tax allowances based on the historic cost of an asset with
allowances calculated using the straight-line method over relatively
long recovery periods. Normal law allowances also were determined by the
historical cost of the asset and so did not adjust for inflation,
although such an adjustment is required when measuring economic
depreciation, the age related fall in the real value of the asset.
Beginning with the 2004 Budget, the tax expenditures for accelerated
depreciation under the normal law concept have been recalculated using
as a baseline depreciation rates and replacement cost indexes from the
National Income and Product Accounts. \30\ The revised estimates are
intended to approximate the degree of acceleration provided by current
law over a baseline determined by real, inflation adjusted, and economic
depreciation. Current law depreciation allowances for machinery and
equipment include the benefits of a temporary expensing provision. \31\
The estimates are shown in tables in the body of the main text, e.g.,
Table 19-1.
---------------------------------------------------------------------------
\30\ 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.
\31\ 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.
---------------------------------------------------------------------------
The revised tax expenditure estimates differ substantially from
estimates calculated under the old methodology. In general, the new tax
expenditure estimates are smaller than the old estimates. \32\ In part,
this is because the new baseline uses depreciation allowances that are
faster than those in the old baseline. In addition, the new baseline
calculates depreciation on a replacement cost basis rather on the
historic cost basis previously used; this translates into larger
depreciation allowances to the extent that asset prices rise over time.
In many years the new tax expenditures are negative, indicating that
current law's tax depreciation allowances are smaller than those implied
by economic depreciation. Because these estimates are on a cash flow,
rather than a present value, basis, the negative value does not
necessarily indicate that tax depreciation is decelerated relative to
economic depreciation over the life of an investment. Even when tax
depreciation is accelerated over the life of an investment, negative
annual cash flow estimates could obtain in the later years of an
investment's economic life. This type of vintage effect contributes
importantly to the negative tax expenditures calculated for equipment in
2006-2010 because the temporary expensing provision expires at the end
of 2004. Calculations that compare the present value of tax depreciation
(without the temporary expensing) with the present value of inflation
indexed economic depreciation over each investment's economic life show
that for many types of assets tax depreciation is accelerated, but only
slightly, assuming a moderate rate of inflation. \33\
---------------------------------------------------------------------------
\32\ Estimates under the old methodology are no longer shown in the
tables.
\33\ U.S. Department of the Treasury, Report to the Congress on
Depreciation Recovery Periods and Methods (Washington, D.C.: U.S.
Government Printing Office, July, 2000), p. 32.

---------------------------------------------------------------------------
Owner-Occupied Housing

A homeowner receives a flow of housing services equal in gross value
to the rent that could have been earned had the owner chosen to rent the
house to others. Comprehensive income would include in the homeowner's
tax base this gross rental flow, and would allow the homeowner a
deduction for expenses such as interest, depreciation, property taxes,
and other costs associated with earning the rental income. Thus, a
comprehensive tax base would include in its base the homeowner's
implicit net rental income (gross income minus deductions) earned on
investment in owner-occupied housing.
In contrast to a comprehensive income tax, current law makes no
imputation for gross rental income and allows no deduction for
depreciation or for other expenses, such as utilities and maintenance.
Current law does, however, allow a deduction for home mortgage interest
and for property taxes. Consequently, relative to a comprehensive income
baseline, the total tax expenditure for owner-occupied housing is the
sum of tax on net rental income plus the tax saving from the de

[[Page 356]]

duction for property taxes and for home mortgage interest. \34\
---------------------------------------------------------------------------
\34\ The homeowner's tax base under a comprehensive income tax is net
rents. Under current law, the homeowner's tax base is-(interest +
property taxes). The tax expenditure base is the difference between the
comprehensive income base and current law's tax base, which for
homeowners is the sum of net rents plus interest plus property taxes.
---------------------------------------------------------------------------
Prior to 2006, the official list of tax expenditures did not include
the exclusion of net implicit rental income on owner-occupied housing.
Instead, it included as a tax expenditure deductions for home mortgage
interest and for property taxes. While these deductions are legitimately
considered tax expenditures, given current law's failure to impute
rental income, they are highly flawed as estimates of the total tax
advantage to housing; they overlook the additional exclusion of implicit
net rental income. To the extent that a homeowner owns his house
outright, unencumbered by a mortgage, he would have no home mortgage
interest deduction, yet he still would enjoy the benefits of receiving
tax free the implicit rental income earned on his house. The treatment
of owner-occupied housing has been revised in the 2006 budget, which now
includes an item for the exclusion of net rental income of homeowners.
\35\
---------------------------------------------------------------------------
\35\ This estimate combines the positive tax expenditure for the
failure to impute rental income with the negative tax expenditure for
the failure to allow a deduction for depreciation and other costs.
---------------------------------------------------------------------------
Appendix Table 3 as well as the Tables in the body of the main text,
e.g., Table 19-1 show estimates of the tax expenditure caused by the
exclusion of implicit net rental income from investment in owner-
occupied housing. This estimate starts with the NIPA calculated value of
gross rent on owner-occupied housing, and subtracts interest, taxes,
economic depreciation, and other costs in arriving at an estimate of
net-rental income from owner-occupied housing. \36\
---------------------------------------------------------------------------
\36\ National Income and Production Accounts, Table 2.4.

---------------------------------------------------------------------------
Accrued Capital Gains

Under a comprehensive income baseline, all real gains would be taxed
as accrued. These gains would be taxed as ordinary income rather than at
preferential rates. There would be no deferred unrealized gains on
assets held at death, nor gains carried over on gifts, or other
preferential treatments. Indeed, all of the provisions related to
capitals gains listed in the tax expenditure budget would be dropped.
Instead, in their place the difference between the ordinary tax on real
gains accrued and the actual tax paid would be calculated. For 1999, for
instance, the tax on real accrued gains on corporate equity is estimated
at $594 billion. This compares to an estimated tax on realized gains of
$62 billion, for forgone revenues of $562 billion. However, this forgone
revenue may easily turn into a revenue gain given the limits on capital
losses. For 2000, for instance, real accrued losses in corporate equity
amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion
in capital gains taxes. This roughly translates into an overpayment of
taxes to the tune of $464 billion.

Double Tax on Corporate Profits

A comprehensive income tax would tax all sources of income once. Taxes
would not vary by type or source of income.
In contrast to this benchmark, current law taxes income that
shareholders earn on investment in corporate stocks at least twice, and
at combined rates that generally are higher than those imposed on other
sources of income. Corporate profits are taxed once at the company level
under the corporation income tax. They are taxed again at the
shareholder level when received as a dividend or recognized as a capital
gain. Corporate profits can be taxed more then twice when they pass
through multiple corporations before being distributed to noncorporate
shareholders. Corporate level taxes cascade because corporations are
taxed on capital gains they realize on the sale of stock shares and on
some dividend income received. Compared to a comprehensive income tax
current law's double (or more) tax on corporate profits is an example of
a negative tax expenditure because it subjects income to a larger tax
burden than implied by a comprehensive income baseline.
Appendix Table 3 provides an estimate of the negative tax expenditure
caused by the multiple levels of tax on corporate profits. This negative
tax expenditure is measured as the shareholder level tax on dividends
paid and capital gains realized out of earnings that have been fully
taxed at the corporate level. It also includes the corporate tax paid on
inter-corporate dividends and on corporate capital gains attributable to
the sale of stock shares. The estimate includes the reduction in the
dividends and capital gains tax rates enacted in JGTRRA.
The negative tax expenditure is large in magnitude; it exceeds $33
billion in the years 2006 through in 2010. It is comparable in size (but
opposite in sign) to all but the largest official tax expenditures.
JGTRRA reduced but did not eliminate the double tax on corporate
profits.

[[Page 357]]

Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2006
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Comprehensive Income Tax
Net exclusion of pension contributions and earnings: Employer plans.................................................................... 51,050
Net exclusion of pension contributions and earnings: 401(k) plans...................................................................... 48,140
Capital gains exclusion on home sales.................................................................................................. 36,270
Exclusion of net imputed rental income on owner-occupied housing....................................................................... 29,720
Capital gains (except agriculture, timber, iron ore, and coal)......................................................................... 28,370
Exclusion of interest on public purpose State and local bonds.......................................................................... 26,610
Exclusion of interest on life insurance savings........................................................................................ 24,070
Net exclusion of pension contributions and earnings: Keogh plans....................................................................... 9,980
Expensing of research and experimentation expenditures (normal tax method)............................................................. 7,920
Deferral of income from controlled foreign corporations (normal tax method)............................................................ 7,440
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................... 7,310
Exclusion of workers' compensation benefits............................................................................................ 5,940
Extraterritorial income exclusion...................................................................................................... 4,260
Credit for low-income housing investments.............................................................................................. 4,010
Exclusion of veterans death beenfits and disability compensation....................................................................... 3,750

B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications
Deductibility of mortgage interest on owner-occupied homes............................................................................. 76,030
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes.................................................. 34,620
Child credit........................................................................................................................... 32,810
Step-up basis of capital gains at death................................................................................................ 28,760
Exclusion of Social Security benefits for retired workers.............................................................................. 19,770
Deductibility of State and local property tax on owner-occupied homes.................................................................. 14,830
Earned income tax credit............................................................................................................... 5,423
Deduction for U.S. production activities............................................................................................... 5,420
Exclusion of Social security benefits of dependents and survivors...................................................................... 3,990

D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax
Exception from passive loss rules for $25,000 of rental loss........................................................................... 4,750
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The measurement of certain tax expenditures under a comprehensive income tax baseline may differ from the official budget estimate even when the
provision would be a tax expenditure under both baselines.

Source: Table 19-2, Tax Expenditure Budget.

[[Page 358]]

Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2006
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Consumption Base
Exclusion of net imputed rental income on owner-occupied housing....................................................................... 29,720
Exclusion of workers' compensation benefits............................................................................................ 5,940

B. Probably a Tax Expenditure Under a Consumption Base
Deductibility of mortgage interest on owner-occupied homes............................................................................. 76,030
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes.................................................. 34,620
Child credit........................................................................................................................... 32,810
Exclusion of Social Security benefits for retired workers.............................................................................. 19,770
Earned income tax credit............................................................................................................... 5,423
Exclusion of Social Security benefits of dependents and survivors...................................................................... 3,990
Exclusion of veterans death beenfits and disability compensation....................................................................... 3,750

C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care.................................................... 125,690
Deductibility of charitable contributions, other than education and health............................................................. 32,550
Deductibility of State and local property tax on owner-occupied homes.................................................................. 14,830
Deductibility of medical expenses...................................................................................................... 9,140
Deductibility of self-employed medical insurance premiums.............................................................................. 4,330
Extraterritorial income exclusion...................................................................................................... 4,260
Credit for low-income housing investments.............................................................................................. 4,010
Social Security benefits for disabled.................................................................................................. 3,870

D. Not a Tax Expenditure Under a Consumption Base
Net exclusion of pension contributions and earnings: Employer plans.................................................................... 51,050
Net exclusion of pension contributions and earnings: 401(k) plans...................................................................... 48,140
Capital gains exclusion on home sales.................................................................................................. 36,270
Step-up basis of capital gains at death................................................................................................ 28,760
Capital gains (except agriculture, timber, iron ore, and coal)......................................................................... 28,370
Exclusion of interest on public purpose State and local bonds.......................................................................... 26,610
Exclusion of interest on life insurance savings........................................................................................ 24,070
Net exclusion of pension contributions and earnings: Keogh plans....................................................................... 9,980
Expensing of research and experimentation expenditures (normal tax method)............................................................. 7,920
Deferral of income from controlled foreign corporations (normal tax method)............................................................ 7,440
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................... 7,310
Deduction for U.S. production activities............................................................................................... 5,420
Exception from passive loss rules for $25,000 of rental loss........................................................................... 4,750
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even when the provision
would be a tax expenditure under both baselines.

Source: Table 19-2, Tax Expenditure Budget.

Appendix Table 3. REVISED TAX EXPENDITURE ESTIMATES \1\
----------------------------------------------------------------------------------------------------------------
Revenue Loss
Provision ---------------------------------------------------------------------
2004 2005 2006 2007 2008 2009 2010
----------------------------------------------------------------------------------------------------------------
Imputed Rent On Owner-Occupied Housing.... 24,590 28,600 29,720 33,210 36,860 40,630 44,786
Double Tax on corporate profit \2\........ -23,730 -30,170 -29,600 -30,330 -31,540 -33,260 -35,074
----------------------------------------------------------------------------------------------------------------
\1\ Calculations described in the appendix text.
\2\ This is a negative tax expenditure, a tax provision that overtaxes income relative to the treatment
specified by the baseline tax system.